Investing in Real Estate for Retirement Income
About the author: G. Brian Davis is a real estate investor who has owned dozens of investment properties over the last 15 years. He’s also the co-founder of SparkRental.com, an online resource which provides free landlord education and video series for anyone looking to build passive income from rentals.
Ever thought about buying an investment property for retirement income?
Investing in real estate for retirement boasts plenty of advantages over traditional retirement planning. In the traditional model for retirement income, workers save and invest money over a 40-some year career, then gradually draw down their nest egg over the next 15-30 years. The premise centers around "safe withdrawal rates" and the strategy of how much of your nest egg you can sell off each year without running out of money.
Real estate investing, on the other hand, offers a lot of alternatives to traditional stocks and bonds if done right.
For example, investors can buy rental properties for ongoing passive income, invest in REIT shares, or hold private notes. Property investors can even flip homes after leaving their day job, as a post-retirement part-time business for fun and extra money.
In this article, you will learn 6 ways investing in real estate for retirement can improve a retirees’ income, the 6 different real estate investment options that can be used for retirement, and strategies to mitigate the risks to maximize potential returns.
Advantages of investing in real estate for retirement income
Beyond the ongoing income of rental properties and the high dividend yields of REITs, here are 6 other benefits of investing in real estate for retirement income to complement your existing strategies.
The golden rule of investing is a simple one: the more diversification, the safer the portfolio.
If most of your nest egg is invested in stocks, what happens if the stock market crashes when you retire? This is known as sequence risk, which is a serious concern for new retirees. The more of your nest egg is invested in only equities, the greater the risk.
Real estate provides an alternate source of income so that retirees can lean less on their stock portfolio during bear markets and minimize their withdrawal rate.
Another advantage to investing in real estate for retirement is that you can leverage other people’s money to buy the properties, so that you can risk less of your own nest egg up front. In the case of fix-and-flip and rental properties, you can borrow up to 90% of the purchase price and 100% of the renovation costs, if needed, to build your own portfolio of assets.
This is a great advantage over investing in stocks, in which you are typically allowed to buy up to 50% value on margin (borrowing money from a broker to purchase the stocks).
Rental properties held long-term tend to appreciate over time, even as tenants pay off your mortgage balance. In addition, rent prices generally rise over time alongside inflation, so you get more passive income if you aren’t planning to sell the property anytime soon.
Contrast that with the equity investments where investors must subtract out inflation to determine their "real" annual returns.
Real estate investing also comes with a lot of tax deductible expenses that can save you money in the long run. These expenses include but are not limited to: all renovation expenses, management fees, home office expenses, travel expenses, other ownership-related expenses, and many paper expenses.
Investors who sell properties that they have owned for longer than a year also pay the dramatically-lower capital gains tax rate on their profits, rather than their normal income tax rate.
Learn how to maximize property investing tax benefits here.
Investors can predict returns on flips and rental properties with a reasonable sense of accuracy given the amount of control they have over the experience..
Through extensive research, experience, and hard work, rental investors can forecast the price they’re paying, the rent they can ask, the ongoing expenses (e.g. vacancy rate and maintenance) to budget for, and the value after repairs based on comparables.
While many of the real estate investing options for retirement income (i.e. rental properties) are income-oriented, private notes and crowdfunding websites generate interest income for investors.
In addition, REITs also tend to pay a far higher dividend yield than traditional stocks or mutual funds, since REITs returns are generated from mortgages or income-producing properties.
Real estate investment options for retirement income
Before deciding how to invest in real estate for retirement, do your homework and evaluate the different investment strategies.
One popular choice that stands out is rental property investing. Investors can buy rental properties before retiring, then delegate management to a property manager so that they can kick back and enjoy the rental income as a hands-off retiree.
If you already have experience flipping homes, you’re in a perfect position to parlay the skills and network you’ve already built to investing for retirement income. First, you already know how to look at comparables and evaluate property values and have an eye for identifying and finding deals. You also have existing relationships with contractors, realtors, home inspectors, and other investors. In addition, you’re familiar with the process of acquiring hard money loans for investment properties.
Best of all, you can use the cash you earn from flipping houses as investing capital for retirement income. In fact, you can even save money on taxes by using a 1031 exchange to defer the tax bill, if you buy another investment property with your earnings.
