Four questions to consider before you invest in rental properties
Being a landlord in retirement seems like a sound financial decision. Retirees who want passive income often turn to rental properties hoping to retire on rental income. But while they’re a tax-efficient way to invest, many are surprised at how non-passive owning rentals can be. It takes time, energy and money to be a landlord.
Investing in real estate is generally seen as a good idea, but becoming a landlord for retirement income isn’t always easy.
That’s why you should make sure the positives eclipse the negatives before buying that first rental property. One way to do that is to consider these questions.
How much is left on my mortgage?
Downsizing is a common move in retirement, and if the mortgage on your current home only has a few years left, turning your home into a rental property could be a lucrative investment.
If you have several years left on your mortgage or your interest rate is high, it may be better to sell and use the profit to buy your retirement home or start a low-risk investment like a fixed annuity. Buying rental property for retirement might be better for you this way.
Acquiring a new property to use as a rental is also an option. Carefully consider your price point and confirm that the typical rent rate for your area can cover your mortgage. Buying rental property for retirement income isn’t a decision to take lightly. Also, be sure you have enough funds for a down payment, typically 20% of the home price.
What kind of tax break would I get?
The greatest benefit of renting your property is the number of tax deductions you can claim as the homeowner, but only if you itemize. Repairs and maintenance, proprietary taxes, insurance, marketing, rental applications and mortgage interest can all be deducted from income tax on rentals. Deprecation tax deductions allow you to deduct the cost of the property itself, which helps spread out the cost of buying the property over time as you save money each tax season.
Although the tax breaks sound exciting, remember filing can quickly become complicated with so many moving parts. Being a landlord in retirement can have some drawbacks. When you file, you’ll need to fill out additional forms, and most people need the help of a CPA to make sure everything is filed correctly. You’ll have to decide if your potential tax break outweighs the time and cost of filing a complicated tax return for your investment property.
Will I earn an income?
Rentals can be an efficient income stream if the tenant’s rent exceeds the necessary costs. Zillow has an easy calculator to estimate the income from your rental property. Keep in mind rental properties don’t always have an excellent return on investment.
The question of whether rental income is good for retirement arises for retirees who want to sustain a comfortable retirement lifestyle with a source of income. Rental income may be good for retirement. However, when investing in real estate, you must be aware of the risks and responsibilities associated with property management and maintenance.
In an environment with rising interest rates, people often assume property values will appreciate, but it's not guaranteed. The housing market still has market risk!
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I have two rules for my clients with rental properties: don’t rent to family and don’t rent to friends. When inflation causes your expenses to increase, you have to increase rent which can be difficult with personal ties. I've worked with people nearing retirement who rented a few properties to friends and family.
But they didn't feel comfortable raising rent prices on their close connections, and eventually they lost money on their rentals. If you can't charge a fair rate to cover your costs, rental properties can quickly become a money pit.
A common question among real estate investors and those who want to be a landlord in retirement is how much rental income is needed to retire. For you to determine how much rental income is necessary to retire comfortably, consider factors like living expenses, healthcare costs, and desired lifestyle.
The amount of rental income required to retire will depend on your financial goals, and investment strategy.
Are you equipped to find tenants?
Being a landlord in retirement means taking on the responsibility to find good tenants. This is a feat that can cause some pain for your rental real estate. The real estate market is always risky, but you need to be able to find responsible tenants who can pay on time and won’t abuse your property.
Vetting tenants can be a daunting task, especially if you’re new to being a landlord in retirement. It’s important to do your due diligence and conduct thorough credit and background checks on potential tenants.
While these checks can be costly, they often provide invaluable insight into the tenant's rental history, credit score, and more, making them an essential part of the vetting process for any landlord.
Managing tenants is a challenging task for many landlords, especially when it comes to dealing with difficult ones. From daily calls to late or unpaid rent and the time-consuming move-out day, being a landlord in retirement can be an emotionally and financially draining experience. Are these activities that you are willing to endure during your retirement years?
Am I ready to be the fix-it man (or woman)?
For many people, retirement is all about enjoying your golden years with ease, but being a landlord in retirement can be quite the opposite. When pipes burst or appliances need updating, you’re responsible. Not to mention, some tenants can simply be a pain in the neck to deal with. The hassles of being a landlord in retirement multiplie when you have a number of rental properties.
Landlords typically spend 4 hours on maintenance every month for each rental property they own. If you plan on being a landlord in retirement, you might not have the time and freedom you would expect from your retirement years.
Property management companies can be hired to handle maintenance and tenant relations, but make sure the cost of their service doesn’t cut too deeply into your income. Management fees can put a huge dent into your profits as a landlord in retirement. The bottom line is this: if you want a stress-free retirement with minimal responsibilities, rental properties might not be the right investment for you.
Alternative Investments
If rental properties are off the table, there are plenty of other options to consider. A good retirement plan creates an investment strategy to reduce tax exposure. I recommend using Roth conversions to move your retirement funds away from accounts with high tax liabilities, like 401(k)s. Ideally, you want 100% of your assets in after-tax accounts, like Roth IRAs, because paying taxes up front will allow your money to grow without paying taxes when you withdraw funds.
There are fees associated with Roth conversions, but the end return typically outweighs the upfront cost. Instead of renting your home, consider selling your home and using the profit to cover the cost of a Roth conversion. When you start using those funds tax-free in retirement, you’ll be double thankful. Saving on taxes and avoiding the headache of being a landlord in retirement.
Carefully weighing the pros and cons of being a landlord in retirement will keep you from making an investment you regret down the road. At Asset Preservation Wealth & Tax, we believe your retirement income plan should ultimately align with and provide for your retirement lifestyle and goals. This includes whether you choose to rent as an investment strategy or not. You’ve worked hard your entire career, so make your investments work for you while you enjoy a long, happy retirement.
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Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
A Roth conversion may not be suitable for your situation. The primary goal in converting retirement assets into a Roth IRA is to reduce the future tax liability on the distributions you take in retirement, or on the distributions of your beneficiaries. The information provided is to help you determine whether or not a Roth IRA conversion may be appropriate for your particular circumstances. Please review your retirement savings, tax, and legacy planning strategies with your legal/tax advisor to be sure a Roth IRA conversion fits into your planning strategies.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
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