Investing in real estate for retirement

[smr91481]

I'm currently 35 year old with only around $130,000 in my 401k. My dream has always been to own real estate and I believe that the key to me having a good retirement is owning some paid for rental properties.

I'm having a tough time deciding which route to take. My current residence is worth around $190k. I owe approximately $157k. This is definitely not the house we want to spend the rest of our lives in, so my plan was to start aggressively paying it down to zero and then make it my first rental. I figure this will take about 5-6 years.

We would then use the rent from the first house to help aggressively pay down the next house we purchase in about 5 years, then make it the next rental.
If we keep repeating the process, the next one would take about 3 years, then 2.5, etc... keep rinsing and repeating.

That seems like the safest way to go. My only problem is that I can be impatient, and waiting to pay my house off in 5-6 years to get started feels like it would be an eternity. The other side of me wants to go out and finance my first rental now and get the ball rolling.

Any advice on whether it would be better to buy one house at a time and pay it down, or to leverage multiple properties and try to build a big portfolio?

 

[Starsky]

The challenge with leveraging multiple properties is that lending for single family rentals is classified as a rental mortgage rather than a commercial investment in commercial property; and your ability to leverage multiple purchases will be limited by your personal income. If you are willing to take more risk, you can get highly leveraged SBA loans on qualifying multiple-unit apartments - that qualify as commercial property - on the basis of the numbers themselves.

Personally, I think Banks value cash more than equity. In other words, the ability to make a larger down payment and lower the loan to value ratio is probably worth more than having equity in my current home. Unless you've recently refinanced, having more equity doesn't usually translate into having more money in your pocket to pay the new mortgage every month - so it's not worth much until the loan is paid off completely. If you have a very good interest rate, you might want to hang onto your mortgage and let your cash work for you.

I also have a few friends who play around with REITS and often offer apartment building partnerships to investors in $50K+ blocks. I find a lot of those REITS are financially structured for people who have a lot of income and a big part of their ROI is to use the investment to recapture future taxes due by taking large deductions at the highest marginal rate.

There is also the issue of rising real estate prices and ROI on rentals. The market has tightened significantly in my markets and finding the right properties at the right prices is more challenging than it has been in the recent past, especially with rising interest rates. I see increases in rents lagging way behind increases in home prices.

I think returns are very market-dependent right now and your local market may or may not be a good place to invest. I wouldn't plan on using your 401K for those investments though, so structure your savings wisely and research your market.

Years ago we started our rental career by selling our single-family home and buying a big triplex that we lived in until we decided to get our own place. It worked out beautifully. Something like that might be a viable option too...

One last suggestion, if it makes sense for you: when you are putting together your savings strategy - after taking full advantage of company matching funds - try and save the bulk of your tax-deferred savings in the older spouse's account. If you are more than a couple of years apart, it could be valuable to have penalty-free access to that money sooner, when the elder spouse turns 59 and a half. In our case we are 11 and a half years apart and both work. It was a huge part of our strategy; and we took full advantage in 2011 to bulk up our single-family rental portfolio.

Good luck!

 

[NgineER]

Here are my thoughts...
You get the best rates when you get a conventional mortgage and live in the property. I believe you have to live in it for two years to not be dishonest when signing mortgage application.
You.need to make sure you cash flow with a mortgage payment and 50% expenses.
Do what starsky did and buy a multi family and live in one unit. Conventional mortgage still applies for less than five units. Get 30 year mortgages and once you have enough properties, start paying them down.

My family is too big to want to move every two years, but it is a great way to access the lowest rate loans.

 

[evilanne]

You actually don't need to pay of the first before buying a new home, however, you do need to make sure that it can be rented for more than the mortgage plus any other expenses, that you have 20% down payment for new home and income + emergency fund/savings to cover both mortgages in the event it is vacant for any period of time. When I moved to a different state, I kept my prior home as a rental and eventually paid it off. The depreciation, taxes, interest, management fees and other expenses reduced the taxable rental income while paying off the mortgage and now it provides decent income stream. I would recommend having more equity in your current house before making it a rental but I'm rather cautious when it comes to debt. I've been lucky in that it has been consistently rented with very little turnover but there are risks as renters often don't properly care for the property and some can cause a lot of damage.

