Most retirement planning calculators assume you are putting your investments in a mutual fund or a variable life insurance product. But real estate has long been, and still is, a solid way to build assets for retirement, whether it involves capitalizing on your primary residence or purchasing rental properties.
Retirees need a somewhat steady and predictable income stream that will go up with inflation and last throughout a retirement that could last 30 years. Real estate, particularly rental properties, can accomplish that.
Retirement real estate is still a solid option for long-term assets. It is important, however, to be realistic. The days of buying a home and flipping it for a quick profit are long gone. The housing bubble, like the tech bubble before it, showed that common sense about valuation and affordability could not be ignored. Property values do not always go up, but then stocks and other investments don’t either
Considerations when purchasing rental properties
Whether the property includes a multifamily structure, a second home that will be rented part of the year or a commercial site, there are several fundamentals that cannot be overlooked when deciding to purchase real estate. These include a preferable location, reliable tenants, routine but not excessive maintenance costs, and adequate insurance to protect your investment. All these elements, as well as who will manage the property, need to be factored in to determine if it will be a sound investment.
The great thing about real estate is that a lot of these numbers can be soundly estimated so the longer-term picture is more realistic than with stocks, where investors have little control over their returns. Here are some key considerations:
Location: Knowing the neighborhood and plans for the area is crucial. Check on the rental market and how many buildings are for sale in the area. Look into development plans, whether it is major freeway project that will be a headache for tenants or plans for additional entertainment, shopping or medical facilities in the area. These all can affect desirability. If the location is too far from you, it is harder to be the landlord and hiring a property manager will eat into your profits.
Rental income versus cost: The rent needs to cover the mortgage and expenses, so the purchase price paid should reflect the reasonably expected income. (Do not assume you will get 100 percent occupancy.) A recent U.S. News & World Report article suggests that price for the property be no more than 10 times the expected annual rental income.
Cash reserves: Owning a building — whether it is your home or a rental property — will often costs more than anticipated. So, make sure you have some reserve cash for the inevitable unexpected expenses such as plumbing problems, a leaky roof or vacancies. Building property taxes, repairs, vacancies and a reserve into your projections helps ensure your investment’s income exceeds the true costs of ownership.
Partnerships or TICs: Many people pool their money and invest in real estate as partners or a “tenancy in common” (TIC). This is a great way to buy into a multifamily property as a retirement asset without having to come up with all the money on your own. There is no limit on the number of people who can be part-owners, and the portions do not have to be equal. This type of co-ownership allows each participant to choose who will inherit his or her ownership interest upon death. A downside is if one participant stops contributing to the mortgage payment or will not help cover a large repair bill, the remaining participants could get stuck. It is wise to seek the advice of a real estate lawyer if you are considering a TIC.
Your residence as a retirement asset
When figuring on retirement assets, many include “investing” in their primary residence in their asset plans. Here are some things to think about regarding your current home or homes:
Mortgage debt: Today’s mortgage rates may be favorable and offer a tax deduction. However, that deduction may not make much of a difference after retirement and minimizing monthly expenses may be more important. Most retirees live on Social Security, their savings as well as any IRA or pension distributions. As a result, the tax deduction loses significance.
Downsizing or moving to a retirement community: A big house is great for raising a family, but eventually the empty nest becomes an expense not an asset. In today’s sharing economy, those empty rooms could produce some income on Airbnb, depending on whether the location is near a vacation spot, a college, or an area attracting new residents looking for a temporary place to land.
For many, however, retirement means downsizing the home to something manageable with a little room for children or grandchildren to visit. Or, it means moving to establish a post-retirement life. Large sections of Florida and Arizona are populated with retirees leaving colder climates in favor of something sunnier.
If you do downsize or move, keep the proceeds from the sale as a retirement asset. Do not be tempted to buy something at a comparable cost or with a mortgage that will still be there when you’re 90.
Vacation homes: Many people purchase a second home near recreational sites they enjoy with the intention to retire to the second home someday. However, maintaining two residences until retirement can be a financial drain. Consider using the second home as an income-earning property. This may cut into how much of the time you can enjoy the beach house or condo by the slopes, but the income from the peak season could more than cover your costs for the whole year.