Is Real Estate Your Retirement's Secret Weapon?
[OPINION: The views expressed by Investopedia columnists are those of the author and do not necessarily reflect the views of the website.]
If you’re closing in on retirement, trying to put your money to work in a zero interest rate world is not an easy job. Financial writers and gurus are obsessed with the stock and bond markets. But despite the lack of attention, many Americans have fallen in love with real estate as an investment option
- 28 million Americans are real estate investors (according to data shared by Landlordstation.com in 2013)
- 35% of Americans now believe real estate is the best long-term investment (Gallup), compared to 32% who favor stocks
- Stock ownership is at a low point: Just over 50% of Americans have money invested in the stock market (Gallup)
Americans may believe in real estate, but they don’t necessarily do anything about it when it comes to retirement. Real estate plays only a minor role in most people’s retirement portfolios, according to USA Today, and there are three good reasons.
- Liquidity. Stocks and bonds are much easier to buy and sell.
- Fear of bubbles. Many investors (and homeowners too) were traumatized by the credit crisis of 2008 and 2009 when the U.S. housing bubble burst.
- Too complicated. Investing in real estate can seem very complex because there are multiple ways to own real estate.
Most financial advisors lean heavily on the stock market for retirement for these reasons. Then there's the not unimportant fact that stock investors have seen massive gains over the past five years.
The issue is what will happen in the next five years and beyond. There are now big questions about how long the bull market will last, and fixed-income investments are paying less and less. All are good reasons to consider what role real estate could play in your retirement portfolio.
Just like any other investment, it’s essential to set realistic expectations from the get-go. But deciding what to do next is complicated. Where should you start?
Options in Real Estate
Aside from owning your own home and counting it as part of your retirement savings, these are some of the most popular ways to invest in real estate either directly or indirectly:
- Flipping houses (buying fixer uppers to repair or update and sell at a profit)
- Owning apartment buildings or houses to rent out (you can also own these in a self-directed IRA, if you follow certain rules – see House Your Retirement with Self-Directed Real Estate IRAs).
- Directly owning commercial real estate and renting to business tenants
- Holding shares in a real estate investment trust (REIT) or through mutual fund (see 5 Types of REITS and How to Invest in Them)
- Holding a stake in real estate through a partnership (read up on this in How to Invest in Private Equity Real Estate)
- Owning publicly-traded or privately-held debt on real estate
- AAA-rated commercial mortgage-backed bonds
Any of these options, especially bonds that package up loans on commercial properties, can make your head spin. Investopedia's tutorial Exploring Real Estate Investments can help you get a more detailed sense of what's involved.
Real Estate Returns
Then there’s the question of how much of your money should go in the real estate bucket. There’s no simple one-size-fits-all answer, but advisors across the board agree that investing 5% to 10% of your retirement savings is a sound strategy. They also say to go in expecting that long-term annual returns on any real estate investment should average 3% to 6% a year. The more real estate you own directly, the higher your risk for losing money – and the bigger your potential for making more.
Seasoned owners of rental properties typically look for annual returns on their original investment to be in the 5% to 10% range after all expenses are paid. Indirect investments in, say, publicly traded REITs or real estate mutual funds act more like the stock market with returns on REITs ranging from 27.5% in a bumper-crop year (2014) to 7.5% over ten years, according to REIT.com. Returns over the last 25 years were 10.6%, while 40-year returns averaged 12.83%. In many cases, according to the website's study, REITs outperformed large-cap U.S. stocks. For example, large-cap growth stocks returned only 13.69% in 2014 and 9.62% over 25 years.
Taking the Hands-on Approach
If the idea of being a landlord and collecting rent checks sounds appealing, think carefully about how much time, sweat equity and effort you really want to put into this investment. Plenty of everyday people generate steady, predictable cash flows by owning rentals and you could be one of them. Since real estate values depend mostly on location, how much you can make by investing in a rental property depends on where and how you invest, including how much you borrow and pay for financing.
Playing landlord means making sure your tenants pay their rent on time, evicting them if they don't, handling repairs and maintenance on the property, and who knows what else (see The Complete Guide to Becoming a Landlord). Owning an income property is different from other investments because it requires much more active involvement even when you hire a property manager to oversee it.
Before moving ahead, here are what the pros recommend for first-time investors:
- Find a rental property that’s in a high-demand area to avoid a long-term vacancy
- Negotiate a purchase price that’s below the current market value
- Make a down payment of at least 20%
- Set aside plenty of cash reserves to cover all expenses
Real estate as the centerpiece investment for retirement isn’t for everyone, but if your goal is to generate more retirement income, adding some real estate exposure in your portfolio can make sense. It doesn’t have to be a question of the stock market versus real estate. You can have both.
How much exposure is a question you can talk through with an experienced financial advisor who has real-world real estate knowledge and practices as a fiduciary. He or she can help you come up with a real estate strategy that works for your specific situation.
Pam Krueger is the founder of "WealthRamp," co-host of "MoneyTrack" on PBS and national spokesperson for The Institute for the Fiduciary Standard.