Investment Property

Updated on April 26, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Investment Property?

Investment Property refers to the real estate property acquired to earn returns on the investment in the form of rental income, royalties, dividends or future appreciation and is not a primary residence of the investor.  Such properties may be in the name of an individual investor, a group of investors or an investment company, and it can either be a short-term or a long-term investment.

Investment Property Meaning

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In case of short-term investment, the investor often engages in flipping wherein a real estate property is purchased, renovated and then sold at a profit within a brief period. The aim is to generate a source of income for long term and build wealth. However, there are some tax implications to consider in this case.

Key Takeaways

  • Investment property is real estate that has not been purchased as the investor’s primary residence but is instead purchased to generate returns on the investment through rental income, royalties, dividends, or future appreciation. 
  • These properties may be owned by a single owner, a group of investors, or an investment firm and may be bought for short-term or long-term investment purposes. 
  • While making a short-term investment, the investor frequently flips properties, buying them, renovating them, and then quickly selling them for a profit.
  • Prominent real estate websites: Of the free options accessible, this one is the best for finding investment properties. 

Investment Property Explained

Investment property is the investment made in real estate that is a source of income in the form of rent or capital appreciation. Investors buy them not for their own persona use but to earn money and make profit. They invest in properties that they consider to give them a considerable return on investment property.
Such properties may be commercial, industrial or residential in nature that may include apartments, office spaces, warehouses, manufacturing plants, etc. The main aim is to earn profit when the value increases.
In order to earn higher return, the property is usually renovated or repositioned. However, it is necessary to carefully analyse and evaluate the worth of the property before buying an investment property.

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Features

A property has to satisfy the following conditions to be classified:

  • Held to generate income through capital appreciation or rental or both
  • Not occupied by the owner;
  • Not employed in the owner’s ordinary course of business;

Types

It can be primarily classified into the following three types:

Investment Property

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  1. Residential: These are rental homes that are one of the most popular ways for investors to earn some additional income. Basically, the investors purchase residential properties, rent it out to tenants and earn monthly rentals. These properties can be either single-family homes, apartments, condominiums, townhomes etc.
  2. Commercial: These are properties that are usually used as office spaces, shops etc. The investors purchase commercial properties and rent them out for business purposes. The rentals, as well as the maintenance expenses, are higher as compared to residential properties. These properties can be apartment buildings, retail store etc.
  3. Mixed-use: These properties are simultaneously used for both residential and commercial purposes. These properties may have a retail storefront on the ground floor and residential units on the upper floors.

Example

Let us take the example of David, who purchased a property in the city for $500,000 five years back. During this period, he rented out the property to a couple at $25,000 per annum. At the end of the five years, the couple decided to buy the property for themselves, and they agreed to pay David a sum of $650,000 for the house. During the 5 years, David had to spend $20,000 for maintenance and repair. Determine the profit earned by David on this investment property.

Solution:

Given,

  • Purchase price = $500,000
  • Maintenance and repair expenses = $20,000
  • Rental income = $25,000 * 5 = $125,000
  • Sale price = $650,000
Investment Property Example 1

Now, the profit earned by David can be calculated as,

Profit = (Sales Price + Rental Income) – (Purchase price + Maintenance and Repair Expenses)
Investment Property Example 1-1
  • = ($650,000 + $125,000) – ($500,000 + $20,000)
  • = $255,000

Therefore, David made of a profit of $255,000 over a period of five years.

Strategies

Before buying an investment property, it is necessary to see whether the investment properties exhibit some (if not all) of the following features:

  • High rental yield and yet affordable for tenants;
  • Low maintenance expenses along with the adequate quality of amenities;
  • The low purchase price, which may be possible in case of booking during the project launch;
  • Sites situated in prime locations;

How To Buy?

