12 Mar Are You Ready to Add an Investment Property to Your Portfolio?
by Al Meadows
Buying an investment property can be a big step in diversifying an investment portfolio, filled with risk, uncertainty and possibly even leaky faucets.
However, an investment property can also mean a regular stream of passive income, or earnings from a venture in which a person is not actively or materially involved. Even if an individual has a full-time job, he or she would welcome additional, passive income, as it does not require a large amount of effort. As such, passive income is very desirable.
So how do you know if you are ready to balance the risk of an investment property with the reward of adding a potentially high-value asset to your portfolio? Let’s have a look at some of the opportunities, challenges and considerations of purchasing an investment property.
Unless you have the cash to purchase a second property outright, expect lenders to ask you for a larger down payment (at least 20%, plus closing costs) and to offer you a higher interest rate than you might expect. This is because any incentives for first-time homebuyers, such as from a bank or federal agency, cannot be applied to second properties.
Further, lenders may have even stricter borrowing requirements, such as the necessary amount of liquid assets that you’ll have to have left over after paying the down payment and closing costs. This is because second homes, whether used as a vacation property or rental property, are seen as a greater risk to lenders. If you lose your job, become ill, are faced with a sudden, large expense, or there is an economic downturn, the lender will presume that you will stop making payments on the second property first.
However, on the flip side, the IRS has allowed owners of rental properties to take deductions on certain expenses related to their rental properties, which can make owning one an attractive proposition.
If you receive income from a rental, you may deduct mortgage interest, property tax, operating expenses, depreciation and repairs on your tax return. You can also deduct the costs of certain materials, supplies, repairs and maintenance that you make to your rental property to keep your property in good operating condition, according to the IRS.
Becoming a Landlord
Unless you hire a manager or management company to oversee the property — adding extra fees and reducing any potential passive income — you’re going to be the one your tenants call when something breaks or an issue crops up. Depending on the size of your investment property, managing the day-to-day operations could quickly spiral into a full-time job, potentially decreasing your profit margins.
Furthermore, thanks to pandemic-related mandates, tenants may skip out on rental payments or not pay at all. According to a recent study released by the Urban Institute, the apartment industry faced an estimated $60 billion in lost rent for 2020. As such, investors looking to purchase a rental property in the hopes of renting it out to residential or commercial tenants may not see a regular income stream immediately. Location, employment and economic health will be important barometers for where to buy.
Alternative Ways to Invest in Real Estate
It’s important to note that investing in real estate doesn’t necessarily mean buying a second property and renting it out for income. Nowadays, there are several other ways that investors can take advantage of the real estate markets.
For one, investors can flip properties: buying an undervalued piece of real estate and then immediately turning it around and selling it for a profit. Some investors fix and flip, where after purchase, they perform renovations on the property before selling it for a profit. The benefit of these strategies is that there are none of the headaches of being a landlord: finding and vetting tenants, worrying if they’ll pay, fixing broken fixtures and the like.
Another strategy for real estate investing is almost completely hands off: Instead of buying, renting or selling properties, investors can buy into real estate investment trusts (REITs), or companies that own portfolios of commercial real estate, including office buildings, retail spaces, apartments and hotels. Shares of publicly traded REITs can be purchased in a regular brokerage account. Investors can reap the rewards of a strong-performing real estate market without the headaches of being a landlord, relying on the investing expertise of the REIT portfolio manager to select the assets.
Even if you are certain you are ready to take the leap into buying an investment property, having a trusted team of wealth advisors by your side can help ensure that the type of investment you choose will help you achieve your financial goals. Gratus Capital has extensive experience helping individuals and businesses evaluate real estate investments in the Southeast and across the country. Contact us today to discuss investment properties, financing and other real estate-related investments.