Recently, buying an investment property has become more popular for individual investors.
In an era marked by single-digit returns, investing in real estate has become a popular alternative for investors searching for both diversification and yield. The Yale Endowment is famous for its strategy, which has outperformed traditional stock and bond allocations for decades by allocating up to 20% of its investment portfolio to real estate.
For individual investors in particular, owning an investment property has become popular recently due in part to the number of fix-and-flip TV shows making it seem like an easy way to “get rich quick”. And it’s not all hype – owning an investment property can be lucrative with the potential to make money from steady residual income, tax benefits, and long-term appreciation.
However, buying an investment property isn’t quite as simple as the TV shows make it out to be. It is a time intensive process that can be deceptively difficult and expensive.
Purchasing an investment property isn’t a decision to take lightly and it certainly isn’t the right choice for every investor. Below we’ve outlined a few key considerations to help you determine if buying an investment property is right for you.
1. Will the investment help you meet your financial goals?
Understanding the financial goals for your portfolio will help you determine the type of investment strategy you should pursue and, as a result, the right investment property.
For those looking to grow their portfolio over the long-term, investing in a property that has the potential to appreciate over time allows for the benefit of compounding growth.
Meanwhile, investors searching for a steady residual income stream might choose to invest in a property that generates most of its return as income from rent payments. This cash can be used to supplement an annual salary or as retirement income.
Another goal of many investors to is build a tax shelter. By owning an investment property you can benefit from the property’s depreciation which can help minimize your overall taxable income.
2. What do you know about the property’s location?
People often say when it comes to investing in real estate it’s all about location, location, location. Ultimately, a property’s location can single-handedly determine its success or failure as an investment.
When considering an investment’s location, first be honest about how much you actually know and understand about the area. What are the major trends? Who lives there now and who will live there in 10 years? Is there a strong job market? How are the schools and public transportation systems? Is there other development taking place nearby? What about crime?
There are an endless number of questions to be asked. While these are all important to research, the most important question is usually… is there potential for future growth? When looking at an investment property, it’s imperative to think about what the market will look like going forward. Real estate is an asset whose value is driven by demand; generally, an area that is growing will have greater demand for all types of real estate.
3. How much management will the investment require?
Many first time investors dramatically underestimate the amount of time and energy that goes into effectively managing an investment property. Depending on the structure of the leases in place, as an owner you may be responsible for all of the maintenance of the property – think fixing broken toilets, repairing HVAC units, landscaping upkeep, and coordinating with tenants to collect rent. Alternatively, you can look for investments that only require passive management, like properties where the tenant is responsible for all maintenance (NNN properties) or you can hire someone else to manage the property for you.
Keep in mind that either of these will ultimately end up increasing costs and decreasing the overall potential return. When purchasing an investment property it is critical to consider the amount of active or passive management for which you want to be responsible.
4. What can you afford?
Essentially, what you can afford is also inherently a question of risk, because it will be impacted by how much debt you want to put on the property. More debt means you can buy a larger property with the same amount of equity, however servicing (making payments on) that debt becomes an obligation regardless of how the property itself is performing.
Depending on the condition of the property you may also want to maintain a reserve of additional money that can be used for unexpected expenses that may occur or to make repairs to the property over time. This cost along with things like property taxes and insurance will all factor into what you can afford. Traditionally, investment properties have often been viewed as an investment only available to the wealthy because of the large amount of money that is required up front to be able to purchase a property.
Investing in real estate without buying your own property
At EOG, we recognize the value of real estate as one of the strongest asset classes, but realize that direct ownership of investment properties isn’t for everyone. That’s why we’ve leveraged experienced from EOG partners to offer the first ever low-fee, diversified commercial real estate investments available directly to accredited investors, no matter where do they live.
Regardless of which avenue you decide to pursue, it is essential to evaluate and understand the risks involved in any investment and determine which approach makes the most sense for you.