Investment properties, also known as non-owner occupied properties, can be very profitable for casual homeowners and real estate investors alike. While there is no guarantee that you’ll be successful, extensive research and the right timing could result in a tidy profit.
That said, it’s important to know the demographics for a particular neighborhood, and whether the market is set to improve or decline in the near and long term. It’s equally important to find a tenant to rent out your property to ensure you’ll achieve positive cash flow immediately.
Achieving Positive Cash Flow
While it’s not imperative, positive cash flow will allow you to invest in other properties by minimizing losses and out-of-pocket expenses, which will keep your DTI ratio low. It’s also quite important if the property you buy isn’t expected to increase in value significantly.
Cash flow isn’t as important if the property is expected to surge in value, but finding a property on the cheap with the potential to appreciate is the ultimate goal.
Discovering that “hot property” is often the impetus for real estate investment. But always take your time to investigate before diving in. Certainly pay attention to local area rents to determine if buying makes more sense than renting. If the price-to-rent ratio is considerably favorable, it could be a no-brainer.
And take special care when investing out of state, and especially out of the country. If you plan on buying an investment property in Mexico or Spain, do your research and make sure you’ve got a good understanding of the laws of the land. Ensure you’re working with a reputable broker or builder. Ask for references!
Obtaining Financing on an Investment Property
The next hurdle is obtaining financing on an investment property. Even if you’re familiar with how mortgage works, it’s important to understand the restrictions tied to investment properties as they often differ from owner-occupied properties and second homes.
If you plan on buying an investment property, be prepared to put some money down, usually 20% or more. The days of 100% financing on investment properties is a thing of the past because banks and lenders incurred heavy losses from massive defaults and mortgage fraud.
All that speculation during the previous boom led to widespread strategic default, with investors cutting their losses on properties they had very little if anything invested in.
Today, you may even need to put 30% or more down on an investment property depending on your credit profile, documentation type, and the value of the property.
Another hitch is that gifts for down payment are not allowed on an investment property, for obvious reasons. One way around this is to occupy the property first and then rent it out in the future.
Also note that many exotic mortgage programs such as option-arms limit financing on investment properties to 80% or less for the most part, so be prepared to come in with more cash if you’re looking for an ultra-low start rate or negative amortization.
Lender Restrictions on Non-Owner Occupied Homes
Now comes the trickier stuff. Most lenders don’t like to lend to investors with over 10 investment properties. And many lenders have a limit to how much they will finance, so if you’ve got two loans with a certain bank or investor, they may not be able to provide financing on a third property if you’re over their aggregate financing limit.
Additionally, if you plan on buying an investment property within a condominium complex, note that investor concentration usually cannot exceed 50 percent. This means at least half of the units need to be owner-occupied. And if it’s a new development, usually at least 50 percent needs to be sold and closed before many lenders will provide financing.
Most lenders also limit the total percentage of a complex owned to 10 percent by a single entity, so if there are only 10 units, you can typically buy just one.
Of course, these rules vary from bank to lender, and often developers will provide special financing on site to new investors. But these issues can and often do arise, preventing investors from obtaining favorable financing terms.
So do your financing homework and obtain pre-approvals before making an offer or jumping into a contract. And be prepared to show up to the signing table with a hefty down payment or you’ll likely be out of luck.
Lastly, an important note about mortgage rates. Many investors forgo mortgage financing and simply purchase investment properties with cash. But not everyone has deep enough pockets to do that.
If you do plan to finance your non-owner occ property with a mortgage, expect sizable pricing adjustments for both occupancy type and multiple units, if applicable.
In other words, if you purchase a NOO 4-unit property, expect your closing costs and/or mortgage rate to be significantly higher compared to an owner-occupied single-family residence.
That’s the price of risk; investment properties inherently carry more risk and are priced accordingly. Yet another reason most investors try to buy with cash instead.