Real estate investing means buying property to make money, either through rental income or by selling it later for a profit

Most people start by buying a single rental property or a share of one through a real estate investment trust (REIT). You need cash for a down payment — usually 15 to 25 percent of the purchase price for an investment property, though this varies by lender — plus money set aside for repairs, vacancies, and property taxes. The other main route is buying a home to live in first, then renting it out later once you move. A third option, REITs, lets you own real estate through the stock market without buying physical property.

The path you choose depends on how much cash you have, how much time you want to spend managing tenants, and whether you want to borrow money. Each route has different tax consequences, different ongoing costs, and different ways to lose money if things go wrong.

Key Takeaways

  • Investment properties require a larger down payment than primary residences, typically 15 to 25 percent, and lenders will check your credit and income more closely.
  • You must have cash reserves beyond the down payment to cover repairs, property taxes, insurance, and months when the unit sits empty or a tenant does not pay.
  • Rental income is taxed as ordinary income, and you can deduct mortgage interest, property taxes, repairs, and depreciation, but the rules are complex and change based on how many properties you own.
  • REITs offer real estate exposure without buying property, but you pay capital gains tax on profits and have no control over which properties the fund buys.
  • Most first-time investors either buy a home to live in and convert it to a rental later, or partner with someone to split the down payment and management work.

How much money you need to start

A down payment is only the beginning. Lenders typically require 15 to 25 percent down for an investment property, compared to 3 to 5 percent for a home you will live in. On a $300,000 property, that means $45,000 to $75,000 upfront. But you also need cash reserves — most lenders want to see 6 to 12 months of mortgage payments, property taxes, insurance, and maintenance costs sitting in the bank before they will approve the loan.

Beyond the lender's requirements, you should have your own buffer. Tenants move out without notice. Roofs fail. Furnaces break. A typical rental property needs 1 to 2 percent of its purchase price set aside each year for repairs. On a $300,000 property, that is $3,000 to $6,000 annually. If you do not have this money saved separately, a single repair can wipe out months of rental income.

Some investors partner with others to split the down payment and ongoing costs. Others buy a home to live in first, build equity over a few years, then use that equity as a down payment on an investment property. Both routes reduce the cash you need upfront.

Buying a rental property versus converting your home

Buying a rental property outright is straightforward: you find a property, get a loan, and rent it out. But the loan terms are stricter. Lenders charge higher interest rates for investment properties because they see them as riskier than primary residences. You will also pay higher property taxes in some states if the property is not your main home.

Converting a home you already own into a rental is often easier financially. You already have a mortgage at a lower rate, you know the property's condition, and you can move out and rent it whenever you are ready. The downside: you may owe capital gains tax on the profit when you sell, unless you lived there for at least two of the last five years before selling. If you rent it out first and then sell, that exemption shrinks or disappears.

A third option is house hacking — buying a duplex or triplex, living in one unit, and renting out the others. The rental income helps cover your mortgage, and you still get the lower down payment and interest rate of a primary residence. The catch is that you must live there, and you become a landlord to your neighbors.

Understanding rental income and taxes

Rental income is taxed as ordinary income at your regular tax rate, not the lower capital gains rate. If you earn $50,000 from your job and $12,000 in rent, the IRS taxes you on $62,000. However, you can deduct almost every cost of owning the property: mortgage interest (but not principal), property taxes, insurance, repairs, utilities you pay, property management fees, and depreciation.

Depreciation is a major tax benefit. The IRS lets you deduct a portion of the building's value each year, even though the building is not actually losing value. On a $300,000 property where $50,000 is land value, you can deduct roughly $7,143 per year for 27.5 years. This deduction can wipe out your taxable rental income even if you are making money.

The rules change if you own many properties or if you are considered a real estate professional by the IRS. They also change if you sell the property — you may owe depreciation recapture tax, which taxes back the depreciation deductions you took. A tax professional who works with rental properties is worth the cost, especially in your first year.

Real estate investment trusts (REITs) as an alternative

A REIT is a company that owns and manages real estate, and you buy shares like a stock. You get dividends from the rent the properties collect, and you can sell your shares if the REIT's value goes up. REITs are simpler than owning property: no tenants to manage, no repairs to coordinate, no mortgage to may have access to for.

The downsides are real. You have no control over which properties the REIT buys or how it manages them. Dividends are taxed as ordinary income, not capital gains. If the REIT performs poorly, you cannot fix it — you can only sell. And REITs do not give you the tax deductions that owning physical property does.

