If you’re a real estate investor who’s in it for the money, then it’s time to find an investment property and start investing. But first, you might want to learn why investment properties are what you’re looking for. This blog aims to delve into investment properties, what they are, what types of investments they are related to, and the advantages of investment properties in regards to financing and taxes.
What Is an Investment Property?
An investment property is a real estate property that functions as a source of income for the real estate investor. A property is considered an investment property if the main purpose of owning it is to generate money for the investor (through rental income). And while it is possible to generate money by renting out a part of your primary residence to cover mortgage payments and other property-related expenses, the nature of investment properties gives them a higher potential for making a profit than if you were to make them your primary residence.
Related: 5 Ways to Find an Investment Property
Investment Property: How to Invest
Any type of real estate investment that aims to earn the investor a profit could be applied to investment properties. Of course, before purchasing an investment property, the investor will first need to decide on the strategy that he/she is going to use in order to generate profits from his/her investment.
There are three main types of strategies that apply to investment properties in order to earn a profit:
Rental properties are investment properties that generate an income over time through the rent paid by tenants residing in the property. This is the most common type of investment property, and it is the most accessible in terms of financing, making it the best choice for beginner investors.
Related: How to Narrow Down Choices During an Investment Property Search
Selling properties is another common strategy when it comes to investment properties. There are many different routes to take when you’re intending to sell an investment property; Fix-and-flips, for example, allow an investor to purchase an investment property at a low market value due to the poor condition of the property, fix or renovate the property, and sell it back into the market at a higher value. Meanwhile, holding an investment property is a technique used for investment properties with high appreciation potential, and it revolves around purchasing an investment property for the sole purpose of selling it back at a higher market value due to appreciation after a long period of time.
Mixed investment properties is a technique that involves both renting out and selling a property. This method is very effective in certain cases, as some investment properties can be rented out for a period of time until their value increases due to appreciation before selling them back at a higher price, giving the real estate investor the chance to earn money through rental income as well as through selling the property for higher gains.
Advantages of an Investment Property: Financing
Financing an investment property is, in general, more challenging than financing a property to reside in. This is due to the higher risk level related to investment properties, and the complications that could arise if an investment property fails to generate a positive income. Homeownership mortgages, for example, sometimes require a down payment that is as little as 5% or less, while most investment property loans will require a down payment of 20%. Additionally, selling an investment property could take a long time, and if you’re renting out the property, then you might be facing periods of vacancy time during which the property won’t be generating an income for you.
In order to make sure that the property is not losing you money, you will need solid financial planning to cover all expenses that may arise during periods of vacancy without actually losing money. If, however, your property manages to attract enough tenants, your finances will be easily manageable, and the rent that you’re earning will cover your mortgage expenses in addition to any other expenses related to your investment as well as providing you with positive cash flow at the end.
Related: Investment Property Calculator for Analyzing Real Estate Investments
Of course, one of the best features of an investment property, and real estate properties, in general, is appreciation. Although real estate appreciation is not a guaranteed value for any property until it happens, a smart investor will be able to realize the appreciation potential of a property, which will further facilitate saving the investor from bad financing.
Advantages of an Investment Property: Taxes
When it comes to taxes, real estate investments have a clear advantage over other types of investment. There are several tax advantages that can be utilized to improve your real estate investment and avoid major tax expenses that are usually applied to other types of investment. Some of the best tax features that can apply to investment properties include:
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Tax Deductions
In real estate investing, you get the advantage of being able to deduct any costs or expenses of running your investment property from your taxes. This includes any major expenses such as reparations, maintenance, and property management.
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Depreciation
Depreciation, the opposite of appreciation, is the deterioration of an investment property or its components. This includes any installments in a property that have a limited lifetime, or that are expected to wear out or break after a period of time.
So, how does depreciation give you a tax advantage as a real estate investor? It is considered an advantage because depreciation is usually a registered loss on paper whether or not the loss actually happens. That means that if you install an AC for your investment property, and that AC has a life expectancy of 5 years, you get to deduct the cost of the AC over the duration of its depreciation, allowing you to effectively deduct its entire cost of tax payments without any regard to whether the AC stays functional for 5 years or more.
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Capital Gains
Capital gains are the gains you make from selling an investment property. Meanwhile, capital gain taxes are taxes that apply to the earnings that you make from selling the investment property. These taxes can be very high, reaching up to 25% of the profit that you made on the sale. There are, however, certain advantages in real estate investing that allow you to effectively avoid paying capital gain taxes, such as the 1031 exchange which gives you the opportunity to avoid or delay paying capital gain taxes if you decide to invest the money earned from the sale to make another real estate investment or buy another investment property.
Bottom Line
Investment properties are among the most common types of investment out there, and it is so for a multiple of reasons. Whether you’re in it for the ease of financing or for the tax benefits, investment properties are your step as a real estate investor towards success and financial freedom.
For this reason, Mashvisor aims to facilitate the process of finding and investing in investment properties across the US by providing investors with the tools and services needed to make the best investment decisions and make the highest value investments.