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Is Retiring with Rental Properties the Right Move for You?

At HomeLight, our vision is a world where every real estate transaction is simple, certain, and satisfying. Therefore, we promote strict editorial integrity in each of our posts.

When you think of retirement planning, a handful of common strategies come to mind: 401ks, IRAs, stocks, bonds, CDs, money market accounts. But rental properties offer some can’t-be-beat perks, too, like multiple sources of income, and greater control over your assets.

“My philosophy is, it’s better to earn rent from an income property where you’re the one in control of your investment,” says Brad Korb, a top Los Angeles agent and investor who owns 11 buildings and over 80 doors.

“When you have your savings invested in company stocks, you never know if the company you’ve invested in is going to be bought up by another company, or broken up and sold off piecemeal.”

Sounds great, but real estate isn’t a liquid asset and can leave you with a lot of overhead, too. Before you take the plunge into retiring with rental properties, take a look at these frequently asked questions to help you decide if investing is the right move for you.

Source: (Gutesa/ Shutterstock)

What are the upfront costs I’ll pay to purchase and set up a rental property?

When you set out to buy rental properties, you’ll face three types of immediate expenses: the down payment, closing costs, and renovation funds depending on the condition of the home.

Down payment

As with any house purchase, the biggest upfront cost you’ll have is the down payment.

“It’s standard to have a 20% down payment to get a mortgage on a rental property,” says Steve Behringer, a senior broker with Kruse Acquisitions and private real estate investor who currently owns 68 single-family rental houses.

And when you’re buying a rental, it’s almost like you’re a first-time home buyer again. You won’t have the proceeds from the sale of your primary residence to put towards the purchase of a rental. However, you won’t have some of the other benefits afforded to first-time home buyers, like the low 3% down payment offered to new homeowners by some lenders.

Since it’s a rental property, aside from the down payment, your lender will probably require you to have additional cash on hand to cover vacancies and unexpected expenses.

“Depending on the loan requirements, you may also need an additional six months worth of mortgage payments in reserves to cover vacancies and other expenses—especially if you’re a first-time rental property investor,” advises Behringer.

Having an additional six-months worth of mortgage payments in reserves may sound nuts, but lenders need the reassurance that you’re financially covered in case your inexperience results in some unexpected expenses.

This also reassures your lender that you can afford to cover carrying costs for any period you’re without a renter in the property. These include the mortgage payment, property taxes, home insurance, maintenance costs, and any HOA fees.

Closing costs

Aside from a 20% down payment and an additional, sizable sum in cash reserves, you’ll also need enough money on hand to cover standard buyer’s closing costs, such as appraisal costs, title company fees, loan fees, and insurance.

While you may be able to roll some of those costs into the mortgage, be prepared to cover things like an appraisal, title company costs, insurance, and recording fees.

Typically, closing costs run anywhere from 2% to 5% of the purchase price of the house. So if you’re buying a rental property for $150,000, your closing costs will run you anywhere from $3,000 to $7,500.

Rehab funds

Plus, unless you’re buying a move-in ready property, you’ll also need additional funds to get the property ready for tenants.

Rehabbing your rental could be relatively inexpensive if all it needs is a carpet cleaning and a coat of paint, but if it needs work done in the kitchen and baths, you’re looking closer to $10,000 for minor remodels, and over $70,000 for a major overhaul.

Can I buy a rental property with a mortgage?

Having a mortgage on your primary residence shouldn’t hurt your chances at getting a loan on an investment property.

“In fact, having a mortgage can sometimes help you,” says Behringer. “Lenders look at your debt-to-income ratio when you’re qualifying for a mortgage, so any equity built up in your home that’s accessible with a line of credit adds to your accessible assets.”

But a few things can still trip up your chances of qualifying for an investment loan, such as:

  • Glitches in your credit history
  • Lack of funds for a down payment
  • Spotty job history

Depending on your circumstances, you’ll need to spend as much time shopping for your money lender as you do spending time looking for deals on houses. Behringer recommends using mortgage broker to help you identify which lenders allow lower credit scores if you’ve got a solid job history, or which ones say that the credit score is everything, etc. Brokers can go to multiple lenders to find the best deal for you.

