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Should Rental Income Be Part of Your Retirement?

The pros and cons of being a landlord in retirement

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Everyone has some kind of plan for income in retirement, whether it’s a pension, or stocks and bonds, or Social Security.

But Sam Stoia has an intriguing retirement plan: He’s living in it.

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The lawyer from Jersey City, New Jersey, bought a three-family brick row house in 2003; he lives on two floors and rents out two other floors as one-bedroom apartments. He’s 57 now, but as he starts planning for his retirement years, here’s the best part: The rental income covers his mortgage and maintenance costs, so he’s basically living for free.“I often say that I wish I did this sooner,” says Stoia, who specializes in family law. “I like being a landlord.”

For some, being a landlord can be an ideal way to supplement other sources of income and to make sure you don’t outlive your savings. It can also be an opportunity to leave a family legacy and pass on assets to the next generation.

For others, the idea of dealing with constant tenant hassles is not exactly what you envisioned for a period when you are supposed to be gearing down and enjoying life a bit more. And knowing where you fall in those two camps is a very much a personal decision.

An alternative to stocks and bonds?

Real estate is an intriguing option for retirees, and especially appealing considering the current stock market plunge. Stocks can be volatile, and 9-to-5 jobs have to be given up at some point — but real estate can keep generating monthly income no matter what your age.

Just go into it clear-eyed: This is not exactly passive income. Being a landlord will require a lot of you — from the initial stage of identifying a property that will be profitable, to amassing the capital needed to make it happen, to the ongoing costs of mortgages and taxes and upkeep, to the daily headaches of maintenance.

“Are you a natural landlord?” asks Ilyce Glink, real estate expert and author of 100 Questions Every First-Time Home Buyer Should Ask — and owner of a Chicago rental property herself. “There’s a fair amount to do, including leasing and maintaining the property, and keeping track of expenses. If you’re not a people person, you may find other ways to generate additional cash flow that require less time and attention, and with a lower annoyance factor.”

Despite the hassles, owning real estate for rent real estate “has been a retirement strategy for much longer than I have been around,” laughs Bob Pinnegar, president and CEO of the National Apartment Association, which represents more than 92,000 members and their 11 million rental units worldwide.

“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.

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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.”

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