If you’re looking to diversify your investments as you approach retirement, you might consider rental real estate. Usually, retirees focus on stocks and bonds, but real estate can also provide excellent opportunities.
Real estate properties that yield high returns are out there. It all comes down to buying the right piece of real estate for the right price.
Determining the Amount of Money Needed
If you plan to take out a mortgage for a real estate purchase, you’ll probably want to do so before you retire. The guidelines that lenders follow typically favor someone who’s employed with a steady employment history of at least two years versus someone who’s retired. By using a home affordability calculator, you can quickly determine how much you can afford based upon your current financial status. If you plan to use the property for rental purposes, a lender will likely require you to put down at least 30 percent of the purchase price.
You could also take the funds out of your IRA by using a self-directed IRA. In that case, income and equity growth from rental receipts will rise within your IRA on a tax-deferred basis. This is because you already paid taxes on your Roth IRA, so real estate earnings and equity increase tax-free.
Add Recurring Expenses
You’ll want to be realistic about the cost of ongoing–and unexpected–expenses. These might include maintenance such as fixing a leaking roof, repairing a broken pipe, or dealing with an electrical problem. You could also lose income if you don’t have the place rented all the time.
There are also marketing expenses to consider, whether advertising online or in another form. When calculating how much you’ll spend on real estate, never assume higher than a 92 percent[MP2] occupancy rate, regardless of current demand. That way, you’ll have some cushion in your projections.
When using a piece of property as a source of income during retirement, you need to think about tax benefits. You can claim a depreciation deduction on your federal income tax for capital improvements you make to the property. Since depreciation reduces the property’s value (on paper, at least) each year, it also reduces how much you pay in taxes. Over time, depreciation should lower your cost basis, as well. But if you sell at a profit, those deferred taxes will eventually be due when that depreciation is recaptured.
Location, Location, Location
Location is the key to buying real estate. Unless you choose a property in an area where people want to rent, you’ll end up without tenants. If you pay a higher price for a property because it is in a desirable location, you’ll probably end up spending less in the long run since you won’t have to worry much about marketing or occupancy. Some of the best sites might be near colleges, downtown, or close to job opportunities.
Make sure you buy a rental property that makes sense for the neighborhood. For instance, if you find a cute one-bedroom house but it’s in a community where young families live, you might have a hard time keeping it occupied. Just because you find a bargain doesn’t mean it will benefit you.
For your real estate investment, you want to earn at least eight percent on your capital after expenses. Those expenses include the mortgage payment, insurance, professional management (if you go that route), taxes, and maintenance. If spend $100,000 on a property, you’ll want to earn $8,000 annually, net, at a minimum. That eight percent compensates you for the risks and relative illiquidity of the investment.
Many people use spreadsheets to analyze whether or not real estate makes sense in a retirement portfolio. But there is much better technology today for analyzing real estate when it comes to retirement planning. WealthTrace offers detailed financial and retirement planning analysis and this includes the ability to add real estate transactions and rental income. You can even control the tax rates for every source of income.
Along with all the benefits of using real estate as retirement income are some potential issues. You might end up with tenants who refuse to pay rent. Or perhaps the property will need a new roof, but it’s not covered by insurance.
Also note that some municipalities have strict regulations for inspections, or might impose fees if you turn your primary residence into a rental property. Be aware of any issues or penalties.
As a landlord or property owner, you’ll have to stay involved. Whether it’s you, your significant other, a family member, a friend, or a company, someone has to manage your real estate. Having someone else manage your property will cost you, but might be worth the money so you can enjoy traveling during your retirement. You might even live in an entirely different city or state.
One last thing is that, as a landlord, you’re going to meet people from all walks of life. If you’re not a people person by nature, you might consider hiring a professional property manager. Of course, you want to rent to the right people, but that requires work. You’ll want to verify their past rental and credit history–another thing professional managers are able to do.
The Bottom Line
Stocks and bonds are two options for retirement, but so is buying rental real estate. When managed correctly, rental property can turn into an excellent source of extra income. However, you need to do your due diligence by working with a reputable real estate agent, finding the appropriate property in the right location, and making sure you run the numbers.