Investments in real estate are usually considered by investors a bad choice when it comes to funding your retirement – property prices fluctuate, the sector is unpredictable and finally, this class of assets is illiquid. However, many people still use it to save for the future. So, is real estate a good investment for retirement?
It’s true the real estate isn’t as liquid and as trading-efficient as a stock, which is easily purchased and sold. It’s a common misconception that stocks are the largest financial asset class, but according to experts, it’s not exactly true. As of December 2013, for example, the total value of commercial real estate in the U.S. was $20 trillion, which was equal to the value of publicly traded stocks. In fact, the largest asset class was bonds at a total worth of $37 trillion. So, although few people have real estate in their retirement plans, this is actually a great idea. The key is to do it right.
A popular concept among investors is that the worst thing you can do when holding a property is to own it directly. A popular way to invest in a real estate is via real estate investment trusts (REITs). The publicly traded REIT is similar to an ETF (a form of a mutual fund) and is more transparent than registered limited partnerships for example. REITs are liquid, while the fees, associated with them are low, which makes them perfect for investing. The non-traded REITs, on the other hand, although promoted as assets with high potential for dividends and low volatility, are a bad idea – their volatility is not real, but only suggested by their illiquidity, while they lack transparency.
Publicly traded REITs are good options, but for investors and for people with at least basic knowledge or experience in the sphere. For the average person who is expecting retirement, the direct ownership is usually an easier, more comprehensible option. But no matter how you decide to invest your money, you will need help from a certified financial planner. You will need all the information you can get, so start researching and ask your accountant for advice. Before you put your money into real estate, you need to know what exactly you are getting into.
Some people believe that once they buy a property and find a tenant, they will immediately start collecting income. But it’s not so simple. The first question you need to ask yourself is: Can I really afford it? Real estate is expensive, but if you have cash, that wouldn’t be a huge problem. If you don’t have a huge amount of money, which is usually the case, you will need a loan. Mortgages aren’t cheap, as well, and banks typically charge higher interest rates and require a bigger down payment in the beginning for rental properties than they do for owner-occupied homes.
So, calculate well your monthly or annual expenses – mortgage, taxes, upkeep, renovation costs, and so on. Compare them to the expected rent for this particular property and see if it makes sense to buy in the first place. In many cases, the income may turn out to be less than your total expenses. But that’s not always a bad thing – don’t forget that properties always appreciate with time. Even in a slow economy, rental real estate in solid locations will always be in a demand. When something is in demand, its price stays high or goes even higher. So, the rent will always go up, unless another global crisis hits the market once again. There is no way to predict such a thing anyway.
As a result, even if you are making a little in the beginning, you will start receiving more and more over the years. This will be extremely profitable if you consider a fixed mortgage rate. So, let’s summon up the pros of investing in a rental property – it generates a steady income, it will go up in value, ability to fix the mortgage rate, and in some cases there are tax advantages such as depreciation.
The risks on the other hand can be very intimidating for someone who enters the real estate market for the first time. The most obvious downside is the initial investment, but the most underrated by regular retirees is the illiquidity of real estate. It means that it it’s slow to buy and sell. For example, you may find yourself in a situation, when you are forced to sell. But if that happens in the middle of a down market, you risk selling the property at a lower price (if you can sell it at all). Meanwhile, there’s always the risk of not finding a renter, which will cost you a lot. There’s a also the scenario when the tenant don’t pay you.
To avoid stressful situations like these, you should keep savings that will cover the expenses for at least six months. Being a landlord is also not a job for everyone – do you really want to handle tenants, their demands, complainants, and so on? There are property management companies that will deal with everything, but you will have to pay it 10% of the rent, on average.
So, is investing in real estate right for you? It can not only support your retirement or fund it completely, but it’s also a great solution, if you are 10-15 years away from retirement and you know you want to live in a better neighborhood or in another town. And before buying, you will need to know what to look for in a property.
One alternative is to buy a commercial estate such as retail stores or offices, but experts recommend sticking to good single-family homes – houses or apartments in solid, popular areas of the city, in proximity to schools, retail areas, and parks. The property should be able to generate positive cash flow of at least 6 percent above the costs. It shouldn’t be too large or too small and should be evaluated by inspectors and evaluators for its current condition and real price. The most important thing before buying is do your homework – research, ask advice, and read. This is the only way you can avoid financial disaster in the most vulnerable years of your life – your retirement.