Skip to Content

Get a FREE assessment of your rental property. Start here!

Get a FREE assessment of your rental property. Start here!

Retirement Income: Have You Considered a Rental Property?

Most Americans find saving for retirement income difficult. Today, the key ways this is done is through Individual Retirement Accounts (IRAs) and 401K plans. These are great savings vehicles because the money saved is often deducted from your taxable income, and interest accrues without taxation until the funds are withdrawn.

There is an additional retirement income investment opportunity most people never consider: buying a rental property. If one buys the right property and manages it well, it can easily become an additional retirement nest egg. By diversifying investments, one can also mitigate risks from stock market volatility with a more balanced portfolio.

Generally, an investment property such as a three-bedroom single family residence requires a 20% down payment. That’s the biggest hurdle to be overcome – saving for the down payment. (A future post will discuss ways IRA money can be used to buy an investment property.) Over time, a rental property can basically pay for itself using tenant rental payments to cover the mortgage and other costs. At the end of a 30-year mortgage, much of the rental income becomes an annuity to the owner, and the value of the property will have risen dramatically.

Following is an example to demonstrate the point. This example ignores the tax advantages of depreciation and operating cost deductions for the sake of simplicity.

Assume an investor buys a median priced existing home and puts 20% down. The rent for the property would be $1,379 which is the median rent for a 3BR single family residence according to RentRange. Add average maintenance costs, insurance, property management fees and property tax expenses, and this investment would lose just $230 per month for the first year. With rental prices rising, the loss would become a profit in just a few years. (All estimates based on March 2017 online data sources.)

 

Median existing home price in U.S. (Source: YCharts 1Q17) : $236,400

Down payment @ 20% : $47,280

Monthly median rent for 3BR single family residence (Source: RentRange): $1,379

Monthly mortgage cost @ 5% interest (Source: YCharts ) : $1,015

Monthly maintenance & repairs @ 1% of home value (Source: Zillow) : $197

Insurance (Source: Vale Penguin) : $80

Management fees (Source: RPM estimate of average property management fees): $138

Property taxes (Source: WalletHub): $179

Monthly estimated cost: $1, 609

Monthly net loss/out-of-pocket expense: ($230)

 

The first year’s annual out-of-pocket expense would be $2,760 , yet the average growth in the value of the house would 3.4% per year ($8,037) according to Case-Schiller data from 1968 – 2009. Over time, rents will increase, so each year the out-of-pocket expense would drop.

When the mortgage is paid off in 30 years, the net monthly retirement income would increase by the mortgage amount of $1,015. Since rental rate growth keeps pace with inflation, the actual monthly income will likely be substantially more.

In addition to the cash flow from the property after 30 years, the property value will increase over time. Assuming an average 3.4% property value increase during the next thirty years, the $236,400 house value will become $477,528. If converted to an annuity with a 2% return above inflation, it would produce $2,500 in monthly retirement income for 30 years.

As this example demonstrates, a rental property investment can basically pay for itself after the initial down payment is made, and becomes a source of on-going retirement income thereafter. Since the actual cash investment was $47,280, the return on invested cash is tenfold. If sold in retirement, the property would yield a payout of nearly half a million dollars.

Not many IRAs or 401Ks can be expected to deliver that type of return. The main reason is that 80% of the initial property cost is paid by a bank via the mortgage process. The loan funds are being leveraged. Investors receive the full benefit of housing price appreciation, despite only putting 20% down.

The biggest complaints property investors have about rental properties is the time and hassles they can present. By hiring a Real Property Management office, these issues are overcome. We find and screen tenants, collect rents, manage maintenance, and handle the bookeeping. This type of investment can be as easy and carefree as an IRA or 401K. And the benefits include excellent returns, reduced risk from a balanced portfolio of investments, and tax benefits.

Want to learn  more about Real Property Management’s services in the Middle Georgia area? Contact Real Property Management Vesta.