For those lacking the necessary means to retire in the traditional sense, income property can be a major bridge to a more comfortable retirement. Because real estate is an inefficient market, it’s possible to find exceptional bargains with very high returns on your investment. This article describes how much you can expect to invest and earn, how to choose a location for your rental property, and how to avoid some problems that might cause trouble if you’re not careful.
How Much Do You Need?
If you plan to finance your property with a mortgage, then you need to take action long before you get ready to retire. Mortgage lending guidelines routinely require applicants to be employed and have at least two years in the same occupation. Lenders also need a large down payment, are as high as 30% or more, if you aren’t occupying the property.
If you’re without the funds to make such a large down payment, consider using your IRA funds. Purchasing the property with funds from a Roth IRA, where you’ve already paid taxes, which means all your earnings and equity will grow tax-free forever. All capital growth and income from rental receipts will grow inside your IRA tax-free. Don’t overlook marketing expenses and periods of vacancy and tenant change-over. Tax considerations will also play into what you can afford.
Depreciation reduces your commercial property value each year, for fair wear and tear, and lowers your tax bill each year you claim it. However, it reduces your present tax basis, and means you might have to pay more tax when you sell. Another of the benefits associated with rental property is the ability to claim a depreciation deduction on your federal income tax returns.
First and foremost, discuss the financials of your plans with a CPA, a real estate attorney, and an insurance agent. Know how much everything will cost.
Choosing a Location
Purchasing the least expensive property won’t help you realize a return on your investment if you can’t find and keep renters. It’s essential to take a good look around the neighborhood and purchase a property that reflects the area’s current demographic. Research the history of the area and know whether prices are appreciating, maintaining, or depreciating.
What Will You Earn?
“You want to realize at least 8% from the capital invested in the rental, net of all expenses,” says John Graves, managing principal of an independent RIA, editor of the “Retirement Journal” and author of “The 7% Solution: You CAN Afford a Comfortable Retirement.” Expenses include the mortgage, taxes, insurance, maintenance, a 10% property management fee and a 10% vacancy allowance.
If you invest $100,000 in the property, you want to be earning a net income of $8,000 a year, he says. The reasoning behind the 8% is that it compensates you for the risk and lack of liquidity of your investment. If you or your spouse can work on the property by doing repairs and maintenance and/or managing the property, those costs will decline, he says.
Foresee Potential Problems
Investment property owners could run into a number of challenges, including renters who don’t pay, severe maintenance costs and trouble finding tenants.
Many municipalities impose drastic inspections and fees on landlords who want to turn owner-occupied properties into rentals. Aspiring landlords should assess their temperament before getting into property ownership.
Selecting the best tenants is key
The best advice I can offer to income property owners is to complete an in-depth tenant screening as possible.
The Bottom Line
Owning income-producing property can be a practical resource for providing retirement income and even leave a legacy to your beneficiaries.
Please call me if you’re interested in improving your retirement through real estate holdings.