If your financial track record isn’t stellar, you’re likely to get turned down in you only look for loans at the big banks. But you might find a smaller bank willing to take a chance on you if you comparison shop.

What are the mortgage rates like on investment properties?

You’ll likely pay a bit higher mortgage rate on an investment property than on your primary residence. However, the condition of the home you’re buying, and how well real estate is selling in your area play a role in determining overall rates. Your lender will look at your personal financial status, including your credit score, assets, and income. They’ll also weigh factors like the loan type and terms, the size of your down payment, and how much you need to borrow.

As of 2019 mortgage rates are still trending low.

“The beauty of it is, if you get a 30-year, fixed-rate mortgage, your rates will stay at that low 4% or 5%, but your rental rate will continue to go up,” says Behringer. “So, you’ll be making more money each year, but your costs stay the same.”

What are the monthly and annual expenses on a rental property?

After the initial purchase, the same types of recurring costs that you have to pay with a primary residence will also apply to your investment property.

Interest

Your biggest expense when buying a rental property is your cost of money—aka how much you’ll be paying out in interest. So lock in at a low interest rate or you’ll be sorry for years to come.

While your interest expenses won’t increase if you get a fixed-rate mortgage, there are other expenses that will increase over time, like your property taxes and insurance.

Property taxes

How much you’ll pay in taxes depends on the property tax rates in your state. Location plays a role in your landlord insurance policy, as do your coverage options and your choice of insurance company.

Maintenance costs

The other major expense you’ll need to pay out as a rental property owner is for maintenance, but it’ll probably cost you less than you’d expect.

“You will have some maintenance costs on your rental properties, but I usually don’t pay out that much for maintenance on a yearly basis,” says Korb. “Water heaters go out every four or five years, maybe a leaky faucet or toilet here and there, or a clogged sewer line. Plus the roof only has a lifespan of twenty years or so.”

Maintenance expenses like these are easily covered by those cash reserves many rental property lenders require their investor borrowers to keep on hand. That working capital can also be used to cover the cost of hiring a property management company to handle all the details, like fielding maintenance requests and collecting rent.

Tenants in a rental property owned by a person retiring.
Source: (Toa Heftiba/ Unsplash)

How will I find and manage my tenants?

Working with a property management company is a good idea for retirees who don’t want to be personally involved in the day-to-day of being a landlord, like maintenance requests.

“I started working with a property management company to take care of my properties so that I don’t personally have to manage them,” says Korb. “Basically, the only time my property management company contacts me is to let me know when I have a vacancy.”

Handing control over to a property management company does require giving up some control, though. You’ll need to authorize their ability to pay for repair requests and other expenses that come up.

However, if you’re just starting out with one or two rental properties, you may want to handle the property management yourself.

“I do advise new rental property owners to self-manage at the start, because it’s important to get a feel for the business, like maintenance calls in the middle of the night,” says Behringer.

“When I self-managed, I had a second cellphone for property management that I didn’t pick up at night, and my tenants understood that. And there aren’t that many calls. Even with 68 houses, we get maybe one call or work order a week.”

The beauty of renting out single-family houses is that you can expect your tenants to do a lot of the heavy lifting.

Unlike condo or apartment complex renters, single-family home tenants need to handle basic maintenance themselves, like the lawn mowing, squeaky hinges, or replacing light bulbs. You can even provide them with extra HVAC filters, with a reminder that replacing them frequently will save them on their electric bill.

When you’re renting out a house to tenants paying their own utilities, those renters are more apt to act like homeowners.

How do I make money from a rental property?

This one seems like a no-brainer: you make money by collecting rent. But that’s not the only way.

There are two different ways that rental properties are benefiting your retirement plan. First, you’ll get a little monthly income by charging more in rent than you’re spending on the mortgage, maintenance, taxes, insurance and other expenses.

“When you have a rental property, that income keeps going up every single year because rents are typically raised once a year. You don’t have to raise them of course, but most rental rates increase 3% to 5% annually to keep pace with inflation,” says Korb.

The second way you’re making money is in the value of the house itself. Not only are you building equity by paying down your debt with every mortgage payment, but the property itself is appreciating over time.

