Key Takeaways
- An income property is real estate bought or developed to generate income through rent or leasing. Its secondary aim is to grow in value.
- Both commercial and residential real estate can serve as income properties, each with different risk and return profiles.
- Owners must maintain a financial reserve for unexpected expenses, including repairs and property taxes.
- Income properties offer portfolio diversification yet entail risks like fluctuating interest rates and tenant issues.
- Owners may need property management services, increasing costs, if unable to self-manage.
What Is an Income Property?
An income property is a real estate investment purchased or developed to generate income through renting, leasing, or selling at a higher price. This makes them different from principal residences. Learn about the different types available, including residential and commercial properties, along with the potential benefits and risks involved in investing in them. There are also practical considerations you’ll need to understand before you invest, such as interest rates and market conditions, that can significantly influence returns and shape smarter investment decisions.
Deep Dive into Income Property Investments
Income properties can be a good investment for a variety of reasons. It offers an alternative to standard market investments in stocks and bonds. It also offers the investor the security of real property with many investment diversification benefits. Investing in real estate for income requires a broad range of considerations, including interest rates and the state of the housing market, among others.
A real estate property can be an excellent long-term investment that may even provide a source of income in retirement. But income properties require a great deal of analysis to ensure that steady cash flow is available throughout the life of the loan and beyond. Determining a base rate of income to rentals is often important in order to determine the desired rate of return (RoR). One way to do this is by analyzing the current rental rate on similar properties in the area while factoring in the monthly payments required for the mortgage.
Because the costs to maintain an income property may be high, property owners should consider having a financial cushion on which to fall back in cases of emergency. This includes being able to pay for repairs, regular maintenance, or other costs they are liable for on the building like property taxes and utilities. Managing the cash flow and ensuring that it exceeds the cost of borrowing and expenses helps to increase the return on the owner’s investment.
As mentioned above, income properties can be both commercial and residential. Income-producing commercial real estate is mainly used for business purposes such as office buildings, retail spaces, hotels, or mixed-use properties. Residential properties, on the other hand, are used primarily for personal use by people other than the owner. Residential income properties may be single or multifamily homes, condominiums, townhomes, apartments, or seasonal homes such as cottages.
Important Considerations for Income Property Owners
Income properties may be part of primary residences or additional properties owned by an investor. In some cases, the homeowner rents out a portion of their own home—say, their basement or the upper level of the property—in order to produce income while maintaining a residence there. This is called an owner-occupied income property, meaning both the owner/landlord and the tenant live in the same property.
A non-owner-occupied property is one that isn’t occupied by the owner and is purely retained for income-producing purposes. This means the property is only used by the tenants or lessees.
Fast Fact
Residential income properties are commonly referred to as non-owner occupied.
Navigating Income Property Mortgage Loans
An investor typically needs to be approved for a mortgage loan to purchase a property used to generate income. Investors interested in income-producing real estate generally need to have high credit scores and steady incomes to prove they can make monthly installment payments. For many investors, the most common type of loan for a real estate property will be a conventional bank loan.
In order to qualify, the investor needs to make a formal credit application. The bank analyzes information about the borrower through its underwriting process. An underwriter provides a loan offer with a specified interest rate, principal value, and duration based on the underwriting analysis.
Important
Most lenders want investors to have high credit scores and steady income before they approve an income property mortgage. Income property mortgages are often harder to qualify for than mortgages geared toward owner-occupied and single-family residences.
Flipping Income Properties: Risks and Rewards
Flipping is now a very common investment strategy for many real estate investors. With a fix and flip property, the income property owner believes the resale value after renovations will cover the cost of interest on the loan and renovation expenses, generating an immediate positive return when sold. This type of income property investing includes higher risks than conventional income property ownership, but it provides for a lump sum payout at the time of resale rather than over a prolonged period of time.
Several resources for fix-and-flip investors are available in the real estate market such as a fix-and-flip loan. These loans are really popular with online debt crowdfunding platforms willing to take on some of the higher risks of fix and flip investments. These loans are generally offered for shorter time periods with higher interest rates than conventional loans. With a fix-and-flip loan, the income property is used as collateral, and the owner must be prepared to buy and renovate a property to resell it within a short period of time.
Benefits and Drawbacks of Investing in Income Properties
Just like any other investment, there are distinct benefits and pitfalls to owning income properties. As mentioned above, they are great investment opportunities that can provide diversity to someone’s portfolio. This helps spread the risk across different investment vehicles. Investors are also able to generate income, providing security and savings for their retirement.
But owning an income property requires a lot of time, effort, money, and patience. For instance, dealing with tenants can be difficult at times. This can lead to additional repairs, trips to the home, and court costs if the owner needs to pursue an eviction. Furthermore, if the owner isn’t able to manage the property themselves, they may have to spend additional money to hire a property management company to do the work for them.