Rental income for diversification?

[jm67]

I recently took early retirement (at 56), and currently most of my income comes from renting out two residential properties. The houses are on the opposite coast so I have a property management company handle the day-to-day. But they are still an occasional headache.

I'm considering selling them and just using a 4% withdrawal rate from the proceeds to make up for the lost rental income. But... intuitively I like having a stream of rental income since it's independent of market returns and provides diversification beyond stocks and bonds.

For those of you with rental income, how important is portfolio diversification a factor in having those properties? Or would putting some of the proceeds into a Real Estate ETF provide the same advantages?

 

[Winemaker]

After 24 years in the residential real estate market(6 doors), I realized I'm not in a big hurry to get up on a ladder and paint window trim. We sold them and will close before Thanksgiving. While I will miss the $48,000 in gross rents, it's time for us to move on. They have been an important leg in our retirement income stool, and honestly, we are not getting back into real estate in any form; REITs, RE ETFs, RE stocks or RE preferreds. We made our profits and aren't going back, I'm not looking immediately to replace it/them in current market conditions.

 

[MarieIG]

For OP - I would recommend that you take a deep dive as to tax ramifications before you finalize your plan.

(As an aside, I hold my REITs in an IRA due to tax considerations, although obviously YMMV.)

 

[LateToFIRE]

FWIW, I have rental property, self-managed, and not yet retired from day job. My plan is to sell the rental property upon retirement.

My reasons:

(1) I just don't want the headaches. When everything is going great, it's great, but when problems occur, whether its tenants or maintenance/repair, its real work and real stress.

(2) There are substantial gains locked up in the property relative to the net rental income. So, if I invest the proceeds from the sale in a securities portfolio, I don't think I'll be missing out on any income, though I would probably miss out on a further windfall of future value appreciation. But, you know the saying - pigs get slaughtered - thinking I should just be happy with winning the real estate lotto as it is.

(3) The capital gains tax on the sale is going to be crazy no matter what I do - and the year I sell will push me into the top tax bracket and beyond. There are some ways to mitigate, but its gonna be ugly. Still I need retirement to be RETIREMENT. Money is not everything.

(4) BUT, The considerable after-tax cash proceeds from the sale will pad my taxable savings, and might help keep my taxable income real low in the early years of retirement, which could facilitate a mega-load of Roth conversations.

In terms of diversification, my real estate is a significant component of NW, so to my thinking, converting that to cash and securities is a diversifying event.

[Oh, and adding one more thing - the after-tax cash proceeds would fund 5-6 years of retirement expenses, so would also help reduce SoR risk on the securities portfolio in a big way! Hmm, but I guess depends how I invest the proceeds. Will have to think about that.]

 

[OldShooter]

I had residential rentals for about 25 years but sold everything before retirement. I was managing them myself so had pretty good income but continuing with this didn't fit my concept of "retirement." YMMV, of course.

 

[Sunset]

OP - I also have a LD rental.

My plan is to sell it when able to do so.

If I were in your shoes, I'd plan to sell 1 per year, the capital gains and depreciation recapture for each will possibly result in lot of taxes.

Then I would put the money into Treasuries and other term interest investments, at age 56, you probably need access to cash to live until IRA is available at age 59.5.

I generally view my rentals as long term bonds, that are a PIA, and produce anxiety, along with concentrated risk.

I self manage them, as it's not really too hard and has worked for over 20 years, as I have great tenants.

 

[Another Reader]

I have a fairly large rental house portfolio, out of state. No way would I sell them. I have third party management that I watch closely and I have contractors to do the big jobs. I would not buy in today's market, but I am not giving up the income and tax advantages.

I could never have saved enough in tax deferred paper investments to produce anywhere near the income and net worth the houses gave me. I will buy more if we have another crash. New depreciation!

 

[RetiredAt49]

We have rentals (in retirement). Used their income generating capabilities and we sold one last year to buffer us and prevent SORR. They are worth it IMO but we do plan to sell them all over the course of 5 years.

 

[jm67]

Good feedback from everyone - thank you. I think the stress of maintaining the properties is what's driving me to sell. Too many "what ifs"... (a fire that burns them down, changes in property tax laws, termites, bad tenants, etc...). Also, while the properties are pretty much on autopilot now, they will need some rehab (kitchens, bathrooms) in the next decade, and I'd like not to have that hanging over my head.

 

[Letj]

I recently took early retirement (at 56), and currently most of my income comes from renting out two residential properties. The houses are on the opposite coast so I have a property management company handle the day-to-day. But they are still an occasional headache.



I'm considering selling them and just using a 4% withdrawal rate from the proceeds to make up for the lost rental income. But... intuitively I like having a stream of rental income since it's independent of market returns and provides diversification beyond stocks and bonds.



For those of you with rental income, how important is portfolio diversification a factor in having those properties? Or would putting some of the proceeds into a Real Estate ETF provide the same advantages?

I own a substantial number of properties and live almost entirely on rental income. However, that comes with the headache of dealing with tenants, repairs and turning over the houses (I do my own property management). I found that it’s easier to get into real estate but difficult to get out, primarily because of the tax implications and the unwillingness of property investors to pay what you know your properties are worth. I attempted to get rid of them by renovating and selling about 14 properties over the years but paid a ton in taxes and didn’t enjoy the process of renovating and selling.