“I make way more money on appreciation than I do on cashflow,” advises Behringer.

“I’ve got 68 houses right now, and each is worth around $200,000. If you add them up, they were worth $12 to $13 million last year. Then apply a 5% appreciation to that number, and those properties appreciated more than half a million in a year.”

Thanks to the IRS, there’s arguably a third way to make bank on a rental property—with a depreciation deduction.

You see, although the land itself appreciates over time, the house itself actually depreciates in value due to wear and tear.

“Depreciation on your rental property is typically deductible,” advise Korb. “Basically, your property has a real estate life which allows you to depreciate the asset which is a great write-off.”

So, even though the properties are going up in value, the IRS says you can write it off as though they’re going down in value.

Multiple rental properties purchased in retirement.
Source: (Daryan Shamkhali/ Unsplash)

Do I need more than one property to retire on the rental income?

This is a tricky question to answer because it largely depends on how much is “enough” for you personally for retirement income. No matter how much monthly income you want or need, the rent from one property won’t cut it.

Remember, if you’ve taken out a mortgage to buy the rental house, a good chunk of that monthly rent is going to go directly toward the mortgage payment. Then you’ll need to cover all those monthly and annual expenses, like property management costs, and property taxes.

So, in the short term, one property won’t add much to your monthly income.

“Based on the current cost of living, you definitely need more than one house if you want to retire on the rental income,” advises Korb.

“We teach our clients how to create their own retirement income through multiple rental properties. Once you buy your first property and turn it into a profitable rental, in a couple years you’ll be able to afford to buy another one. Some of my clients have been doing just that for a long, long time.”

Since you’ll need to purchase multiple properties to help fund your retirement, it pays to get started early. The sooner you acquire multiple properties, the more equity you’ll build up in those properties.

“Let’s say you buy one house a year for ten years. When you’re ready to retire in about twenty years, those houses will have probably all doubled in value based on the rule of 72,” advises Behringer.

“Instead of living off the rental income, you can sell one every couple of years and have $200,000 to $300,000 to live off of. And since it’s not regular income, all you’ll have to pay is capital gains tax on that money. Plus, you’ll still have the rental income from your other properties.”

How will owning rental properties impact my taxes?

As long as you own your rental properties, the only taxes you need to worry about are property taxes—and your depreciation write-off will help offset that expense.

“For retirees making less than $150,000 a year from their rentals, they can take a depreciation deduction on their rental houses,” says Behringer.

“The IRS offers house depreciation tax breaks because the government wants to encourage homeownership—even in a rental situation. Allowing rental property owners to deduct depreciation on an appreciating asset gives landlords a tax incentive to buy houses and rent them out at reasonable rates.”

Of course, the depreciation deduction isn’t completely free money. You will need to pay some of those savings back to the IRS when you sell.

“The only taxes you’ll pay on rental properties is property tax, until you go to sell it. At that time, you’ll have to pay capital gains tax and what’s called depreciation recapture,” says Korb.

Of course there are ways to put off paying those capital gains and depreciation recapture taxes, such as through a 1031 exchange.

“Essentially, instead of the money coming to you when you sell, a 1031 exchange lets you defer paying taxes while your company holds the money from the sale of a property,” says Behringer.

“You then have a short window to turn around and invest that money in another rental property while deferring the taxes on any profits. Ultimately, you can keep on rolling that gain over and over again—and if you pass away without cashing out on those properties, your heirs inherit them on a stepped up basis.”

A sunset near rental properties purchased in retirement.
Source: (Basil Thomas/ Unsplash)

Buying rental properties in retirement: yea or nay?

Investing in rental properties as a retirement strategy comes with a lot of pros and cons. Any cash put into real estate is difficult to access, unless you take out a home equity line of credit, which will cost you in interest.

However, becoming a property-owning landlord lets you make more money in multiple ways—which means your real estate-invested dollars are working harder for you than cash that’s invested in the unpredictable stock market or other retirement accounts.

Still unsure about what to do? Talk over your options with your financial planner and meet with a seasoned real estate agent with investment property experience to determine if rental property ownership is right for you.

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