Building Wealth Through Income Properties
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An income property is a property bought or developed to earn income through renting, leasing, or price appreciation. Income property can be residential or commercial. Residential income properties are commonly referred to as "non-owner occupied." A mortgage for a "non-owner-occupied" property may carry a higher interest rate than an "owner-occupied" mortgage as lenders often view it as a higher risk.
Breaking Down Income Property
Income property can be a good investment for a variety of reasons. It offers an alternative to standard market investments in stock equity and company bonds. Additionally, it offers an investor the security of real property with many investment diversification benefits.
Investing in real estate for income requires a broad range of considerations. Interest rates and the housing market environment are top considerations for real estate investors. Location, rent levels, and the potential for return are usually also leading concerns for an investor seeking to buy and rent a property for income.
If after doing property due diligence an investor identifies a property they wish to invest in, then they will typically need to obtain a mortgage loan for the property. Income property investors generally need to be high-credit quality borrowers with steady incomes for which to make monthly installment payments. For many investors, the most common type of loan for a real estate property will be a conventional bank loan. This will require a standard credit application which will analyze a borrower’s credit score and credit history in the underwriting process. An underwriter will provide a loan offer with a specified interest rate, principal value, and duration based on the underwriting analysis. A down payment will typically be required and can significantly help to reduce the installment payments overall.
Rate of Capitalization
The capitalization rate, also known as the commercial real estate cap rate, is the rate of return used by CRE investors to assess the risk and potential return of an asset or property. Cap rates are usually expressed as percentages ranging from 2% to 30%. An average cap rate is typically 7% but this can vary between business sectors. When comparing investment properties, capitalization rates are commonly used. Compared to securities investments, it has a similar expected effective rate of return.
Return on Investment
A real estate property can be an excellent long-term investment that can even provide a source of income in retirement. However, income properties require a great deal of analysis to ensure that steady cash flow is available throughout the life of the loan and beyond. Thus determining a base rate of income to charge rental tenants will be important in obtaining the desired rate of return. Generally, an income property owner will need to analyze the current rate for rent on similar properties in the area while also considering the monthly payments required for the mortgage. Additionally, income property owners must also save funds each month to cover any repair and maintenance costs they are liable for on the building. Managing these cash flow balances and ensuring that the funds exceed the mortgage cost of borrowing and expenses on the property will help to increase the return on investment overall.