With that said, there are investing options other than buying properties directly. Ways to generate retirement income with no labor required include investing in REITs, crowdfunding websites (such as Kiavi), private equity funds, opportunity funds, and private notes.
Of course, you don’t have to stop working entirely just because you quit your day job. Why not start a part-time real estate investing business? You could flip houses, wholesale, buy short-term vacation rentals for Airbnb guests, and much more.
Mitigating the risks of real estate for retirement income
With all those advantages to investing in real estate for retirement, why isn’t everyone doing it?
It takes knowledge, experience and hard work. Anyone can throw money in an index fund that tracks the S&P 500 and sleep soundly knowing that if they leave it there long enough, it will potentially perform for them. But there are some fundamentals of real estate investing that new investors should learn in order to maximize their chances of earning potential profit.
Luckily, learning to mitigate the risks of real estate investing is not difficult. Here are the four most common risks and how to successfully avoid them.
Risk #1: Uneven rental income month-to-month
In most months, your rental income will simply be the rent minus the mortgage payment.
But then, suddenly, you may have a $2,500 furnace bill. Or, your tenants will move out and you’ll need to advertise and screen new tenants, all while carrying the mortgage on your own. Rental income is not like Social Security income, which is a regular and predictable check that arrives in the mail every month. You may periodically be hit with large expenses that eat into reserves, which could make retirees uncomfortable.
Tip #1: Budget for long-term average costs
Sure, the furnace might need replacing and you will occasionally have vacancies.
So? Budget for them!
Before investing in a property, ensure you calculate the cap rate, which includes your non-mortgage expenses. For example, you can determine the vacancy rate and set aside a certain percentage of the rental income for potential vacancies, in any given neighborhood. Likewise, budget for maintenance and repairs.
As you set aside money each month for expenses, you’ll build a cash cushion that you can then use to cover "unexpected" expenses when they pop up.
Risk #2: Rent default and tenant property damage
What happens if your tenants stop paying you?
You have to go through the long, expensive eviction process. For several months, you could receive no rental income at all. Tenants, both those evicted and those who vacate voluntarily, may also leave damage behind that exceeds what their security deposit covers.
In most cases, you’re out-of-pocket for the repair costs when that happens.
Tip #2: Screen tenants thoroughly
The solution to avoiding your chances of leasing to a bad tenant? Screen potential tenants thoroughly from the get go.
Check their credit, criminal, and eviction history. Verify their income, confirm with their supervisor about how reliable they are, and talk to their current and even previous landlord about what kind of tenant they are.
By prioritizing prevention, you’ll find your rentals far more profitable and reliable.
Risk #3: Lawsuits
Your S&P 500 index fund won’t sue you if it doesn’t like you. Your tenants might.
Landlords are vulnerable to lawsuits, particularly in tenant-friendly states and jurisdictions. Lawsuits can be incredibly expensive for landlords, even if they win, and the legal fees can be crushing.
Tip #3: Limit your liability
Spend a few extra dollars every year on liability coverage since you need to get property insurance regardless. That way, you can sleep at night knowing that even if a nightmare buyer, seller or tenant sues you, you’re protected.
If you want to further protect yourself against liability, then set up your property investing business under an LLC. This way, if someone sues you and wins, the only asset they can come after is the property owned by the LLC. Your personal assets are protected.
Risk #4: Unforeseen repairs
Whether you’re flipping a house or buying a rental property, one risk is that you miss important and possibly expensive repairs, such as issues with the electrical system or plumbing.
Tip #4: Always perform home inspections before buying
To avoid unpleasant renovation surprises, always order a home inspection before buying any property.
This will help you sleep at night, knowing the exact condition of the property before investing your time and money in it.
Never stop learning (even in retirement!)
Diversifying your retirement investments in real estate can yield great potential returns and is one of the best ways to mitigate your worries of a stock market crash right after retiring.
Although it may take more extensive research and sweat than parking money in an index fund, the reward is that you can earn high potential profits, all while protecting your nest egg against most major real estate investing risks, if done properly.
If you’re looking to actively invest in flipping houses or rental properties, continue your education by listening to the top real estate investing podcasts and picking up some of the best books on real estate investing.
To further diversify, consider passive options such as investing in REITs, crowdfunding websites, private equity funds or private notes. That diversification will leave you far less vulnerable to stock market gyrations, and help you sleep soundly at night knowing that your income flows from multiple, diverse sources.