Second Home vs. Investment Property: What’s the Difference?

On January 18, 2021   /   Home Buying  
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second home investment property

By Sara Kuta

You hear these terms thrown around all the time: Second home, investment property, vacation home, rental property. But is there any real difference among them? And does it even matter what you call it?

As it turns out, there are some very big differences between second homes and investment properties, especially if you are financing it.

“Both are fantastic ways to build wealth over time by capturing the appreciation of a real asset,” says Tony Julianelle, CEO of Atlas Real Estate in Denver. However, “both come with inherent risks and expenses that should be carefully considered when making a purchase.”

As with any real estate transaction, you’ll want to do your homework and make a smart choice for your wallet, no matter which path you go down. We chatted with experts to get the scoop.

What is a second home?

A second home is just that: a second property where you and your family spend time, away from your primary home. You might also hear a second home referred to as a vacation property. You may rent it out for a few days each year on Airbnb or VRBO, but you primarily use it yourself.

Buying a second home makes financial sense if there’s one particular vacation spot you visit regularly. Why spend a fortune on hotels or Airbnb when you can own your own piece of paradise that will hopefully appreciate in value over time?

“Let’s say you live in San Francisco, but you are an avid skier in the winter and like to hike in the summer,” says Rachel Olsen, a real estate agent in California. “If you spend many weekends and vacations in Lake Tahoe, it may make sense to purchase a second home there.”

What is an investment property?

An investment property, on the other hand, is one that you purchase with the explicit intention of generating income. The investment property could be right next door to your own home, or it could be in another state—it doesn’t really matter. You’ll be playing the role of landlord, with long-term or short-term renters paying cash to stay in the home.

“Never forget that an investment property is all about the Benjamins,” says Lamar Brabham, CEO and founder of financial services firm Noel Taylor Agency. “The entire point is to turn a profit. No emotions, no affection.”

Before making an offer on an investment property, you’ll want to crunch the numbers to make sure it’s a solid investment. Similarly, consider what factors will be important to prospective tenants (e.g., access to public transportation, good schools, parking, and low crime rates).

How to finance a second home or investment property

If you’re paying cash, you can skip this section. But if you need a mortgage for your new property, you should know that financing a second home or investment property is very different from financing a primary residence. And, while mortgages on second homes and investment properties have some similarities, there are also some key differences.

  • Interest rate: You can expect to see a higher interest rate for both second homes or investment properties than for primary homes. Why? Because lenders view those transactions as riskier. If you get into a tight spot with money, you’re far more likely to stop paying the mortgage for your second/investment property than for your primary home.
  • Qualifying: Whether you’re buying a second home or an investment property, you might need to do some extra legwork in order to qualify for that second loan. Your bank may require you to prove that you have healthy cash reserves (so it knows you can afford both mortgages). It’ll take a long, hard look at your overall financial situation, so be sure everything is on the up and up before you apply.
  • Down payment: Depending on your situation and the lender, you might also need to bring a larger down payment to the table for an investment property or second home, typically 15% to 25%. Again, this is because the bank wants a bigger cushion to fall back on in case you default.
  • Rental income: If you’re buying an investment property, your lender might allow you to show that anticipated rental income will help cover the mortgage payments. However, proving how much rental income the home will generate can be complicated. Prepare to pay for a specialized appraisal that takes into account comparable rents in your area.
  • Location: Your lender may require a second home to be 50 to 100 miles away from your primary home. An investment property, however, can be anywhere in comparison to your primary home, even next door.
  • Taxes: Federal income tax rules are different for vacation homes and investment properties. Generally, you’ll treat your second home just as you would your first home when it comes to taxes—if you itemize, you can deduct the mortgage interest you paid up to a certain limit. (The rules vary if you rent out your second home for part of the year.) If you own an investment property, you get to deduct the mortgage interest, plus many of the expenses that come with operating a rental business, but you also have to report your rental income, too.

Why it’s important to not confuse the two

It’s important that you’re totally clear about the difference and not use the terms “second home” and “investment property” interchangeably. Some people try to pass off their investment property as a second home to get more favorable financing, but you should never do this.

If you lie on your loan application, you could be committing mortgage fraud, which is a federal offense.

Your lender’s underwriting team is aware of this possibility, so don’t try to pull the wool over their eyes. They’ll take the big picture into account when deciding what loan terms to offer you, says real estate attorney David Reischer.

“A single-family residence by a lake that is located in a completely different state from the borrower’s primary residence is much more acceptable to be categorized as a second home by a bank underwriter,” he says. “A multifamily-unit property with rental income in an urban area is likely to be treated as an investment property.”

Bottom line: Keep everything aboveboard, and you won’t have to worry about a thing.

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The Rookie’s Guide to Investing in Real Estate

On January 30, 2017   /   real estate investing  
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home

By: Craig Donofrio

When you wrap the covers around you at night, do dreams of townhouses, condos, ski cabins, and beach houses dance in your head? Do you fantasize about becoming the Trump of your town, but don’t know where to start in real life?

