By Jeff Detwiler, President and Chief Operating Officer, The Long & Foster Companies

Homeowners who have experienced the benefits of recent price appreciation may be considering expanding their real estate holdings and purchasing a vacation home or investment property. While real estate values change over time, prices rose about 5.5 percent in 2014¹. The industry also predicts home prices will grow another 4 to 5 percent in 2015², which makes housing looks like a good bet right now. It’s important to remember, though, that real estate investing is highly local and requires professional guidance to make wise decisions about which property to buy, how to finance the purchase and how to manage tenants or short-term rentals.

While both real estate and stock market investing are impacted by the economy, an investment in real estate may bring steady cash flow from rental income and tax benefits. Real estate investments also offer a tangible asset for individuals—an actual home in which they could live, if necessary. Additionally, would-be investors can use leverage through mortgage financing, allowing them to spend less of their own money upfront and position themselves for an increased return. While those returns may vary depending on the market, residential real estate has, from 1978 to 2004, shown an 8.6 percent annualized return.³

Financing a real estate investment property

According to the National Association of Realtors’ (NAR)2014 Investment and Vacation Home Buyers Survey,vacation-home sales accounted for 13 percent of all transactions in 2013, their highest market share since 2006. Investment purchases, which were extremely high during the foreclosure crisis, dropped from 24 percent in 2012 to 20 percent in 2013.

Whether you’re contemplating a vacation property or an investment home, you need to consider how you’ll pay for it. Mortgage financing for a second home typically requires a higher down payment than a first-home purchase, so you’ll need funds to make a down payment of at least 20 percent or more. According to NAR’s survey, 46 percent of investment buyers paid all cash for their properties in 2013 along with 38 percent of vacation-home purchasers. Buyers who financed their investment homes typically made a down payment of 26 percent and vacation-home buyers put 30 percent down.

In addition, you’ll need the funds for the related taxes and insurance, as well as to maintain and repair the property over the long-term. If you plan to rent your vacation home or investment property to offset the cost, your lender may be willing to include some of the potential rent as part of your loan qualifications depending on whether the home has a history of steady tenants. Be sure you allocate funds to pay the mortgage yourself during months when your property is vacant, as well as to cover your ongoing taxes and insurance fees.

Vacation home or investment property – which works for you?

According to NAR’s survey, lifestyle factors remain the primary motivation for vacation-home buyers, while rental income is the main factor in investment purchases. If you’re looking for a vacation home you’ll need to decide how often you intend to use the property and whether you want to rent it to other vacationers to generate income. If you opt to rent, you may want to look into hiring a property management company to vet tenants, take care of maintenance and handle payment issues. The same goes for investment properties.

Buy and hold or buy and flip

If you’re focused on buying an investment property, you’ll need to decide whether you’re interested in making some quick money or want long-term rental income. NAR’s survey showed that most investors last year were looking for income, but some still prefer to find a low-priced or distressed property, make improvements and then sell it for a profit. Now that there are fewer distressed properties, it can be tough to find a house that you can buy at a low price and sell high, but if you work with a professional Realtor who knows your market well, it’s a possibility. You’ll need a good idea of the cost of home improvements and how fast homes are selling in your area to evaluate a potential deal.

If you’re looking for rental income, you’ll still need to search for a property with a reasonable price and then compare it with market rents for similar properties. When you’re searching for a rental property that will generate a good return on your investment, look for features that appeal to typical renters in your area such as access to public transportation, recreational amenities or nightlife for a condo or small home that will attract young people. If you’re investing in an area that attracts families, check out the school district, too. Evaluate demand for rentals in the area to be sure you’ll be able to keep the property occupied as much as possible. Some investors choose to work with a property management company to do a background and credit check on potential tenants, help maintain the property and make sure the rent and utilities are paid. Fees for a property management company’s services depend on how many properties you own and are negotiable, but they typically range from 6 percent to 10 percent of the monthly rent.⁴

Insurance considerations for your investment property

When you buy a second home, you should also consider home insurance costs, which vary according to numerous factors, from the property location and to how often it’s occupied. Tax treatment for second homes depends on whether you’re using the home yourself or renting it occasionally or constantly. Consult a tax advisor to understand the implications of the purchase.

If you’ve made the decision to expand your real estate investment portfolio, Long & Foster Real Estate offers multiple divisions that can help you find, finance and insure home, as well as a property management division that can help you find tenants and maintain your property. Representatives of Prosperity Home Mortgage and Long & Foster Insurance are available in most Long & Foster offices in the Mid-Atlantic and Northeast regions to assist prospective buyers with financing. Working with experienced professionals can make your real estate purchase a worthwhile investment.

About the author

Jeffrey S. Detwiler is president and chief operating officer of The Long & Foster Companies, parent company to Long & Foster Real Estate, the largest independent real estate company in the United States, and Prosperity Home Mortgage, LLC, a full-service mortgage banker. From extensive, neighborhood-level market information to Long & Foster’s core services companies, providing mortgage, settlement, insurance and property management services in a streamlined manner, Long & Foster offers the services necessary to make today’s real estate transactions manageable for owners and investors.

Sources

1. Based on November sales figures for 2014 and 2013, CoreLogic: “CoreLogic Reports Home Prices Rose by 5.5 Percent Year Over Year in November 2014,” Jan. 6, 2015
2. Realtor.com 2015 Housing Forecast
3. Report: Contrasting Real Estate with Comparable Investments, 1978 to 2004
4. Northern Virginia Association of Realtors Update magazine, May/June 2013

*The information contained in this article is not intended to be and does not constitute financial or investment advice.