What is an Income Property?
An income property refers to a piece of real estate that is purchased or developed primarily to earn income by renting or leasing it out to others, with a secondary goal of price appreciation. Income properties, a subset of investment properties, can be either residential or commercial.
Investors must consider several factors—such as interest rates and the housing market environment—before purchasing an income property, as there are unique risks associated with this type of investment.
Key Takeaways
- Income Generation: An income property is purchased or developed to earn income by renting or leasing it out to others, or through price appreciation.
- Diverse Types: Income properties may be both commercial and residential.
- Owner’s Financial Preparedness: Owners should maintain a financial cushion to cover repairs, maintenance, and other emergency costs such as property taxes.
- Risk Considerations: Investors should consider the risks including interest rates, housing market conditions, and tenant-related issues.
Understanding Income Properties
Income properties can be a valuable investment for various reasons. They offer an alternative to standard market investments in stocks and bonds, and provide the security of real property with many benefits of investment diversification. Investing in real estate for income requires a broad range of considerations, including interest rates and the state of the housing market, among others.
A real estate property can be an excellent long-term investment that may even provide a source of income in retirement. However, income properties require careful analysis to ensure steady cash flow throughout the life of the loan and beyond. Setting a base rate of income to rentals is often important to determine the desired rate of return (RoR). One method is by analyzing the current rental rate on similar properties in the area while factoring in the monthly payments required for the mortgage.
Due to high maintenance costs, property owners should have a financial cushion for emergency repairs, regular maintenance, and other expenses such as property taxes and utilities. It’s essential to manage cash flow and ensure that it exceeds the cost of borrowing and expenses to increase the return on investment.
Types of Income Properties
- Commercial Real Estate: Primarily used for business purposes, including office buildings, retail spaces, hotels, or mixed-use properties.
- Residential Properties: Primarily used for personal use by people other than the owner, including single or multifamily homes, condominiums, townhomes, apartments, or seasonal homes such as cottages.
Special Considerations
Income properties may be part of primary residences or additional properties owned by an investor. In some cases, homeowners rent out part of their home—such as a basement or upper level—to produce income while living there, known as an owner-occupied income property, meaning both the owner and the tenant live in the same property.
A non-owner-occupied property, on the other hand, is purely retained for income-producing purposes and is only used by tenants or lessees. Residential income properties are commonly referred to as non-owner occupied.
Income Property Mortgages
Investors usually need to be approved for a mortgage loan to purchase an income-generating property. Stable incomes and high credit scores are typically required to qualify for a loan, such as a conventional bank loan. The lender reviews the borrower’s credit application through an underwriting process to determine loan terms such as interest rate, principal value, and duration.
Flipping as an Income Strategy
Flipping is another investment strategy for many real estate investors. With fix-and-flip properties, owners renovate a property to sell it at a higher value, covering loan and renovation costs and generating an immediate return. This method includes higher risks than conventional income property ownership but offers a lump sum payout at resale. Various resources such as fix-and-flip loans and online debt crowdfunding platforms can support these investments, offering shorter-term, higher interest rate loans.
Advantages and Disadvantages of Income Properties
Benefits
- Diverse Investment Portfolio: Income properties provide diversity to an investment portfolio, spreading risk across different investment vehicles.
- Income Generation and Security: They generate income, offering financial security and savings for retirement.
Drawbacks
- Management Effort: Managing income properties requires substantial time, effort, and money. Dealing with tenants can lead to additional repairs, legal challenges, and court costs if eviction is necessary.
- Property Management Costs: If unable to self-manage, property owners may need to hire property management services, incurring extra costs.
Related Terms: investment property, rate of return, mortgage, commercial real estate.