 

[brucethebroker]

Currently own some rental homes in semi-retirement, which we have owned 20+ years and are paid off. Makes a huge difference in your retirement cash flow. Down market in Real Estate? No problem, our rents stayed the same through 2007-2010 downturn. Great for total AA.

Now, looking back over 30 years of Real Estate investing, what would I change? Sold the first 3 homes we lived in as we moved up to "nicer" personal homes. Should have kept them!

So, my suggestion is to find a new home, and rent the one you currently own, (don't worry about paying it off until you are about to retire). Ask your mortgage broker (experienced in rental financing) how to qualify for a new mortgage without selling. We were able to bring a siqned lease to the lender, and they gave us 75% credit for the monthly rent (numbers could be different now). That is if you have enough cash for a down payment. Lender may be OK with 10% (with PMI) or 20%. Repeat the process every couple of years.

Pros: lower interest rate on new owner occ home than if you get an investment loan, and easier to get (less downpayment). You already know your existing home-many repairs have already been made, etc.
Cons: loss of free capital gains treatment (2 out of 5 years rule) should you sell. The numbers may not result in immediate positive cash flow. (personally, I would look long term and not worry as long as I broke even each year).

I have discussed this strategy with my adult kids. One is doing quite well with it.

BTW, even 2-3 paid off rentals in retirement can be a huge difference maker. Good luck.

 

[pb4uski]

One risk of your plan is geographic concentration... if the area that you are in faces economic difficulty then you're screwed... that is why I prefer stocks... easy diversification. Though I manage a commercial property for my Mom that does well

 

[Freedom56]

I'm currently 35 year old with only around $130,000 in my 401k. My dream has always been to own real estate and I believe that the key to me having a good retirement is owning some paid for rental properties.

I'm having a tough time deciding which route to take. My current residence is worth around $190k. I owe approximately $157k. This is definitely not the house we want to spend the rest of our lives in, so my plan was to start aggressively paying it down to zero and then make it my first rental. I figure this will take about 5-6 years.

We would then use the rent from the first house to help aggressively pay down the next house we purchase in about 5 years, then make it the next rental.
If we keep repeating the process, the next one would take about 3 years, then 2.5, etc... keep rinsing and repeating.

That seems like the safest way to go. My only problem is that I can be impatient, and waiting to pay my house off in 5-6 years to get started feels like it would be an eternity. The other side of me wants to go out and finance my first rental now and get the ball rolling.

Any advice on whether it would be better to buy one house at a time and pay it down, or to leverage multiple properties and try to build a big portfolio?

You should check what homes or apartments rent for in your area before making any decision to buy. Having had rental properties while in my 30's, these are the advantages:

1 - You can depreciate the acquisition price of the rental building (home) when you file your income taxes. This allows you to potentially show a loss through a non-cash depreciation expense while actually accumulating positive cash flow.

2 - Someone else is paying of the mortgage while you build equity

3- Mortgage interest, property taxes, maintenance are all deductible

These are some of the disadvantages:

1- Tenants breaking leases

2- Tenants damaging property

3- Tenants not paying rent

4- Unless your property is local and you are a handyman, you will need a plumber or electrician that you can call to address issues.

5- Carrying your mortgage while your property is vacant.

I rented two homes from 1995 through 2003 during the technology boom era. The home were in an upscale neighborhood and I rented only to corporate relocation clients. I rented to professionals whose companies would back up their leases. I had multiple instances where a lease was broken just after 3-4 months but the companies paid me 3 months extra rent for breaking the lease. During that era there were so many technology firms relocating people, my rental homes were rarely vacant for more than 1 month. Those were good times. Then after the technology bubble busting, my corporate tenants became more and more scarce. The real estate agents were bringing me people that were recently divorced with no source of income other than alimony. I did not want to deal with that situation and rather than deal with discrimination lawsuits, I elected to sell my properties and move my money to other investments. I made a lot of money and built up equity quickly through real estate so I have no regrets. However too much of my time was consumed with my properties.

My best advise on real estate investments are:

1 - Buy properties when the real estate markets are down - Now is not a good time in most urban areas.

2- Check the occupancy rates and rents in the area where you are planning to buy

3- Buy only if you are capable of performing basic home repairs or find someone who can at a low cost

In your situation and given the current market conditions, I would pay down your mortgage and wait for the next down cycle.