One can use the following channels to identify good investment –

  • Real Estate Agent: These agents can be of great help as they have access to off-market investment properties via pocket listings, where the brokers or real estate agents hold exclusive right to sell the subject properties that have not been posted anywhere else.
  • Local Wholesalers: They can be a valuable source of off-market. These local wholesalers are real estate investors who negotiate exclusive right to buy the properties with the sellers and then sell that contract to a buyer at a higher price, thus booking the difference in price as profit.
  • Popular Real Estate Websites: This is one of the most effective of the available free routes to find investment properties. The interested investors can search online at various real-estate specific websites, such as Craigslist, Zillow etc. and shortlist properties according to their preferences.
  • Courthouse Auctions: These courthouse auctions can be another great option to find investment properties, that too at an attractive price. These properties are usually part of tax sale or foreclosure and are required to go through public auctions. Typically, these properties are available at a price that is far below the market value.

Benefits

Let us look at the benefits of investing in such properties.

  • Capital Appreciation – The real estate properties tend to offer high appreciation over a period of time. The value to properties increase and they give a high return on investment property a few years down the line.
  • Investment diversification – This kind of investments allow investors diversify their portfolio, and in the process reduce the risk of loss. Even though other avenues of investment may provide a negative return at a certain point of time due to various reasons, properties always appreciates to a considerable extent, thus covering the loss in other investments.
  • Cash flow – This provides good cash flow and a source of steady income source that is used to cover various expenses and earn profit.
  • Tax benefits – The investment property mortgage provides some tax benefits to the investor because it helps to reduce the loan interest or property tax.

Limitations

Property can be a very good source of income for investors but it also has some potential limitations or risks as given below:

  • Initial investment is high – The investment property mortgage requires a significant amount as initial investment which includes the down payment, the expenses related to renovation or repairs, the closing cost, etc, which makes the procedure very expensive and sometimes unaffordable for many investors.
  • Some fixed expenses – The investor has to incur some particular expenses like repair, property tax, management fee, insurance, etc that are ongoing and cannot be avoided. But these expenditures reduce the income from the property.
  • Tenant problems – If the property has tenants, they may delay rent payments, damage or misuse property or create problems that may lead to legal disputes.
  • Illiquid investment – Putting money in a property means that fund will be blocked till the property is sold again, which is not an easy process. Thus, a real estate property cannot be converted into cash easily.
  • Volatility in market – Some economic or political conditions in the country may lead to fluctuation in real estate prices. This may affect the appreciation in value of the property.
  • Changes in rules – Any change in the laws and regulation related to real estate will affect the value of it. In that case even the income generated can be affected.

Thus, such an investment should be done after carefully considering the rewards and risks. The investor should take the help of advisors who are experts in this investment field who will assess the investor’s risk profile and then advice on the same.

Investment Property Vs Second Home

Let us look at the differences between them.

  • The former is a property purchased fro getting income in the form of rent or appreciation in value after sale whereas the latter is a property that is purchased for personal use.
  • In investment property financing, the down payment needed to purchase the property for investment purposes may be higher than what is paid to buy a home for personal purposes.
  • Lenders may seek investors with better credit rating and financial condition in case of investment property financing rather than second home.
  • Second home is less risky from the lender’s point of view because borrowers tend to pay off the loan of property that they want to use for personal purpose earlier than the one that they take for investment purpose.

Thus, the above are the differences between investment in property and homes for personal use.

Frequently Asked Questions (FAQs)

Are investment property taxes deductible?

Yes, investment property taxes are generally deductible. In addition, as an investment property owner, one can typically deduct property taxes paid on the property as an expense when calculating your taxable income. Hence, this deduction is claimed on the income tax return and can help reduce the overall tax liability.

Is investment property depreciated?

Yes, investment property is typically depreciated for tax purposes. Depreciation is a tax deduction that allows property owners to recover the cost of their investment property over its useful life. It recognizes that properties generally have a limited lifespan and experience wear and tear over time, decreasing value.

Does investment property count as income?

Yes, investment property can generate income for the property owner. The revenue generated from investment property is commonly referred to as rental income.

Recommended Articles

This article has been a guide to what is Investment Property. We explain how to buy them and the strategies, differences with second home, examples & benefits. You may learn more about financing from the following articles –