Stocks, IRAs and employer-sponsored plans are fundamental aspects of many retirement plans, but they are by no means the only options. A frequently overlooked alternative that might be worth considering is owning and renting out real estate.
Rental properties can provide a steady of income while you build equity in a property. In addition, the property may appreciate in value, and you may be able to enjoy certain tax advantages along the way. Here's a look at how the process could work.
It Takes Money to Make Money
You'll have to make an investment to generate cash flow from rental properties. Although mortgage interest rates are still favorable, you will need to come up with a down payment that could range from 20% to 30% for investment properties. Of course, you'll have recurring expenses, as well. Factor in your mortgage, taxes, landlord-specific insurance policies (both property and liability), repair and maintenance costs, and unexpected expenses related to your tenants – such as legal fees incurred as a result of a problem tenant.
For more on this see Rental Properties: Cash Cow Or Money Pit?
…And it Takes Time
It can take a few years to generate a stable and positive cash flow from rental properties. The price you set for rent is an important factor, and one that will affect your bottom line. If you charge too much, you may not find a tenant; charge too little and you might not generate enough cash to make ends meet. When figuring out how much to charge for rent, try to find a number that allows you to:
Cover your operating expenses (mortgage payments, property taxes, insurance, maintenance, utilities and administrative costs)
Earn a reasonable return on your real estate investment
Be competitive with the local rental market
It's important to consider the supply and demand for your area's rental market. If the rental market is flooded with properties, you may have to decrease the rent to attract tenants; if demand is high and people are having a hard time finding housing, you may be able to set a higher (yet still attractive) rate. See How To Value A Real Estate Investment Property and Top 10 Features Of A Profitable Rental Property.
It's Not Easy Money – Landlord Responsibilities
Being a landlord isn't easy, and it's definitely not for everyone. As a landlord, you'll have many obligations and responsibilities, including:
Financial obligations. You have to make your monthly mortgage payment and meet all the other expenses, even if the property is vacant or if your tenant hasn't paid.
Legal obligations. As a landlord (and business owner), you must understand and abide by the laws, rules and regulations pertaining to rental housing: You are legally responsible for complying with all local, state and federal laws even if you don't understand them. If you are not in compliance, you can be fined, and lawsuits and complaints can be filed against you.
Round-the-clock availability. If your tenant calls at 3:00 am because the dishwasher is flooding the kitchen floor, you need to be available to deal with the emergency. If you can't be, you must designate someone to act on your behalf and make decisions.
Maintaining habitability. As a landlord, you are required to maintain a safe and habitable property for your tenants. You can be held liable for tenant or visitor injuries that result from unsafe conditions. To maintain habitability, landlords must:
Keep all common areas in a safe and clean condition
Make sure structural elements are safe and intact (floors, walls, stairs, roof)
Ensure that electrical, plumbing, heating/air conditioning (HVAC), ventilation and sanitary systems are properly maintained
Make sure tenants have access to running water, hot water and heat in reasonable amounts at reasonable times
Provide trash containers and arrange for trash removal
Manage known environmental toxins, including lead-paint dust and asbestos
For more on this, see The Complete Guide To Becoming A Landlord and Tips For The Prospective Landlord.
Finding Tenants
You won't be able to generate any income without tenants, and finding reliable tenants is a challenge. Ideally, tenants will be able to pay their rent in full and on time each month, keep the property in good condition, and follow the policies in the lease or rental agreement.
It can be well worth the time and effort to find dependable tenants, especially for longer-term rentals. In many markets, an experienced real estate agent or realtor can help you find them.
Property-Management Services
A property manager can perform such duties as marketing your rental property, selecting tenants, maintaining the property, creating budgets and collecting rent. You may consider hiring a property manager if you want to limit your day-to-day responsibilities for your rental property.
Depending on the role you envision for your property manager, you may want to find a person – or management company – experienced in advertising, marketing, tenant relations, collecting rent, budgeting, leasing and maintenance. The property manager also should be knowledgeable about local and state laws. As the property owner, you can be held liable for the acts of your manager (for example, you can be sued if your manager violates fair-housing laws). For more on this, see Hiring A Property Manager.
The Bottom Line
Rental properties provide an opportunity to generate a stable and positive cash flow during retirement, but profiting from them takes work. Like the stock market, investing in real estate has risks and tax implications. It's important to do your homework and consult with qualified professionals – including a real estate attorney and/or tax specialist – before and during your tenure as a landlord.
For more ideas on real estate and retirement, see The Income Property: Your Late-In-Life Retirement Plan and New Retirement Living Option – And Income . Another option to consider is using a self-directed IRA to build your portfolio of rental real estate (check out House Your Retirement With Self-Directed Real Estate IRAs).