Real Estate for Retirement Income: What to Know

You might consider investing in real estate if you’re facing retirement and short of funds. Income property “can be an important bridge to retirement for those without quite enough to retire in the traditional sense,” says Jeff Camarda, a real estate investor and CEO of Jacksonville, Fla.-based Camarda Wealth Advisory Group.

Real estate is such an inefficient market that it’s possible to find awesome bargains with very high returns on investment, says Camarda. And you can collect more income if you can manage the property yourself. A rental property can produce significantly more income than traditional passive investments if you purchase the right property at the right price and on the right terms, according to Camarda.

Key Takeaways

• Rental real estate can be a good source of retirement income.
• The relative inefficiency of the real estate market can produce bargains that offer strong returns.
• Do so before you retire if you have to borrow to buy a rental property.
• Choosing a good location is more important than finding the cheapest property.
• You should look to earn about 8% per year on your investment after costs.

How Much Money Do You Need?

You’ll want to take action before you retire if you plan to finance your purchase with a mortgage, says associate real estate broker Janice Leis who serves the premier residential areas of Philadelphia and South Florida.

Mortgage lending guidelines typically require that applicants be employed and have at least two years of steady employment history in the same occupation. Lenders also require a substantial down payment if the buyer won’t be occupying the property, typically 30% or more, says John Walters of the LeWalt Consulting Groupe in St. Petersburg, Florida.

Don’t overlook the costs of the transaction itself. You’ll want to make sure you have them covered. They can be and typically are included in the overall cost of the purchase but this can increase the amount you have to borrow and/or come out of pocket to cover. The most common of these are commissions paid to the agents who handle the sale. The seller typically pays them but they usually increase the sales price of the home accordingly.

Note

A lawsuit against the National Association of Realtors (NAR) on behalf of home sellers was based on broker compensation and settled in early 2024. NAR agreed to pay $418 million and it has responded by prohibiting offers of compensation on the Multiple Listing Service (MLS). But be aware that brokers can still negotiate compensation privately.

Consider using your IRA funds if you don’t have the cash to make such a large down payment. All equity growth and income from rental receipts will grow tax-deferred inside your IRA, Walters says. Purchasing the property with funds inside a Roth IRA on which you’ve already paid taxes means all your earnings and equity can grow tax-free.

Remember Recurring Expenses

You’ll want to think about how you’re going to cover recurring expenses after you’ve figured out how you’re going to buy the property. Owning residential income property is like owning a principal residence in that there are variable expenses outside the mortgage, says Rob Albertson, a residential real-estate agent with Realty Austin in Austin, Texas. There are maintenance costs for minor items like leaky faucets and major items like a new roof.

And don’t forget about the costs associated with marketing and the loss of income during periods of vacancy and tenant change-over. Albertson says to factor no higher than a 92% occupancy rate into your calculations even in a hot rental market. Be conservative in your estimates of expenses and income.

Tax Benefits and Liabilities

There are also tax benefits and liabilities to consider. Walters notes that one of the chief benefits associated with rental property is the ability to claim a depreciation deduction on your federal income tax return.

Depreciation reduces the value of your property each year to approximate wear and tear. It also lowers your tax bill each year if you claim it but it also reduces your cost basis so you could pay more in taxes if you sell the property at a profit.

Important

Discuss the financial feasibility of your plans with a CPA, a real estate attorney, and an insurance agent to see how much everything will cost, Leis advises.

Choose a Location

Buying cheap won’t help you earn a return on your investment if you can’t find renters who want to lease the property, notes Jenny Usaj, managing broker and owner of Usaj Realty in Denver, Colorado.

“While the price will be higher in better areas, the time marketing the property will decrease as well as the time it might sit vacant,” she says. Start near downtown or a college campus if you’re unsure where to find rentals. Rental residences often follow employment opportunities.

It’s also important to look around the neighborhood and purchase a property that reflects the area’s current demographic, Usaj says. “Is the area populated with single adults or families? Will a one-bedroom or three-bedroom residence be more appealing to the renters nearby? Again, be careful not to jump at the best bargain on the market. Make sure the property will appeal to the lifestyle of the area.”

What Will You Earn?

“You want to earn 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 rate allowance.

You want to earn a net income of $8,000 a year if you invest $100,000 in the property, he says. The reasoning behind the 8% rule is that it compensates you for the risk and relative illiquidity of your investment. Your costs will decline and your income will ultimately increase if you or your spouse can work on the property by doing repairs and maintenance or managing the property, he says.

Potential Problems

Investment property owners could run into some problems, including renters who fail to pay, excessive maintenance costs, and difficulty finding tenants, says Cameron Novak, a real estate broker and owner of the Homefinding Center in Corona, California.

Working with a reputable real estate agent with references to find your investment property is also important, he says. Many municipalities impose stringent inspection regulations and fees on landlords who want to turn owner-occupied properties into rentals, says John Braun, a real-estate attorney with Young Goodman Brown in Minneapolis and a seasoned real estate investor.

Potential investors should look into these issues before committing to a purchase. They should also be aware that homestead exemptions don’t apply to investment properties, which can mean higher property tax bills.

Rental property isn’t entirely a passive investment. “Owning residential income property is not a hands-free affair,” Albertson says. “If you don’t want to manage the property, or can’t, as in you live out of town, you’ll be looking at 8% to 10% of your gross rents going to a management company to cover rent collection and repair requests.”

Why Are Roth IRAs Tax-Free?

Roths aren’t entirely tax-free. You can claim a tax deduction for contributions you make to a traditional IRA in the year you make them but this isn’t the case for money you contribute to a Roth IRA. You’ll pay tax on the income you invest in a Roth but you won’t pay tax on it again at the time you withdraw it and take a distribution.

The growth of the money in a Roth IRA is tax-free as well, subject to certain rules that aren’t difficult to meet. Your property can appreciate over the years and that value is exempt from taxation if you meet the rules.

Is a Reverse Mortgage an Option?

You’re effectively borrowing the equity you’ve built in your residence when you take out a reverse mortgage and you have to repay the loan if you move out. But you can use the loan proceeds however you like if you continue to live there. You must also maintain the property up to FHA standards and continue to pay for the insurance and property taxes.

No payments are due on a reverse mortgage provided that you live there and meet the rules but your home acts as collateral and will be sold to repay the debt should you move out or die.

Why Is Real Estate Considered an Inefficient Market?

Inefficiency translates to “slow” in the real estate market. You typically can’t sell real property quickly if you find yourself in urgent need of cash. Values can rise and fall frequently due to changing market conditions.

The Bottom Line

Would-be landlords should evaluate their temperaments before jumping into property ownership because the job involves dealing with a variety of personalities. Selecting the right tenant is key.

Thorough screening is crucial, says Albertson. “This is the person you’re entrusting with your retirement asset so you’d better be sure you’re not setting yourself up for disaster or numerous headaches.”

Read the original article on Investopedia.