Rent To Retirement: Building Wealth Through Rental Properties

The Big Picture On Rent To Retirement:

• • Investing in rental properties can provide a stable income for retirement, with options like steady monthly rent, lump-sum cash from sales, and equity loans. This makes it a sustainable alternative to traditional retirement funds.
  • Rental income can enhance retirement stability, allowing for regular cash flow even after the property mortgage is paid off. Additionally, selling the property or borrowing against equity can provide financial flexibility when needed.
  • While real estate investment offers significant retirement advantages, consider factors like property management, tax implications, and long-term planning for sustainable benefits.

(Guest article by Michelle Cornish, CPA)

Most North Americans aren’t on track for retirement, according to a recent survey conducted by Bankrate.

I spent sixteen years working in public accounting, where I helped people with their taxes and retirement planning. Over and over, I found that people fear they haven’t saved enough for retirement. Nearly everyone wonders, “Do I have enough?” “How do I know my 401k won’t run out?” and “What happens if the stock market crashes right after I retire?”

The good news is that there is more than one way to retire comfortably. One way is to start investing in rental properties before retirement.

Consider three of the ways rental properties can ensure a comfortable retirement:

• Steady monthly income,
• Lump sum cash payout, and
• Equity loans.

Stocks typically must be sold to supplement retirement income, and bonds eventually finish paying out. In other words, traditional nest eggs risk running empty at a certain point, but rental properties keep paying indefinitely.

Why Rental Properties Make Smart Retirement Assets

Let’s dive in and take a closer look at these advantages of rentals for retirement, shall we?

Steady Monthly Income

Rental income is a great supplement to other income you may have in retirement. It can even provide the bulk of your retirement income!

Ideally, you’ve owned the property long enough that the mortgage is paid in full. This increases your monthly cash flow because you don’t have to worry about paying the mortgage out of the rental income you receive.

If the property has been well maintained over the years, then your only major repair bills should be CapEx (capital expenditure)-related. You can also increase the rent to raise yourself. Just ensure you stay within the confines of your local and state landlord-tenant laws. There are often rules regarding how often you can raise the rent and by how much.

If you feel like being a landlord is too much work, consider whether you’d rather bust your butt to contribute to that 401k… or find a job that even has a 401k plan. There are tons of great resources for landlords to help make it simple. Check out this landlord survey with many great tips, including 5 critical factors to consider when screening tenants.

Important Financial Aspects of a Rental Property Investment

Thoughtful planning around these aspects of rental property ownership can help create a more stable retirement income stream.

Lump Sum Cash Payout

Unlike lump sum pension payouts, when you own rental property, it’s up to you when you receive a lump sum payout. A lump sum payout from real estate investing occurs when you sell your property. The payout amount will depend on how much the property has gone up in value, how much of the mortgage you have left to pay, and how much capital gains tax you will owe on the sale. However, in the U.S., long-term capital gains tax rates (0%, 15%, or 20%) apply depending on the household income.

Here are ten things you can do yourself to increase the value of your property as much as possible.

Tax laws can vary depending on where you’re located, so consult with a tax professional before your sale is complete or even before you decide to sell the property.

Be sure to consider timing and taxes before selling any properties. If you own more than one rental property, you may want to time the sales so they end up in different taxation years so you can save the most tax (and keep the most cash) from each sale.

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Equity Loans

If you have equity in your rental property but are not ready to sell yet, or if you’d prefer to pass the property on to your heirs but still need a quick influx of cash, you can always borrow against the property’s equity. This can be a risky move, though, so make sure you know what you’re getting into before you do it.

A major advantage of an equity loan is that it’s not considered income, so you won’t be taxed on it. But you need to pay it back with interest, so proceed cautiously.

You’ll also want to know what will happen to the debt when you die, especially if your goal is to pass the property on to your heirs. A required loan payout on death (like in a reverse mortgage situation) may force your family members to sell the property, which is not what you want.

If you are considering borrowing against your rental property, do so cautiously. It’s critical to fully understand the contract terms, required repayments, interest rate, and what happens to the loan when the property transfers to your heirs. Work with a reputable lending professional you know and trust, or get a referral and triple-check their references.

