You may have heard that rental properties can be a great way to generate passive income. Rental properties can provide monthly cash flow, protect against inflation, and usually appreciate over the long term. Some retirees swear by rental properties instead of the usual stock and bond portfolio because they don’t have to stomach the volatile stock market swings. Owning rental properties can help fund your retirement, but being a landlord isn’t for everyone. Here’s how to tell if a retirement property is the right fit for you:
How long until you retire? A rental property can take a few years to generate a stable positive cash flow. Some locations are better than others, and you might be able to generate some income right away in some markets. However, it can be much more difficult in western states like California. The good thing about a rental is that it is an inflation hedge. Rent goes up and your mortgage payment remains the same. If you have five or more years before retirement, then it’s a good bet that a rental property can turn a profit in that time frame.
Do you have the funds? You need quite a bit of money to start investing in rental properties. Nowadays, banks generally require a 20 to 25 percent down payment on investment properties, and this is beyond the reach of many middle class investors. You will also need to pay the closing costs and save up plenty of money for maintenance and vacancies. If you don’t have a lump sum to invest at once, maybe a real estate investment trust (REIT) would be a better option.
Repair bills can be high. Can you pay $5,000 immediately for exterior paint or roof repair? A rental property inevitably will need costly repairs. One big repair can push you into negative territory for the year. Many new investors underestimate the repair bills and are surprised by these big items.
Poor liquidity. Rental properties are not liquid assets. If you need a large amount of cash, it will be difficult to get it quickly with rental properties. The housing market has long up and down cycles, and if you need to sell during a down cycle, you might have to settle for less than you’d like.
Do you have other types of investments? Do you have stocks, bonds, annuities, and other types of income-generating investments? It’s a good idea to be diversified. When one asset class is down, others might be up. While rental real estate can be a great investment, it’s also a good idea to invest in stocks and bonds. Income from dividend stocks and bonds can cushion the blow of vacancies and other problems.
Being a landlord isn’t for everyone. Rental properties can be a good way to generate income in retirement, but being a landlord isn’t for everyone. If you are young and have many years until you retire, then you should try your hand at rental properties. You’ll be able to figure out if being a landlord is the right move for you, and you will have a lot of time to turn the property cash flow to positive.
Joe Udo blogs at Retire By 40 where he writes about passive income, frugal living, retirement investing, and the challenges of early retirement. He recently left his corporate job to be a stay at home dad and blogger and is having the time of his life.