Using rental properties to help improve the cash flow in your retirement years can absolutely work.
In fact, it can help you get across the retirement goal line even faster.
However, you have to pick the right location and right properties to ensure you have a stable income producing asset and not just a headache.
First Step in Getting Cash Flow Positive is Financing
A couple of considerations when getting your finances together is that lenders look at owner occupied properties and rental properties differently.
This is mostly because of the ability of lenders to sell-off (securitize) traditional loans (Fannie Mae, Freddie Mac, FHA) to investors.
If an originator (banks) can get you into a loan that can easily be bundled they can get it off of their books, collect their origination fees, and retain little risk. Because of these advantageous terms, the cost to borrow (your interest rate changes) will be low compared to rental.
Not only are interest rates different but so are the down payment requirements. Often times on rental properties lenders will require a 30% down-payment.
This is mostly tied into default risk, which have been historically higher for rental vs. owner-occupied properties. This logically follows in that the need for housing is a base need, and it’s much easier to walk away from an investment that is not meeting expectations than it is your primary residence.
There are a few tactics to navigate the above dichotomy. One way is to buy a multi-family asset and choose to live in one of them.
The second is to work with a lender that retains the loans that they originate, and therefore, can be more generous with lending terms.
Get the Right Price
Your analysis should definitely start with buying an undervalued property in a stable developing market with hopefully a growing population.
Real Estate is always about supply and demand. If you are in a market where rental housing or affordable housing outstrips the available inventory it will cover many of the mistakes you could make.
Have the ability to refinance later because of price appreciation can you get you out of poor financing terms, so “right property, right location” will always be our primary focus.
So how to get a bargain?
I will also work listings from local real estate brokers that I have developed relationships with, which usually gets me a 1-2 day preview before the public offering.
When I start negotiations I will always start at least 20% below offer but what separates my offers is that I have done the research to justify my offer price.
I will understand the condition of the roof and mechanicals and their replacement costs, and often those additional details will help sway the negotiation into my favor.
I’m always willing to walk away from a deal, and will always ensure that I have a margin of safety built into final offer to help cover the inevitable surprises.
Is rental income taxable in retirement?
When trying to maximize income one of the largest considerations is taxes, and this is where real estate really stands out.
There was a recent tax reform in 2018 the helped convert rental income from “passive income” into “qualified business income” (QBI) for small business owners. This designation allows a business to treat this income source like most others, and be off-set by traditional business costs such as property depreciation and SG&A expenses.
However, keep in mind you will have to deal with the taxes at the time of liquidation. The benefit of deferring this is very impactful but we’ll create a separate post to walk carefully through this.
The best source to work through specifics is, of course, the IRS.
This link is a very good place to start working through their dedicated Q&A on the topic.
Ensure You Have a Reserve
As mentioned in Right Price, negotiating a low price is the starting point.
Next, you will have to take some of that savings and invest in the critical systems of that property to prevent problems where the property will deteriorate over time.
Not only does the property need to have a stable (hopefully positive) cash flow, you need to make sure the property value increases over time. Beyond the purchase and initial maintenance, you will also want to have a reserve fund. If you’ve ever owned a home you know things break and tenants expect to have their needs met.
Without available funds, you will start putting off repairs until the next rent is collected which will start to affect how the renters view your care of their needs.
It’s best to promptly address issues, and having a reserve is the only means to do that.
I do believe rental properties are a very good way to fund and sustain a retirement. I always want to be getting back at least 1% in monthly rental income of the total amount invested.
So if I paid $100k to purchase and $20k to upgrade/stabilize, I’m expecting to get at least $1,200 back in monthly income.
Right Property, Right Price, and ensuring you have a rainy-day fund to promptly address property and renter needs leads to a happy long-term relationship that has a profitable and tax-advantaged return.
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