Should Rental Income Be Part of Your Retirement?

“It can be a tool to build equity and then sell it later, or it can be a tool to drive income in retirement and function like an annuity. Typically, investors don’t like the volatility of the stock market, and are looking for something steadier.”

Can mom-and-pop investors make the numbers work?

You might think of the rental market as controlled by gigantic real estate companies. But the statistics show that the smaller ownership range of between one and four units is still very much the domain of mom-and-pop owners.

Of the nation’s 48.3 million rental units in 2017, almost half consist of smaller groups of up to four units, according to 2018’s Rental Housing Finance Survey from the Department of Housing and Urban Development. And of those, 72.5 percent are owned by individuals like Sam Stoia.

The first step of any landlord’s dream is finding a situation where the numbers make sense. If the projected mortgage and maintenance costs don’t cover the potential rental income, then you are taking on a lot of additional stress for not a lot of return (although it could still make sense if you foresee the home’s value rising significantly over time).

This is very much a local equation, since real estate markets vary wildly across the country. But in terms of national averages, the monthly operating and capital expenses per unit were $830 in 2020 dollars, according to the Rental Housing Finance Survey.

Perhaps you have the advantage of already owning the property, having bought in at a lower price point. For example, maybe your kids have grown up and left the house, and suddenly you have more space than you need. Your monthly expenses for renting could be lower than average, particularly if you live in one of the nation’s calmer markets.

But if you are buying rental property now, the math becomes more challenging. The real estate market has been on a tear the last few years: The S&P CoreLogic Case-Shiller U.S. National Home Price Index, for instance, is up 20.55 percent in the last 12 months.

Meanwhile interest rates have been going up, to over 5.5 percent for a 30-year fixed mortgage. If you are taking out debt to make the deal — 59 percent of rental properties have a mortgage on them — that means more carrying costs for you as a landlord. And interest rates for rental property mortgages are nearly always higher than mortgages for owner-occupied homes.

If those initial costs pass muster, then don’t forget about the many costs still to come. That means property taxes, maintenance and repairs, needed upgrades, and all the other bills that drive homeowners up the freshly repainted wall.

“The price of homes has skyrocketed over the past few years, so the purchase price might take more of your retirement savings than you’re willing to spend,” Glink says. “If you do have the cash, don’t forget you’ll need to cover your property taxes, insurance, condo or homeowner association fees, and maintenance of the property. In the first few years of ownership, those expenses might eat up most, if not all, of the monthly rent you receive.”

Some good news is the often favorable tax treatment for property owners. As an example, if the rental property is your primary residence as well, you are exempt on capital gains taxes from a sale on $250,000 in profit if you are single, or $500,000 if married and filing jointly. (Ask your tax adviser about the tax ramifications if you live in part of the building you rent.)

Also, remember that “generally, qualified rental expenses (like property taxes, mortgage interest, operating expenses and repair costs) are tax-deductible,” Pinnegar says. Depreciation is another key tax benefit: Since apartments get run down over time, you can spread that depreciation out over a number of years and benefit from the deductions.

With any sale, you can also consider what’s called a 1031 exchange, whereby you defer taxes by purchasing another property. For all such matters — including estate taxes, for passing property on to your heirs — consulting with a well-versed CPA is always a good idea.

Room for error

As a landlord, you do have options that can help things go smoothly. For instance, many firms offer tenant screening, to ensure creditworthiness and eliminate candidates with red flags like criminal backgrounds. You can also hire professional management to handle the day-to-day affairs. That will obviously come at a cost and reduce your profit margins, but at least you won’t have to deal with plumbing problems at 2 a.m.

As for Stoia, he likes the idea of his retirement plan being the four walls around him, instead of just abstract numbers in an investment account. This way he won’t be a burden to anyone in retirement, and he’s building equity and creating a legacy to pass on. “Ideally you want your rental property to be where you live, and this enables people to spend their retirement in their forever home,” he says. “I think it is a great way to subsidize retirement.”