In 2005, everyone I knew was buying real estate. With no experience and no money, they bought properties they couldn’t afford and were convinced they were going to make a fortune.
Unfortunately, it didn’t work out that way, and most of them now have a foreclosure or short sale in their past.
Does that make real estate a bad investment? No. It’s an investment. The good or bad part comes from how you approach it. What’s good for one person can be bad for another.
To find out how to make real estate investments work, I decided to talk with a few experienced professionals and asked them whether real estate should be in a retirement portfolio.
“Absolutely,” says Judy LeMarr, a seasoned agent with Russ Lyon/Sotheby’s who works with clients in the Arizona and California areas. LeMarr grew up in a family that was all about real estate, and initially got her license because her dad told her it was something she “just needed to know.” That sounds like good advice.
“The key”, LeMarr says, “is knowing what you’re in it for. Are you looking for current cash flow, long-term appreciation, or are you looking for a flip opportunity? You must know your area.” In the Midwest, you might find smaller residential rentals that will throw off stable cash flow. In other areas near military bases or manufacturing facilities, like Georgia, Kentucky, or Tennessee, your focus might be on Grade B multifamily properties, as you’ll have a steady source of working tenants who will pay their rent.
To make rental properties work, LeMarr advises you look at the age and condition of the roof, windows, plumbing, etc., and keep enough reserves in the bank to cover capital expenses that will come up. Also, plan on holding two months’ rent in the bank to cover turnover costs that occur between renters.
Lukas Krause, chief executive of Real Property Management, also thinks real estate can be a good investment for retirement, as rental rate increases have historically outpaced inflation. “For an individual investor, this means that an investment property bought with a break-even cash flow can become a net profit generator in a couple of years,” Krause says.
He added that rental growth rates do vary by location and said research shows that the three key factors that determine rental rates are the number of jobs, the level of wages, and the amount of available housing in a market. “Smart investors focus on markets with job and wage growth,” says Krause.
Both Krause and LeMarr talk about the importance of doing your homework before you buy. LeMarr likes to focus on finding properties before they hit the mainstream market. She looks for homes where she can go in, make improvements, and then raise rents.
Krause says you must determine a competitive rental rate for the property, and research expenses including capital improvements. Then calculate your cash flows and tax implications before making a purchase decision.
With property, be prepared for the little interruptions. LeMarr recalls one property where all the new blinds came in, but they didn’t fit. These things can slow down the time to market. And of course, with renters, there will be calls and repairs to handle. That’s why Krause says, “Smart investors realize that the value of their time is greater than the fees paid to a property manager, and property management fees are tax-deductible, so they cost less than they appear.”
If diving in to buy an investment property scares you, one way to generate rental income without the commitment of a long-term purchase is to rent out your home, or a room in it, on HomeAway, VRBO, or Airbnb. According to Airbnb’s reporting, seniors, defined as a person over 60 years old, earned a collective $2 billion, globally, from short-term rentals on Airbnb.
Rob Stephens, general manager of Avalara MyLodgeTax says that short-term renting has become very popular and easy, but there are pitfalls. “Nearly all cities and states impose lodging and occupancy taxes that must be paid on rental transactions. Over the past few years, government agencies have increased their focus on short-term rentals and stepping up enforcement tactics to ensure short term rentals are properly registered and paying the correct taxes.”
One mistake to watch out for is making projections that are too optimistic. I’ve seen novice investors make projections as if their properties are rented 100% of the time and if they never have any major repairs. You will have times where your property may be vacant and no rent is coming in. You may have a bad renter that costs you a lot.
I had a bad renter experience myself. I moved from Colorado to Arizona and rented out my Colorado home. My renters paid rent for six months, then stopped paying. They did not respond to calls or emails. I drove to Colorado and discovered they had stripped the house. They stole the shed out of the backyard and stripped every appliance, door handle and fixture out of the property. If you become a landlord, you have to be prepared for these situations.
Overall, rental real estate can be a great addition to a retirement portfolio, but it’s not a get-rich-quick scheme, and it’s not for everyone. Like any business, it takes cash, research, time, and commitment.