Rental Property Investment

Rental real estate can be a good option for some people. There are several advantages of owning a rental property. Tenants pay you rental income. Your property can appreciate due to market conditions and/or sweat equity (home improvements). It can provide you with sizeable tax benefits (deduction of operating costs, depreciation, etc.). Rental property can also help diversify your overall portfolio. Finally, it can act as an inflation hedge as rent will typically increase along the lines of inflation.

There are several disadvantages of rental real estate as well. It can be costly to buy, manage, and maintain. There’s a risk that tenants don’t pay, the property needs more repairs than planned, and the real estate market drops. Rental real estate is a business and it can also take up a lot of your free time.

For people thinking about owning rental property, here are some things to consider:

Would you still have substantial assets outside the rental property? If not, you could be putting a lot of your eggs in one basket. A rental property should help diversify your portfolio, not concentrate it. Also, having other assets to pull from can help smooth out and relieve the stress of tough times.

Do you have enough income (from other sources) and emergency reserves to bridge negative cash flow periods? There may be times when you have negative cash flow, either due to repairs or the property being vacant. You may have substantial assets, but if they’re tied up in 401(k) plans and IRAs, you may be hesitant to pull from those accounts. Having excess cash flow and/or an emergency reserve account would be beneficial.

Are you handy? If so, you could do a lot of repairs yourself and save money. If not, you may need to spend more money than you’d like on maintenance and home improvements.

Do you have the time it takes to properly manage the property? Advertising, vetting tenants, making repairs, and keeping the books all take time. If you already work long hours, are busy with family, or simply don’t want to give up your free time, you should consider a property management company.

Will you use a property management company? A property management company can help you manage and maintain your property. You may hire one out of necessity (you’re unable to deal with it yourself or the property is too far away) or convenience (you’d rather do other things with your time, etc.). Either way, their cost will cut into your profits, so make sure you factor that in when deciding whether or not to pursue rental real estate.

Assuming you have the risk tolerance and capacity (assets and income) for a rental property investment in retirement, here are some of your options:

Keep existing property: You may already own a rental property and you’re wondering whether to keep it. As noted above, if you have other assets and income sources, it’s probably providing a decent amount of diversification. If you have good cash flow, no major maintenance issues, and you expect further appreciation, then it’s probably a solid investment. However, if things aren’t going well, it may be time to consider disposing of the property.

Buy new rental property: A traditional rental property could be a condo, single family home, multi-unit building, or even commercial space. They are not as glamorous as vacation rentals, but they could be a great source of inflation-adjusted retirement income, long-term appreciation, tax write-offs, and diversification. Learn about the local real estate market and work with a realtor that understands rental properties (and hopefully owns some themselves). As the real estate adage goes – make your money when you buy, not when you sell.

Buy vacation rental: A benefit of a vacation rental is that you can use the place yourself. Thus, this investment is often looked at through dual lenses. It’s a rental which provides income and hopefully appreciation, and it’s also a free place to stay, cutting down on vacation expenses. Location, location, location is very important for a vacation rental as most people prefer to be right by the beach, slopes, or other area attraction. That means the property will be more expensive and have higher ongoing costs (if financed), or take up more of your assets. Income can fluctuate wildly throughout the year as there’s likely a high season and a low season. If you have a mortgage and other costs (HOA, etc.), you’ll definitely need a source of funds to pay the expenses during the off season. Vacation rentals may also have more upkeep associated with them because of the turnover of renters and their location (sand, salty air, snow, etc.). If you’re only looking at it as an income investment, you’d probably be better off with a traditional rental property, since they tend to have a steadier cash flow. However, if you think you’d vacation a lot in the rental yourself and you don’t mind strangers staying in your place, then a vacation rental could be a decent option.

Quarter / Fractional ownership: Typically you would find fractional ownership associated with vacation properties, so the issues surrounding them are similar. You will probably have less risk, but also less return. It could be less risky because your investment isn’t as big (as if you bought the whole property), and you have other owners to split major expenses with. However, you should also expect less return because you have to split rental income amongst the owners and these properties are typically bought at a considerable premium, so you might not get the appreciation of a regular vacation rental.