A second home and an investment property are often conflated when talking about buying a second home for rent, but are they the same thing? If not, which one is generally the better real estate investment? Read on to find out as we discuss a second home vs investment property comparison and contrast!
Second Home vs Investment Property: Definitions and Usages
Let’s begin our comparison by answering the first question: Are second homes and investment properties the same thing?
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Second Home
You don’t need a real estate investing for beginners lesson to know that a second home, or a vacation home, is not a person’s primary residence. Instead, a vacation home is used only for a certain period of time by the owner as a temporary residence. It can be rented out during the remainder of the year. To be more specific, a vacation home is defined as a property that is occupied by the owner for more than 14 days or 10% of the number of days in which it is rented during the taxable year.
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Investment Property
Investment properties, on the other hand, are more straightforward in their definition. An investment property is not used as a temporary residence; its sole purpose is to generate profit. Profit primarily comes in the form of rental income, appreciation, and tax benefits.
Second Home vs Investment Property: Location and Investment Versatility
No two investments are the same. This is especially true when it comes to the types of locations and investment versatility of a second home vs investment property.
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Second Home
The location of a vacation home is based on the investor’s preference. This is because the property acts as a temporary residence. While this personalizes the purchase, it limits its potential investment versatility because the location will mostly be set to vacation areas (near beaches, natural parks, etc.). Even if an investor is buying a second home for rent, the investment versatility is restricted, as the property will only set focus on a specific type of tenant group.
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Investment Property
Location is arguably the key factor when making money in real estate through investment properties. However, due to the tremendous investment versatility of these properties, the location range is virtually infinite. Investment properties can come in the form of residential real estate, short-term rental real estate, commercial real estate, and fix-and-flip real estate. Depending on the strategy, an investor could plan on buying an investment property anywhere from a quiescent college town to a busy commercial district.
Related: Top Six Real Estate Investment Strategies
Second Home vs Investment Property: Requirements to Buy a House
The risks associated with a second home vs investment property vary. This leads to different requirements to buy a house for each property type.
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Second Home
Just like with any major investment, real estate investors should ask themselves “Can I afford a second home?” before making a vacation home purchase. The answer will determine if you need to turn to a mortgage lender.
Second homes are riskier to lenders. This is why second home mortgage rates are usually higher than those of primary residences. Second home mortgage rates are not the only thing higher than their primary residence counterparts. Down payments, which can range from 0% to 25% for primary residences, are usually at a 20% minimum for vacation homes. Many lenders also mandate that the property be located at least 50 miles away from the investor’s primary residence.
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Investment Property
Much of the previously mentioned requirements also apply when buying an investment property. Investment property financing, for example, typically requires a 20 to 25% down payment, although there are plenty of methods to reduce and even eliminate the down payment altogether. Mortgage and interest rates are typically higher for investment properties than primary residences as well since they generally carry more risk. Investment property financing, however, is broader than vacation home financing. There is a myriad of options available to finance rental properties. The same cannot be said for second homes.
Related: Can You Buy a House with No Money Down for Real Estate Investing?
Second Home vs Investment Property: Property Management, Taxes, and Overall Cost
Another vital factor when assessing a real estate investment is the overall cost of the property. This includes management fees and taxes. Here are such differences for a second home vs investment property.
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Second Home
Property management is a concern for all types of properties, including second homes. A vacation home requires constant upkeep because it is typically unoccupied for the majority of the year (even if rented out).
In terms of tax benefits, second homes are similar to primary residences. Mortgage interest and property taxes, for instance, are tax deductible. However, since a second home is not inherently used to generate rental income, its overall cost can be burdensome to the owner. The investor must pay for the property out-of-pocket.
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Investment Property
An investment property, on the other hand, is overall more inexpensive than a second home. The reason is simple. Investment properties generate profit all year round, while second homes do not. As a result, investment property management costs are not as financially straining on the investor as second homes. This is especially true of positive cash flow properties.
Tax benefits are also more numerous for rental properties than for vacation homes. Investment property management costs, rental income, insurance, mortgage payments, property tax, and capital gains tax are all tax deductible for investment properties.
Related: All You Need to Know About Investment Property Tax Deductions
Second Home vs Investment Property: The Winner
Let’s settle the debate. Which type of property is the better investment: a second home vs investment property? While a second home can be a useful investment for personal use and may even generate some rental income for a short period of time, an investment property is ultimately the superior investment. Due to its potential for positive cash flow and making money in real estate, investment strategy versatility, the multitude of financing options, numerous tax benefits, and overall cheaper investment, an investment property should be your next purchase in real estate.
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