Real Estate investment properties can represent an excellent revenue stream in retirement. For this reason, many clients are curious as to whether investment properties represent a sound investment when planning for retirement. As with any financial decision, it is important to consult with a financial advisor when you are determining whether investment properties can be beneficial for you.
Should I Purchase Investment Properties?
One of the most common questions we get at Bull Oak Capital is whether or not a client should purchase real estate investment properties. The truth is that there is no one-size-fits-all answer to this question. Whether or not you should purchase investment properties is influenced by a variety of factors, including how far away you are from retirement and how much of a cash surplus you have at the end of the month.
An additional factor to consider when deciding whether you should purchase an investment property is what type of investor you are. Investment in real-estate takes time to produce a positive revenue stream. This can make investment properties less than ideal for those investors who lack patience. Additionally, the real-estate market can experience short-term volatility that can threaten the value of your investments. Thus, investment properties may not be ideal for risk-averse investors.
The Pros and Cons of Investment Properties
There are some significant positive and negative aspects to investment properties that should be weighed when considering whether they are a sound financial decision. One of the main advantages of an investment property, and what prompts many to begin building a real-estate portfolio, is the idea of a steady stream of rental income during their retirement years.
To be sure, a real-estate portfolio can be advantageous during retirement. The additional revenue provided by a real-estate portfolio can help reduce the withdrawal rate from your retirement portfolio, while also allowing you to delay drawing social security. For some, the added financial security provided by additional revenue streams can offset the downsides to investment properties.
The first downside to building a real-estate portfolio is that it takes time. Whether you are investing in a single rental property or a number of properties, the time it takes for your properties to generate a positive cash flow can be extensive. While a short-term profit can be generated through real-estate investment, these profits are unpredictable. In order to ensure that your real-estate portfolio remains profitable over time, it is advisable to approach investment in properties from a long-term perspective. This requires patience and the knowledge that you may not see a positive cash flow from the property for some time.
The second downside to investment properties are the ancillary costs associated with them. There are a variety of costs associated with owning and operating an investment property. These include higher property taxes, property insurance, fees charged by a property management company, and maintenance costs.
Investment properties also come with the added stress that managing them entails. Many investors choose to rely on a property management company to handle the day-to-day business of operating a property. However, utilizing a property management company also comes at a cost, usually resulting in a reduction of the net income generated by the property of up to 10%. By working with an experienced property management company, investors can reduce some of the stress associated with managing investment properties, but finding the right company to work with can be a process of trial-and-error.
Lastly, investment properties are an illiquid asset. They cannot, in general, be quickly sold. Additionally, if an investor wishes to sell the property they will be required to cover transaction costs totaling roughly 6%. Because of this, it is particularly important to carefully consider the long-term financial viability of any property investment.
How Long Will It Take Before I Break Even?
Each real-estate portfolio will have a different timeline associated with it before the investor breaks even. A positive cash flow is the ultimate goal of a real-estate investment, but producing a reliable and passive income stream from your investment properties takes time. Assuming you make a down payment of 20%, and pay off the remaining debt in a timely manner, you will achieve a positive cash flow much sooner. How long that takes depends on your specific situation. To see an example of the long-term profitability of investment properties, read our blog post on the subject.
Other Investment Opportunities
Investment properties can provide an excellent revenue source during retirement that supplements other investments in your retirement portfolio. Making your real-estate portfolio the predominant component of your retirement strategy has some associated risks. Investment properties achieve a long-term positive cash flow as the mortgage is paid off alongside steadily rising rental property fees. However, the value of your investment property is integrally tied to market conditions. Local fluctuations in the real-estate market, or a widespread economic downturn, can have a marked impact on the profitability of real estate investment property. As such, it is important to rely on investment properties as one part of a total retirement strategy that includes other investment opportunities.