I still have a portfolio that I would want to get rid of but I’ve found that people who want to buy rentals are looking for a deal. Even if I were to sell, to avoid the tax, I’ll have to 1031 exchange or DST. Well 1031 doesn’t get me out of the business and coordinating the selling and buying the replacement property can be a nightmare. For one the market is very high now and there really aren’t many profitable deals out there. With DSTs, I lose control and my money is tied up for a long time. So what have I done? Nothing. I continue to hold rentals in the hopes that my children might be interested one day and continue to collect rents which have been steadily increasing lately.

 

[Another Reader]

Good feedback from everyone - thank you. I think the stress of maintaining the properties is what's driving me to sell. Too many "what ifs"... (a fire that burns them down, changes in property tax laws, termites, bad tenants, etc...). Also, while the properties are pretty much on autopilot now, they will need some rehab (kitchens, bathrooms) in the next decade, and I'd like not to have that hanging over my head.

In your shoes, I would have a long, hard look at selling. The depreciation recapture is breathtaking and there are the capital gains to consider. It's tough to replace the cash flow with paper assets and the tax picture is not as attractive.

I would find people to make the properties less hands on, even if you give up some cash flow. Start the renovations now, while you can still manage them, so the properties are in good shape when you can't do them. Consider third party management, but shop carefully. And do the math on the real costs of selling. Ouch!

ETA: Real estate ETF's own mediocre properties in mediocre locations. I cringe at some of the transactions by REITs. They are just not interested in managing efficiently and they don't buy at good prices.

 

[Backpacker]

I'm 59 now retired at 55, we own 4 SFH rentals in 4 different towns, but all within 30 minutes drive. I would really struggle with long-distance rentals. Any management companies I've heard about seem not to really do much for the cost.

I like the monthly income as it has kept us from dipping into retirement accounts. Dw is 55 retired 4 years as well, but she has a pension of about $2600 a month after tax. Between that and rental income, we cover most all expenses. Have used after-tax savings for bigger expenses.

I'm contemplating my exit strategy as well. Hate the idea of depreciation recapture tax hit . I've thought about hiring my son to manage them until I croak, then they'd get a new cost basis for kids.

As others mentioned, selling one per year may help keep your tax level down, depending on how much you'll get from the sale of each house.

For now I just keep self managing and put off decision until I take SS... oh brother, that's another decision I can't seem to figure out [emoji6]

 

[BeanCounter62]

I have the same question.

I own 2 4-plexes (one is a 1031 exchange) - great income. And I like the diversity of income. Property Management company covers most of the work, but it still gets annoying from time to time. So mostly I want to be done with it.

I'm 60 now and also keeping IRMA in mind for timing of a sale (definitely would sell in separate years and will sell the non-1031 building first)

However - the tax hit for selling won't be fun! And do I still want this money to be diversified or do I roll it into the current AA?

No easy answer - so I do nothing.
But maybe it's time to stop ignoring it. I can probably still get it sold and settled by the end of the year.

 

[Finance Dave]

I bought 5 single family homes about 18 years ago to diversify my savings partly into real estate and out of the market. But I didn't want to own rentals late in life for a few reasons:

1) I don't trust many contractors, so I did most of the work myself and I'm now at the age where it's too physical for me
2) I had an agreement with my DW before I got into this...that we would not own any rentals once I reached 68 (or earlier) because I didn't want to burden her with dealing with disbanding a rental business while she was grieving my death
3) As I approached retirement, I slowly moved much of my savings out of the market and into more conservative investments, so the need for diversifying out of the market no longer existed.

For these reasons, and spurred by the recent huge upshot in home prices, we sold all five of our rentals over the past 2 years. We made very large profits, paid large tax bills, and put the rest in our FIDO account and just adjust our AA now using the investments available at FIDO. We still have about 28% in stocks, but the rest is mainly in CDs, GSE bonds, and a few other AAA rated bonds, and we do have TINY holdings in TIPS, copper, and gold.

I would consider who will have to deal with getting rid of the rentals if you pass...that was a big factor for me. If you have kids that have already agreed to take this on, then fine. However, don't leave your spouse with a bunch of stuff to deal with while she's burying you.

Good luck!

 

[Kings over Queens]

For those considering selling but are afraid of the immediate tax bite, you might consider an installment sale. In other words, you hold the mortgage. it's not for everyone, so don't shoot the messenger. For those interested, you get decent return on your money and spread the tax bite over the term of the mortgage.

 

[pjigar]

I am not retired yet and we are keeping them for now. I have sold 1 simply because ROE dropped below my expectation. I plan to keep rentals as long as we are on ACA in order to reduce the paper-income. I will sell them (one every year to reduce the tax bite) at that point. Mainly because I won't be interested in managing them at that age and I don't want to leave rentals to DW or kids when I croak. You must have heard the joke: Let your kids inherit rentals if you don't love them.

FWIW all our rentals are within 30 minute drive. I self-manage them so they are very profitable.