What is an investment property?

Most people understand that purchasing property is an investment in their future. Property values tend to increase over time, so if you own a home, it’s likely you will be able to sell that home for a profit later on.

There are ways to maximize property value to create revenue for yourself. Real estate can be an investment. You can buy an investment property to diversify your portfolio, generate streams of income and to make a profit.

What is investment property in real estate?

Investment property is a piece of land or a building that is bought with the intention of producing a financial return, as opposed to personal use or occupation by the owner. This return can come in the form of rental income or from appreciation, as land and property historically tend to gain value over time.

Investment properties can be residential or non-residential. You might buy property to rent out as studio or office space or storage, or you might purchase a home that can be rented to someone else. If your investment property is a multi-family dwelling, you might even be able to live there and generate rental income at the same time.

Some people invest in property in a less physical way: Rather than buy actual buildings, they invest in financial vehicles like a real estate investment trust (REIT), master limited partnership (MLP) or real estate limited partnership (RELP) that allows them to purchase a share of an income-generating property or properties with other investors. Some of these trade on public stock exchanges; others are found on crowdfunding platforms. While these “passive” real estate investments can bring high returns — and avoid the hassle of building management — they also can be complicated and carry significant risk.

What are types of investment property?

There are different types of properties that can be purchased as an investment. What will work best for you will depend on how you would like to use the property and generate income from it.

Second home

If you already own a home, purchasing a second home offers the opportunity to utilize one of them as an investment property. The home can be rented out or used for a shorter-term dwelling through platforms like Airbnb. The home may also appreciate in value over time and can be sold for a profit later.

Duplexes

Duplexes are common investment properties because they allow the owner to rent out one unit while living in the other, if they choose. Or, both units in a duplex could be rented to generate more income.

Accessory dwelling units

Accessory dwelling units, sometimes called ADUs, are secondary dwellings that exist on the same lot as the primary residence: a basement apartment, detached guesthouse, converted garage, or attached wing with its own entrance. These can be rented out to generate income, though they cannot be sold separately from the main home.

Apartment buildings and multi-family dwellings

Apartment buildings with multiple units that can be rented out often make for good investment properties. In some cases, the owner of the property may live in one of the apartments.

House hacking

House hacking traditionally refers to renting out part of your home in order to generate income. This may mean converting the basement into a rental space or renting out a room in your home to someone else, either for short-term or long-term stays.

Flipping homes

If you have the ability and know-how to buy and fix up a property, house flipping can generate revenue. The process of flipping a home requires buying a property, making improvements to it, and then turning around and “flipping” the property (quickly, within a year or so) by selling it for more money that you put into it. It is faster than waiting for a property to appreciate over time, but carries more risk.

Land

Instead of owning a building, you can choose to buy raw land as investment property. Land is always in demand, eventually, and you might be able to sell a plot that you purchased to someone looking to build, either residential or commercial structures.

Commercial buildings

Residential properties are not the only option for investment properties. You can also invest in commercial buildings, which you can rent out to businesses, for offices, stores or restaurants.

How to find and buy investment property

If you have purchased a home before, you are familiar with the process of searching for a property. In many cases, you can use the same sites and services that you used for that process to find potential investment properties. Multi-family dwellings, duplexes and other potential investment properties are often listed on MLSs and you can use filters that help you narrow your search to find them.

You can also find investment properties on sites that specialize in this space. Commercial properties are searchable on platforms like LoopNet. Find potential properties by searching sites like PropertyShark or RealtyTrac, which offer a huge selection of properties that are available for sale, including at auction or via foreclosure. Even the federal government is a source, as it regularly auctions off HUD homes it has taken over, after the original owners defaulted on their mortgages.

If you would like to work with a professional, consider hiring an agent who specializes in investment properties. You may be able to find agents who are familiar with the multi-family housing options in your area or who work in commercial real estate. Real estate brokers can also help you find these properties.

Financing investment property

Once you have found an investment property, you will have to go through the process of applying to purchase it and securing financing for it. This process can be similar to that of securing a mortgage for a home, but there are some differences.

In most cases, lenders will want you to put down more money and have a strong financial history to fall back on. Investment properties have a higher rate of foreclosure, so lenders are less likely to want to take a risk on a borrower with blemishes on their record or little money to put down for a down payment.

There are other costs that you will have to consider for an investment property, as well. If you are planning on renting part or all of the property, you’ll need landlord insurance to protect your asset — regular homeowners insurance may not cover it (or cover it sufficiently). If you are getting into commercial property, you’ll need a special insurance policy for that, as well. You’ll also want to factor in the cost of repairs and renovations, as they are inevitable.

Pros and cons of investment property

Pros:

• Make money: Investment properties provide solid returns, either through monthly rent or long-term appreciation. Real estate has traditionally been a reliable source of income in particular.
• Diversify your investments: As a different type of asset from stocks or bonds, real estate provides a portfolio with diversification, which reduces investment risk. Tangible assets like property often act as a counterbalance to “paper” ones like securites, rising in value when the others decline.
• Tax benefits: Owning property comes with additional tax benefits and deductions that help cover the cost of depreciation and other expenses.

Cons:

• Ownership challenges: Managing and maintaining a property can be a time-consuming task. You can hire help, of course, but that’ll be an expense that cuts into profits.
• Extra costs: Repairs, remodels, replacements and any other expenses that a property may need over its lifetime all fall on you.
• Illiquidity: Owning property ties up a considerable amount of money that cannot be accessed until you sell the investment. And selling a building takes much longer than unloading mutual funds or stock shares.

Final word

Investment properties offer you the opportunity to make money, either through rental income or through appreciation. They can be a reliable source of income, but owning second homes, buildings or land will also tie up your assets; they’ll require time to manage and time to sell. Happily, the variety of real estate opportunities out there ensures that, should you want to plunge into property, you’re bound to find an investment that works well for you and your personal finances.