Hope this helps

 

[nun]

Don't put all your eggs in one basket and don't think that managing multiple properties won't be a lot of work and worry. So start slowly and see if you enjoy being a landlord and that the numbers work.

Having one or two rentals to diversify your portfolio is a good idea and a great source of income. I bought a two family home 20 years ago. I live upstairs and rent out the first floor so dealing with issues is easy and I can keep an eye on the place. I only have to deal with a single renter so the effort is minimal.

 

[euro]

As others have said, now is a very competitive time to get into rental properties in most (but not all) places. Where are you located?
I like the suggestion to pursue a duple/triplex or quad and owner-occupy one of the apartments. This will get you the best mortgage rates, and you live on-site and can directly observe the property (and the tenants).
As far as your current property, it very much depends on its value and on the potential rent you could get. Not all properties make good rentals. if you can't get close to 1% of the property's value in monthly rent (i.e. a house that is worth $100'000 should bring in $1000 in rent per month), it will be hard to make it cash-flow positive unless you have no mortgage. Hanging on to a cash-flow negative property rarely works out over the long term, unless you are in one of those crazy markets like SF, NY, SD and you hope for massive appreciation. That can work, but there is significant risk and it is really more "speculation" rather than "investing".

 

[CaliKid]

I am a big fan of diversification. You might look at buying a turn key rental house in Memphis, KC, Indy, etc.... Great way to start paying down a mortgage with the rents.

 

[OldShooter]

Lots of good comments here. One thing to remember: Over the long haul, average inflation-adjusted housing prices are approximately level. This makes sense because average housing cost cannot rise significantly faster than personal incomes. Obviously there are exceptions up and down in certain geographic areas (as others have pointed out) but the overall trend is clear.

So to really make money you have to leverage using borrowed dollars, and the more leverage the better. As inflation increases the value of the property, your equity increases by the ratio of the borrowed money to your down payment. And you pay off the debt with inflated dollars. There can be lots of risk in this, as others have pointed out, but that is the basic scenario.

 

[kgtest]

rent must be greater than mortgage plus maintenance to cash flow.

You will want to be able to charge 1% of your purchase price on rent at min. If you buy a 150k rental, you charge $1500/month. Will that cover your mortgage, and maintenance fees?

it costs money to buy and sell...so buy low..and sell high.

 

[OldShooter]

... You will want to be able to charge 1% of your purchase price on rent at min. If you buy a 150k rental, you charge $1500/month. Will that cover your mortgage, and maintenance fees? ...

Well, er ... The market will tell you what you can charge and, unfortunately, the market is completely uninterested in your purchase price, completely uninterested in your costs, and completely uninterested in what you would like to charge.

A better way to approach this is to ask: "Will a conservatively estimated market rental price for this unit cover all of my costs." Remember that there is far more to costs than mortgage and maintenance. For example, real estate taxes, management fees if you hire a manager, advertising, permits, promotional rent discounts, tax prep fees related to the property, ... and the list goes on. Just visiting the property costs you money. On the income side, vacancies will affect your cash flow as will legal costs for collections, evictions, etc. Been there, done all that, got the tee-shirt.

Houses are particularly difficult when looking at vacancies because they are binary. You are either collecting 100% rent or you are collecting zero. Apartment buildings, the larger the better for this, produce smoother case flow. Multi-tenant buildings have another subtle advantage, too: If someone is wrecking your property it is likely to involve something that annoys other tenants, so you will hear about it sooner than you will find it on your own.

 

[socca]

A perky young woman approached me in the gym the other day and said that she was looking for 20 people to attend a meeting on investing in real estate. Ouch. Some contrarians might view this as a sell signal.

 

[Fedup]

It's like the stock market. It depends on your horizon. Buy and hold. I know many people sold their houses in California and can't get back here, they are priced out forever.

 

[OldShooter]

A perky young woman ...

ROFL. Reminds me of the story about JP Morgan deciding to get out of the market when his shoeshine boy started giving him stock tips!

 

[OldShooter]

It's like the stock market. It depends on your horizon. Buy and hold. ...

Well, I would say it's not. See my post #11. Unlike the stock market, without leverage buy and hold will on the national average just keep you even with inflation. Observations: 100 Years of Inflation-Adjusted Housing Price History And that's assuming that the property generates enough income to cover its carrying costs. If it doesn't, you lose. You'd be far better buying TIPS.

