There’s plenty of buzz about the income possibilities of owning rental property and the opportunity to supplement your retirement with the extra cash, but is owning a rental property a good fit for you as you enter this stage of your life? Let’s look at the advantages and disadvantages of keeping your rental property as an alternative investment.
If you play your cards right, a rental property can make a significant difference in your retirement income outlook. Here’s why:
Direct Income Stream
Just like an IRA or 401(k), investing in rental properties is a long-term strategy, but the perk is that it’s a strategy that brings in cash right away. The goal is to have those monthly rent checks be higher than the cost of the mortgage and any other expenses so that you not only build your equity but also create a cash flow. This isn’t a get rich quick scheme, but if you look at the numbers, it makes sense.
Considering that the historic average rate of return for the stock market is 7%, an average 9% return on investment property is enticing. Of course, the return on investment (ROI) for real estate varies widely due to the unending list of factors involved, such as down payment variations, market ups and downs, interest rates, and maintenance costs. That being said, a smart investor has the potential to see returns even greater than the average.
Owning an investment property also offers income tax deductions that could benefit you when tax season rolls around. Here are some common deductions you can use if you are a rental property owner:
- Mortgage interest
- Property taxes
- Cost of repairs
- Travel for rental-related activities
- Insurance premiums
- Legal and professional services
- Casualty and theft losses
- Independent contractor fees
Keep in mind that you can deduct up to $25,000 as a passive investor, but that you cannot write-off deductions that are more than the rental income.
A very real concern when it comes to retirement income is the risk that inflation will deplete your savings. Owning investment properties can help mitigate this risk, as rental rates and home prices generally rise with inflation, but your mortgage payment will not increase. Therefore, if you continue to rent or decide to sell, that extra amount will help offset the cost of inflation on your expenses.
It may seem like a genius idea: buy a second home, rent it out, and create a direct income stream to live on. For many, this does work, but consider these drawbacks to determine if you should hold onto your property:
Illiquidity and Concentration
If you are suddenly forced to sell your rental property, you may find yourself in less than ideal circumstances. Perhaps the real estate market is in a downturn, or it takes several months to unload the property. In this case, the property could cause a loss or extra expenses in your budget and become a liability.
Real estate, as lucrative as it can be, also requires a concentration of your assets. Purchasing a home involves a significant amount of money that is then tied up in an undiversified investment. Not only is the real estate market unpredictable, but sometimes an unexpected road project or an undesirable development may cause your home to lose value.
Tenants can make or break your rental property experience. A great tenant can mean the difference between your property being maintained and rent being paid on time to overdue rent, lawsuits, or even permanent damage to your unit. When a tenant moves, you may have to do a lot of work on the home to get it ready for new tenants, all at personal expense.
Then you have the work and headache of the legal side of things, such as drawing up contracts, calling references, and even just finding tenants. You may go through times of not having a tenant, which means no extra income and the added expense of paying the mortgage yourself.
Sometimes it can be difficult enough to stay on top of the upkeep for your personal home. If owning a rental property is becoming too much of a drain on you physically or financially, it may be time to reevaluate your rental situation.
You can pay a property management company to handle the details, but that will cost you anywhere from 7-10% of your monthly rent, further reducing the income potential.
Many of our clients maintain rental properties in retirement. But our recommendation to do so is based on each client’s unique situation. For example, if the mortgage is paid off, your income off the property will be much higher than if you still owe. If you enjoy puttering around and taking care of repairs, you won’t mind the upkeep risk. If your rental home is in a safe neighborhood in a good school district, your investment is safer than if it’s located in a deteriorating area.
If you want an outside, unbiased look at whether your rental property is right for you as an alternative investment as you reach your retirement years, contact us at (410) 863-1040 or email firstname.lastname@example.org. We want to help you have a predictable, secure retirement.