REITs work well for people who want real estate exposure but do not have the cash, time, or interest in being a landlord. They also work as part of a diversified portfolio alongside stocks and bonds.

Finding and evaluating properties

Most investors start by looking at properties in their own city or region, where they understand the market and can visit in person. You can search on Zillow, Redfin, or Realtor.com, but you will also want to work with a real estate agent who knows investment properties. They can tell you which neighborhoods have strong rental demand, what rents actually are (not what landlords ask for), and which properties have hidden problems.

When you find a property, run the numbers. Calculate the monthly rent you can charge, subtract the mortgage payment, property taxes, insurance, maintenance reserves, and vacancy allowance. If what is left is positive and covers your desired return, it might be worth buying. If the math does not work, move on. Many investors use the 1 percent rule — the monthly rent should be at least 1 percent of the purchase price — as a quick filter, though this rule is too straightforward for most markets.

Get a professional home inspection before you buy. Rental properties get harder use than owner-occupied homes, and you need to know what repairs are coming. Budget for them before you make an offer.

Financing and loan approval

Investment property loans are harder to get than mortgages for homes you will live in. Lenders want to see a credit score of at least 680, often higher. They want proof that you have enough income from your job to cover the mortgage even if the property sits empty. They want to see your tax returns for the past two years. And they want those cash reserves we mentioned earlier.

Some lenders specialize in investment properties and understand the business better than banks that mostly do home mortgages. Credit unions, portfolio lenders (who keep the loan instead of selling it), and mortgage brokers who work with multiple lenders can all be worth calling. Rates will be higher than for a primary residence — often 0.5 to 1 percent higher — but shopping around can save you thousands over the life of the loan.

If you cannot may have access to alone, a partner can co-sign or co-borrow. This splits the risk and the income, but it also splits the profits and creates legal complications if the partnership ends.

Common mistakes to avoid

Underestimating vacancy is the most common mistake. New investors assume the unit will be rented 12 months a year. In reality, tenants move out, you need time to find a new one, and some tenants do not pay. Budget for 5 to 10 percent vacancy, meaning the unit sits empty or unpaid for one to five weeks per year.

Overestimating rental income is the second. You find a property and assume you can charge the highest rent you see advertised. In reality, you can charge what tenants will actually pay for that specific property in that specific neighborhood. Talk to other landlords, check what similar units are renting for, and be conservative.

Buying in the wrong location is the third. A cheap property in a neighborhood with no job growth, bad schools, and high crime will stay cheap. Rent will not rise, and you will struggle to find tenants. Location matters more than the property itself.

Finally, do not borrow more than you can afford if the property sits empty for six months. If your mortgage, taxes, and insurance total $2,000 per month and you can only charge $1,800 in rent, you are losing $200 monthly. Over a year, that is $2,400 out of pocket. Make sure you can absorb that.

Frequently Asked Questions

Do I need to be a real estate agent to invest in real estate?

No. You can buy and manage properties as an individual investor. A real estate license is only required if you are selling properties on behalf of others for a commission. Many investors do get a license to save on commissions when they buy and sell their own properties, but it is not required to start.

What if I do not have enough money for a down payment?

You can partner with another investor and split the down payment and ownership. You can also buy a primary residence with a lower down payment, live there for a year or two, then convert it to a rental and buy another primary residence. Some investors use a home equity line of credit on their primary home to fund a down payment on an investment property, though this adds risk.

Can I invest in real estate with a 401k or IRA?

Yes, through a self-directed IRA or solo 401k, though the rules are strict and the process is complex. You cannot use the money to buy a property you live in, and you cannot borrow against the account. A tax professional or IRA custodian who specializes in real estate can explain whether this makes sense for your situation.

What happens if a tenant stops paying rent?

You start an eviction process through the local court. The timeline varies by state — some take 30 days, others take several months. During that time, you are not collecting rent and you are paying legal fees. This is why cash reserves matter. Some investors buy eviction insurance or require larger security deposits, though state laws limit how much you can charge.

Should I invest in real estate or the stock market?

Both have advantages. Real estate gives you tax deductions, leverage (borrowing money to buy), and control over the property. Stocks are more liquid, require less cash upfront, and need no management. Many investors do both. Real estate works best if you have cash, time to manage tenants, and a long time horizon. Stocks work better if you want simplicity and lower fees.