If you’ve got the dream and the capital, it’s time to start learning about the basics of investing in real estate. We’ll show you how to get the ball rolling!

Step 1: Hone your deal-hunting skills

Investment properties come in many forms: multifamily residential units, condos, single-family homes, and properties that have been converted into rentals. Finding available properties is as easy as searching real estate listings and hiring a Realtor®. The tricky part isn’t locating property investments, but figuring out which ones won’t chew up your bank account and spit it back out.

And the best way to help gauge a property’s potential—aside from seeing it with your own eyes—is to ask your agent for the unit’s financial statements. This will include what the current owner pays for maintenance, utilities, insurance, and taxes—and, if it’s already a rental unit, how much money flows in from rent.

With rental properties, receiving such paperwork from the listing agent or landlord is par for the course during the sales process; if the home isn’t yet a rental, it may be harder to get. But go ahead and ask the Realtor or home seller for whatever documentation they have to know how much the unit will be costing you per month, outside of your mortgage.

When reviewing these papers, don’t just believe everything you read. No, we’re not trying to make you paranoid. But investment veterans often call these “liar’s statements,” because they may underreport expenses and inflate rents. So as a rule of thumb, cut the income by 10% and jack up the costs by 15%, and you’ll have a better ballpark idea.

Step 2: Pick a property with potential

A property’s potential goes deeper than the home itself—literally. You’re going to want to look at the value of the land.

Jason Hartman, founder and CEO of Platinum Properties Investor Network, says he figured that out 20 years ago when he was “chasing appreciation instead of cash flow.” Now, instead, he targets low-priced land with slow appreciation and little volatility, since these properties generally have better cash flow as long-term rental properties. In other words, they’re predictable.

Hartman says to check four things:

  • Land value: Figure out this out by using the tax appraiser, a house appraiser, and an insurance company (the insurance company will insure only the house; what’s left uninsured is how much the land is worth).
  • Cash flow: If homes rent for 1% of their value a month (a $100,000 home should rent for about $1,000 a month, not $3,000).
  • Appreciation history: The market should be up “about 3% to 6% over the last couple of decades.”
  • Newsworthiness: The press isn’t writing about it. “Linear markets are boring. No one writes about Birmingham real estate,” Hartman says.

Good schools are important, too, but shouldn’t be the driving factor. “It’s about getting the best school district you can for the price of the house,” Hartman says.

Step 3: Investigate new construction, too

But wait—what are those shiny new houses over there? New builds are another investment option, and they may appear to be “safer”—that is, since they’re new, they won’t have as many potential problems, right? Not necessarily. You should vet the builder and architect of the home—buyers who don’t can be unpleasantly surprised.

“The No. 1 complaint from clients and myself is all related to the contractor,” says Joshua Jarvis of Jarvis Team Realty in Atlanta. For Jarvis, proper vetting means “driving to see the homes they’ve done and talking with their customers.”

So if you’re thinking about buying a recent development from Super Hyper Global Mega Builders Inc., venture out to see the different types of property it has built, even if that means crossing town or city lines. Talk with the people who live there and see what they think about the build quality. Were cheap materials used? Has there been any problem with the wiring? Does the household heat? Have any terraces collapsed?

If that sounds like a lot of extra legwork, it is. But there’s no such thing as easy money. You knew that, right?

Step 4: Decide if you want to be a long-distance investor or a local one

This seems like an easy decision. After all, as a rookie investor, you should plan on needing to visit your investment property on a semi regular basis; landlords will need to attend to problems, while rehab projects will need you to keep an eye on the progress to make sure there are no surprises. You could always hand off these hands-on duties to a manager in the area, but that starts to eat into your profits—and the margins on rental units can be thin already.

“It’s hard to deal with issues an hour away,” says Bruce Ailion of Re/Max in Atlanta. Recently, he had to deal with a broken furnace in one of his townhouse rentals, which is 30 miles away. The tenant, just having moved from Europe, didn’t have a car yet, so Ailion allocated money for a cab and two space heaters.

The rub? “I have space heaters in my garage we lend out when these issues arise,” he says. Coordinating efforts for repair was also a hassle. “Being five to 10 minutes away makes dealing with this a lot easier,” he adds.

But there’s one big caveat here: If you’re in a market with lots of ups and downs, look elsewhere.

“If [the investor] lives in an expensive, cyclical market, they’re a gambler. They’re a speculator,” Hartman says.

If that’s the case, head to an area that’s comfortable enough for you to visit when you need to but be conservative enough so it’s not so far away you need a plane—save those cross-country investments for when you’re confident in your investing.

Step 5: Lean on your agent’s expertise

Finally, it really is a good idea to get a Realtor or agent who knows the area. Nick Schlekeway, co-founder of Amherst Madison, a real estate company in Boise, ID, says a common mistake of rookie investors is to “view Realtors as someone to ‘open doors and write the contracts I tell them.’”

Instead, you’ll want to “seek out the services of a qualified Realtor with local market expertise” and listen to them, not just use them as a guide to where you should sign.

 

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