Six Tips for First-Time Investment Property Buyers
As soon as they get their first taste of homeownership, a lot of homebuyers start to think about expanding their real estate portfolio by purchasing an investment property. Owning investment real estate, whether a small apartment building, retail center, or single-tenant property, is an excellent way to diversify your income and build wealth. However, for first-time investors, the process can be a little daunting. But with the right resources and guidance, the transition from homeowner to landlord is very achievable.
Here are six things that we say buyers should think about as they begin their real estate investing journey:
1. Know Thyself
The commercial real estate landscape is vast and varied, and different property types involve different levels of attention, risk and potential return. Before you zero in on a property, it’s important to think about what you can – and want to – invest, not only in terms of money, but also time and effort. Are you willing to fix up a property to add value and get a higher return, or do you want the safety of a stabilized asset? Will you manage the property or pay someone to do it for you? Do you want a property down the street that you can monitor, or are you willing to own something hundreds of miles away? By thinking about these questions, you can start to narrow your search. Many first-time investors start with small apartment buildings, as they tend to be easier to manage; however, depending on your goals, a single-tenant retail property, industrial building or commercial condo might be right for you.
2. Understand Financing Differences
There are some key differences between a residential mortgage and a commercial mortgage. Loans for investment properties generally require more equity, carry a higher interest rate and have a shorter loan term, often 10 years vs. 30 on a residential mortgage. Buyers will sometimes work directly with a bank, ideally one with which they have an existing relationship. There are also several types of loans that can be used to finance commercial property, including SBA (Small Business Administration) loans and short-term bridge loans. It can take longer to get approved for a commercial loan, so it’s important for buyers to identify their banking or mortgage relationships and begin the process early.
3. Consider Market Dynamics
A lot of market factors can impact commercial real estate. These include local zoning ordinances, rent trends, vacancy rates, and surrounding development activity. But they can also include larger industry and economic trends like employment, availability of financing, and the recent shifts we’ve seen with hybrid work and bricks-and-mortar vs. online retail. Negative trends in one area shouldn’t always discourage investors; sometimes they can provide opportunities in another area. The bottom line is the more you consider what’s happening in the market today and what could happen tomorrow, the more likely you are to make a smart investment.
4. Plan for Hidden Costs
With any real estate purchase, buyers should expect to incur additional costs beyond mortgage principal and interest, property taxes and insurance. However, most commercial properties usually involve expenses that are higher and more complex than homeownership. These can include more extensive insurance coverage, maintenance costs, repairs, property management, legal and accounting expenses, leasing and marketing costs, and potential lost income resulting from vacancies. It’s important to plan for and include all these expenses when creating a budget.
5. Understand the Tax Implications
When buying investment property, it’s also important to understand the related tax benefits and liabilities. Benefits not only include the deduction of mortgage interest but also depreciation, which is the ability to reduce the value of a commercial property over time. Both deductions can significantly lower your taxes. On the flip side are property taxes and federal and state taxes on income generated by the property. Finally, certain capital gains taxes may also need to be paid on the sale of investment property, although there is a popular rule (the 1031 exchange) that allows owners to defer those taxes if they reinvest the proceeds in another like-kind property. Be sure to consult an experienced accountant who understands all the potential tax implications of owning investment real estate.
6. Protect Yourself from Risks
Although some level of risk is involved in all real estate purchases, owning an investment property comes with its own set of unique – and potentially expensive – risks. To mitigate these risks, many investors form a limited liability corporation (LLC) to purchase property, as it provides you with protection from personal liability for the debts and obligations of your investment. When forming an LLC, you’ll want to decide on the type that fits the size and scope of your business. Additionally, if you have partners, you may need to draft an LLC operating agreement that outlines the rights and responsibilities of the members.
Overall, buying an investment property is a great way to build long-term wealth and generate passive income, but it’s important to understand the risks before diving in headfirst. With some due diligence, careful planning, and the help of a seasoned commercial broker, you can set yourself up for success as a real estate investor.
