Real estate has traditionally been a solid investment that provides income through appreciation and rent. Individual investors buy a property or pool their resources with a group of investors. Buying an investment property is different from buying a primary residence, with tighter requirements to qualify for a loan and several factors to consider before pursuing such an investment.

What Are the Basics of Property Investing?

Yellow duplex in a tropical climate
Image via FlickrĀ by Phillip Pessar

Investing in real estate can provide income through rent and appreciation of its value. Commercial and rental property requires more financial stability and cash than purchasing a primary residence. Property investors have three main financing options: conventional bank loans, hard money loans, and home equity loans.

Conventional bank loans are similar to regular mortgages for primary residences but may require a 30% down payment instead of a 20% down payment. Borrowers go through the standard credit checks and show they can pay for their home mortgage plus the mortgage on the investment property.

Hard money loans, known to some as fix-and-flip loans, are short-term in nature. They are easier to obtain since the property secures them, but they may have higher interest rates. Lasting as little as a year, hard money loans may also have higher closing costs and origination fees.

Investors may also tap into their primary residences’ equity through a home equity loan, home equity line of credit, or refinancing. Homeowners typically can borrow up to 80% of the value of their homes.

Financing options need to be weighed against each other. Potential income and profit need to be weighted against possible risks as well. Interest and fees need to stay at reasonable rates to make real estate investment ventures profitable.

Are You Ready to Buy?

If you’re thinking about investing in real estate, there are many considerations to make sure you’re ready to make this move and qualified to make the purchase.

Check your Finances Before Getting a Real Estate Loan

Make sure you can comfortably invest. Know your budget and how much you’d have for a down payment. Determine what kind of debt load you’re comfortable carrying and consider the risks.

Qualifying to purchase real estate for investment is more complicated and requires more financial stability than buying a primary residence. Qualifications are more stringent for those who seek to rent out the property, with a minimum of 15% down payments common and inspections before occupancy by tenants. Landlords must have income available for repairs, advertising, tenant background checks, possible vacancies, and other expenses.

Take the time to research interest rates and other fees for commercial real estate. Rates likely will be higher than what buyers pay for a primary residence. Consider partnering with another investor to share the expenses and work.

Sufficient ROI is Essential

There must be sufficient return on investment (ROI) in property appreciation and rental income. ROI measures the amount of profit made as a percentage of an investment’s cost, with higher rates showing higher profitability. To calculate the ROI of a potential investment, gather preliminary data on how the investment would work.

ROI varies depending on the type of investment, with lower rates of 3% acceptable for stable rental property; other types of property call for rates above 8%, with rates of 10-12% being desirable. Increasing ROI may be indicative of increased risk, though. Estimate the net operating income by subtracting annual expenses from the annual rent amount. Operating expenses include insurance, property taxes, association fees, and maintenance. Mortgage principal and interest expenses aren’t included in the net operating expenses.

ROI is calculated by dividing the net operating income by the value of the mortgage. For example, a property with a $100,000 mortgage with a net operating income of $5,000 would have an ROI of 5%. As with any investment, consider the cost of potential issues like vacancies and unexpected repairs.

Consider Property Management

Properties need management either by the investor, a partner, or an outside property management company. Management includes recruiting and completing background checks on tenants, collecting rent, bookkeeping, and handling maintenance and repairs.

Other Key Considerations

Having the credit, income, and ability to manage investment in real estate are the basics to become qualified to take on such an investment. Look into other factors that are important in the decision-making process.

Commercial real estate and housing markets vary across cities and states, with some areas hotter than others for commercial and residential properties. Research current and predicted future demand for properties in the area you’re considering. Other investors and investment groups may have valuable insight.

Having a trusted partner to split costs and combine skill sets can increase property investment options and save money on management or maintenance. On the other side, profits are halved by having a partner. Partners also share the risks and legal liabilities.

Check local property tax rates, as rates vary by municipality. Different types of property have different property tax rates as well. Check target investment areas to see how tax rates compare and factor those taxes into investment costs.

Property management companies can handle maintenance, repairs, and tenants, but they also cut into the bottom line. Property management can be a worthwhile option depending on the situation.

Investment Real Estate Loans

Investment property loans require higher down payments than residential loans, and they may also have higher interest rates and shorter loan terms. Investors may choose conventional financing, hard money loans, or use their primary home’s equity to purchase an investment property.

Down payments are more important for an investment property than primary residences. Down payments of 15 to 25% are standard for receiving better interest rates and easier approvals.

Like regular residential mortgages, property investors should get pre-approved before they begin searching. Pre-approval is a step farther than pre-qualification, which indicates the amount buyers could potentially secure. As with residential mortgages, property investors also need to provide tax returns, W-2 income statements, and a couple of months of bank statements.

Residential and commercial real estate investments can offer a solid way to build wealth while earning income. There are different types of financing options for a property that have their advantages and disadvantages. Consider costs against potential profits as well as risks. Real estate, especially in desirable markets in high demand, can be an excellent investment for your future. If you’d like to learn more about getting a loan for an investment property, reach out to the knowledgeable team at Titan Funding today.