How Many Properties Do You Need for Retirement?

Let’s tackle the question that keeps many aspiring real estate investors up at night – how many rental properties do you actually need for a comfortable retirement? The answer starts with understanding your target monthly income. Calculate your expected monthly expenses in retirement, then add a 20% buffer for unexpected costs and inflation.

A practical approach is to work backward from your target monthly income. For example, suppose you need $5,000 monthly in retirement income, and each property generates an average of $500 in monthly cash flow after all expenses. In that case, you’d need approximately 10 properties to reach your goal. However, remember that property values and rental rates vary significantly by location.

To calculate potential cash flow, use this simple formula:

Monthly Rent – (Mortgage + Property Taxes + Insurance + Maintenance Reserve + Property Management) = Monthly Cash Flow.

For instance, a property renting for $2,000 monthly might have $1,500 in total expenses, which leaves you with $500 in cash flow. To be conservative in your calculations, factor in vacancy rates of 5-10% annually.

Finding Properties That Actually Earn

I’ve noticed that investors who take their time choosing properties usually come out ahead. Let me share what I’ve learned about picking the right properties for retirement income.

First, you want to look at the neighborhood’s future, not just its present. Is the area growing? Are new businesses moving in? When will these changes occur? These kinds of changes can mean good things for your property values and rental rates down the road. Many investors I know make good money just by spotting these trends early.

As for the property, consider the big-ticket items that can affect your retirement income. How old is the roof? What about the HVAC system? Although these aren’t very exciting questions, they’re important ones. Trust me, the last thing you want is to drain your retirement savings on major repairs when you should enjoy that rental income.

Also, there are other factors you can consider – who are your future tenants likely to be? Are you near a university that ensures a steady stream of renters? Or, maybe you’re in a family neighborhood where tenants tend to stay longer? Knowing this helps you choose properties that will keep bringing in that steady income.

So, take your time, do your homework, and remember that each property is a long-term part of your retirement plan.

Smart Ways to Finance Your Rental Portfolio

I’ve seen investors use several different approaches, and each has its place in your retirement strategy.

Traditional mortgages are what most people think of first, and they’re certainly common for a reason. You’ll typically need to put down 15-25% of the purchase price. While this might seem like a lot of cash upfront, it’s actually a great way to leverage your money to control a more valuable asset.

Another one is the self-directed IRA accounts; they let you use your retirement funds to invest in real estate. It’s a great option if you’ve already built up some retirement savings but want to redirect them into rental properties. Just be careful, though—there are strict rules about using these properties, and you’ll need to work with a qualified custodian.

And then there’s the 1031 exchange – an option I’ve seen many successful investors use. Think of it as trading up your properties without taking a tax hit right away. You can sell one property and buy another of equal or greater value while deferring those capital gains taxes. However, always consult with a tax professional (as I always told my clients) before entering a 1031 exchange, as the rules can be tricky. 

What About Reverse Mortgages?

A reverse mortgage works differently than an equity loan. Generally, you borrow against the property’s equity with a reverse mortgage, like a home equity loan. However, unlike a home equity loan, the balance of the reverse mortgage goes up over time instead of down, which is why a payout is required when you die.

You can’t get a reverse mortgage on a rental property, but you could get a reverse mortgage on your own home and use that to purchase a rental property if you’re late to the retirement game and wish you had purchased one when you were younger.

Still, you could probably accomplish the same thing with a home equity loan at a lower interest rate. Be sure to research your options carefully.

It’s important to make sure a rental property is the right investment for you. Before investing, ensure you understand how to calculate your net cash flow from the rental to avoid a bad investment.

Of course, as a CPA, I have to mention tax consequences. They are always there, lurking in the background. Rental properties come with some excellent tax deductions, but when it’s time to sell, be prepared to pay the tax collector. To be perfectly safe, contact tax consultants for changes, as they happen all the time and it can be hard to keep on top of all of them.

Before you get carried away with your real estate investing, read these important lessons and always check with a certified tax professional who knows the ins and outs of real estate investing to ensure you’re getting the most up-to-date tax advice possible. Tax laws change constantly, and you don’t want to be caught off-guard!

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