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What Are Investment Property Loans
Investment property loans are real estate property purchased to earn a return on the investment either through rental income, the future resale of the property, or both. The property owner may be an individual investor, a group of investors, or a corporation.
Investment properties can be long-term endeavors or short-term investments. Some investors will often engage in fix & flip, where real estate is bought, remodeled, or renovated, and sold at a profit within a short time frame.
The investor may also use the term property investment to describe other asset purchases for the sake of future appreciation, such as art, securities, land, or other collectibles.
Understanding Properties Investments
Property investments are those that are typically not used as primary residences. They generate some form of income—dividends, interest, rents, or even royalties—that fall outside the scope of the property owner’s regular line of business. Also, it depends on how the investor uses the property significantly impacts its value.
Investors sometimes conduct studies to determine the best and most profitable use of a property, often referred to as the property’s highest and best use. For example, suppose a zoned property investment is for both commercial and residential use. In that case, the investor weighs the pros and cons of both until he ascertains which has the highest potential rate of return. He then utilizes the property in that manner.
Investment properties are often usually referred to as second homes. But the two don’t necessarily mean the same thing. For instance, a family may purchase a cottage or other vacation property to use themselves. Someone with a primary home in the city may buy a second property in the country as a retreat for weekends. In these cases, the second property is for personal use—not as an income property.
Key Point: Property investments generate income and are not primary residences.
Different Types of Property Investments
Residential: Rental homes are a popular way for investors to supplement their income. An investor who purchases a residential property and rents it out to tenants can collect monthly rents. These can be single-family homes, condominiums, apartments, townhomes, or other types of residential structures.
Commercial: Income-generating properties don’t always have to be residential. Some investors—especially corporations—purchase commercial properties explicitly used for business purposes. Maintenance and improvements to these properties can be higher, but more significant returns can offset these costs. That’s because these leases for these properties often command higher rents. These buildings may be commercially-owned apartment buildings or retail store locations.
Mixed-Use: A mixed-use property can be used simultaneously for both commercial and residential purposes. For instance, a building may have a retail storefront on the main floor, such as a convenience store, bar, or restaurant, while the upper portion of the structure houses residential units.
Important Investing Facts
- An investment property is purchased to earn a return through rental income, the future resale of the property, or both.
- Properties can represent a short or long-term investment opportunity.
- Investment properties are not primary residences or second homes, making it harder for investors to secure financing.
- Selling an investment property must be reported, resulting in capital gains, which can have some tax implications for investors.
Investment Property Financing
Borrowers who secure a loan for their primary residence have access to various financing options. These include FHA loans, VA loans, and conventional loans. It can be more challenging to procure financing for an investment property.
Insurers do not provide mortgage insurance for investment properties. As a result, borrowers need to have at least 20% down to secure bank financing for investment properties.
Banks also insist on good credit scores and relatively low loan-to-value ratios before approving an investment property borrower. Some lenders also require the borrower to have ample savings to cover at least six months’ worth of expenses on the investment property. Thereby ensuring the mortgage and other obligations will be kept up to date.
Investment Property Tax Implications
Suppose an investor collects rent from an investment property. In that case, the Internal Revenue Service (IRS) requires him to report the rent as income. However, the agency also allows him to subtract relevant expenses from this amount. For example, suppose a landlord collects $100,000 in rent over a year but pays $20,000 in repairs, lawn maintenance, and related expenses. In that case, he reports the difference of $80,000 as self-employment income.
Suppose an individual sells an investment property for more than the original purchase price. In that case, he has a capital gain, which then he must report to the IRS. As of 2020, capital gains on assets held for at least one year are considered long-term gains. Taxed at 15%, except for married and filing jointly and have taxable income exceeding $496,600 or single have income exceeding $441,450. In these cases, the rate is 20%.
In contrast, if a taxpayer sells his primary residence, he only has to report capital gains over $250,000 if he files individually and $500,000 if he is married and filing jointly. The capital gain on an investment property is its selling price minus its purchase price minus any significant improvements.
To illustrate, imagine an investor buys a property for $100,000 and spends $20,000 installing new plumbing. A few years later, he sold the property for $200,000. After subtracting his initial investment and capital repairs, his gain is $80,000.
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