Yes, you can get lucky and sell into a bubble or into a locally hot market. Just like those happy people shown on the casino billboards.

You can also buy the bubble or a cold market and lose, but nobody puts those pictures on the billboards.

 

[Souschef]

Well, we are sort of renting for life. We bought a brand new manufactured home in a +55 park, where we pay space rent. Fortunately, it is rent controlled.
It is one level,2 BR 2BA, 1400 sq ft and it fits our lifestyle perfectly.

 

[Fedup]

Well, I would say it's not. See my post #11. Unlike the stock market, without leverage buy and hold will on the national average just keep you even with inflation. Observations: 100 Years of Inflation-Adjusted Housing Price History And that's assuming that the property generates enough income to cover its carrying costs. If it doesn't, you lose. You'd be far better buying TIPS.

Yes, you can get lucky and sell into a bubble or into a locally hot market. Just like those happy people shown on the casino billboards.

You can also buy the bubble or a cold market and lose, but nobody puts those pictures on the billboards.

I'm not referring to the rest of the country. I'm in California and that statement refers to California real estate. In the Bay Area, it went up 12% first quarter of 2017, over 16% of last quarter of 2016. Real estate is all about location. I have no idea about the rest of the country.

 

[YVRRocketSurgery]

One of my friends who's in his 30's is focusing on real estate for his investment/retirement strategy. I don't profess to know in detail how he does it but we've had some high level discussions.

I live/he lived in Vancouver where the housing market has been ridiculously hot for the last 15 years and likely in bubble territory. However, he's found inexpensive smaller "housing" (like trailer-type homes) to buy in small towns around the province. The rent is generally enough to cover the mortgages. He has to do the landlord thing, fix and replace appliances and other issues on top of his regular IT job which is flexible in terms of hours and location.
What I could not understand was who in their right mind would pay that much rent that could cover mortgage payments. Why wouldn't they just buy the place themselves and use their mortgage payments to build equity in an asset?
Apparently there's enough demand from temporary workers that don't want to be tied down to a owning a place. So, there is a higher risk of turnover but so far, that hasn't been an issue for him. He's basically continuing to slowly pick up small properties to add to his portfolio and build his cash flow yet has his current job as a safety net.

 

[calmloki]

Many people have horrible credit - many more than I would have thought. Many (my guess) don't have the least idea how to buy a house or the desire to slog through the paperwork and time to find a place. Many have the weird thought that they want to play on the weekends and not have to mow the lawn and keep up the house and grounds. We like to call those people "renters". I fix their toilets, they call me "landlord", and I pocket their "money".

 

[freedomatlast]

Many people have the weird thought that they want to play on the weekends and not have to mow the lawn and keep up the house and grounds. We like to call those people "renters". I fix their toilets, they call me "landlord", and I pocket their "money".

That is a great quote!!

What I did was first buy a primary residence that I was able to pay off in 6 years. Five years after the purchase of the primary residence, when that plan was going well, I bought my first rental. This property spun off enough cash to be able to pay that off in 8 years. It was actually paid off sooner. With that foundation, it gave me confidence to start plowing money into the market via low cost index funds with a buy and hold strategy. I maxed out the 401K and tried to invest equal or greater amounts in low cost index funds outside the 401K. Fast forward 30 years, and I have reached FI. Will make the leap to RE next year.

With rentals, it's all about finding the right property in the right area at the right price and getting and keeping good tenants. I still have the original tenant in one house for almost 30 years. Never a missed payment or vacancy. This makes all the difference in the world between success and failure in the world of rentals.

Being handy and having the ability to do repairs myself quickly and economically, was an important factor for me. Also living close to the property (within 10 miles of the primary residence and work) was also one of my requirements.

 

[Winemaker]

What I could not understand was who in their right mind would pay that much rent that could cover mortgage payments. Why wouldn't they just buy the place themselves and use their mortgage payments to build equity in an asset?

DW and I have been the proud owners of a 4 unit townhouse since 3/2001. I have had one tenant since 8/2001 and one that rented from 4/2001 til 12/2015. My mortgage has been retired for years thanks to these women. If these two women they would have bought an asset, it would have been foreclosed on; as they cannot budget money, live paycheck to paycheck. Sometimes they get months behind but get caught up; I did not charge a late fee.

As soon as I can figure out where I can get the right snowbird location with favorable terms, I will do a 1031 exchange.