Most people, even those with a limited understanding of finance or investing, recognize that real estate can be a valuable investment, especially when it comes to retirement savings. It can generate positive cash flow, grow rapidly, allow you to take advantage of financial leverage, and even help you insulate against the effects of inflation.
But at the same time, real estate can be risky. And it doesn’t quite stack up to other investment types, at least in some regards.
So if you’re planning for retirement savings, exactly how much should you be putting into real estate?
Ways to Invest in Real Estate
First, understand that there are many different ways to invest in real estate, and each of these avenues carries a different set of pros and cons.
Residential single family properties.
One of the most straightforward and accessible options is to invest in single family, residential rental properties. These properties are relatively inexpensive, but they can help you enter the real estate market and start generating meaningful passive revenue. A single property won’t earn you a ton of cash, but if you accumulate multiple properties, the cash flow can be quite impressive. You’ll also benefit from appreciation over time. Managing residential rental properties can be challenging, especially if you’re inexperienced, but there are some practical solutions.
Residential multifamily properties.
It’s also possible to invest in residential multifamily properties, which have multiple units under a single roof. Multifamily properties are a bit more expensive and complicated to manage, but they insulate you against vacancies and help stabilize your rental income.
Commercial properties.
Alternatively, you can invest in commercial properties. Commercial properties are more expensive and more complicated than residential properties, and prices can be a bit more volatile. However, tenants tend to be more professional and reliable, and options like triple net lease agreements can help you make even more money.
Property management.
It’s not a separate option for investing in real estate, but you should be aware that you can always hire a property management company to manage your properties on your behalf. Property management companies can help you with everything from marketing to tenant screening to rent collection to maintenance and even evictions. In exchange for a portion of your gross rent, they can help you turn your rental property operations into a truly passive income source.
REITs.
If you don’t like the idea of building a portfolio with individual properties, you can always invest in real estate investment trusts (REITs). REITs trade on the open market much like stocks or ETFs, allowing you to invest in entities that buy, manage, and sell real estate. Think of it as a quick, inexpensive, and convenient way to get secondary exposure to the real estate market. Just be aware that you’ll need to do your due diligence as you would with any investment.
The Advantages of Real Estate
Investing in real estate, broadly speaking, carries many advantages for retirees and forthcoming retirees:
(Mostly) predictable income.
One of the greatest benefits of investing in real estate is the capacity to generate mostly predictable income. Assuming your properties are occupied, you’ll generate a fixed amount of gross rent every month. You’ll also have fairly consistent expenses, though occasionally, you may have to deal with maintenance or emergency repairs. The only exception to this is when your properties are vacant, which does happen from time to time. This positive cash flow can serve as supplemental income and an easy way to snowball your net worth.
Insulation from the stock market.
While the real estate market and the stock market do have a relationship, they aren’t directly correlated. Some people appreciate real estate because it’s relatively insulated from the stock market. If you have holdings in both the stock market and real estate, you’ll be mostly unshakable from volatility in either area.
Historically validated appreciation.
Relatively speaking, real estate isn’t an especially risky investment. For more than a century, real estate has appreciated at a faster rate than the consumer price index (CPI) across the board. Some areas have seen more growth than others, of course, but real estate remains seen as an asset capable of strong, consistent increases in value.
Financial leverage.
Investing in real estate often means taking advantage of financial leverage. Financial leverage is a unique benefit that allows you to invest with more money than you actually have, since you’ll be utilizing borrowed funds. Taking out a mortgage on a property allows you to multiply your investing power without necessarily increasing the amount of capital you personally put in. This does increase your total debt, but there are some advantages to holding more debt as well.
Debt and inflation.
In inflationary environments, debt can work in your favor. That’s because inflation represents the devaluation of money, so if your debt becomes less valuable, you’ll end up owing less over time. The nominal amount isn’t going to change, but the relative amount is. It’s a complicated economic idea, but the bottom line is that holders of good debt typically benefit when inflation is high.
Tax benefits.
You may also stand to benefit from tax advantages and incentives, based on the types of properties you hold and how you strategically plan your finances around them. Consider talking to a tax professional to see how you can best take advantage of these.
Diversification.
And of course, real estate occupies a somewhat unique niche, with a radically different set of advantages and disadvantages when compared to other assets like stocks and bonds. This makes it a powerful addition to nearly any portfolio. Additionally, because you can invest in real estate in many different ways, you can pursue alternative real estate investments to compensate for whatever risks and drawbacks you perceive.
The Disadvantages of Real Estate
However, there are some disadvantages to consider as well.
Capital intensity.
Some people believe they can’t invest in real estate, or they aren’t motivated to invest in real estate because the action is capital intensive. If you want to buy properties in cash, you’ll need a massive amount of capital. Even if you’re taking out a loan, you’ll need to at least save up a down payment. If you have $100, you can invest in the stock market. The same can’t be said of real property (though REITs do exist).
Difficult entry.
Setting aside REITs for a moment, it’s challenging to invest in real estate. Learning local market dynamics, getting acquainted with neighborhoods, and doing your due diligence for individual properties are all time-consuming affairs, even for experienced buyers. For inexperienced buyers, the landscape is intimidating, to say the least.
Lack of liquidity.
Liquid assets can be easily converted to cash, but real estate assets are typically illiquid. Yes, you can sell your properties anytime you want, but that doesn’t mean you’ll immediately find a buyer. Even if you do quickly find a buyer, the process can take weeks or months. As a retiree, you’ll need to think actively about liquidity, and real estate isn’t always a good holding in pursuit of it.
Management and tenant turnover.
Managing properties is a big responsibility. In addition to filling vacancies, marketing the property, and collecting rent, you will be forced to deal with emergency repairs, problematic tenants, and even evictions. On top of that, extended vacancies can compromise your profitability and jeopardize the stable income that real estate generally promises to offer. Hiring a property manager can ease your woes here, but it’s going to slightly eat into your profitability.
Documentation and tax planning.
Taxation on rental income can be complicated, especially if you have a lot of properties and a lot of expenses to track. Property managers and tracking software can help considerably in this regard.
Long time horizon.
Short-term cash flow is good, but fully capitalizing on the power of real estate takes years to decades. If you don’t get an early start, it’s hard to realize your full potential in real estate investing.
Your Primary Residence
Keep in mind that if you currently own a home, you’re already investing in real estate, so to speak. You may not be generating passive income, and you may not be paying attention to your property appreciation, but you’ll have meaningful equity in your property – and the ability to sell it at any time.
For homeowners in the U.S., equity in a primary residence accounts for a median of 45 percent of their net worth. That’s not necessarily a bad thing, but in retirement, you’ll appreciate liquidity and cash availability. For many retirees, it’s much better to have a lower percentage of your net worth invested in your primary residence.
One option to balance the scales here is to increase your investments elsewhere. Instead of paying your house off early, for example, use the money to invest in other properties, stocks, bonds, and other meaningful investment assets.
Another option is to find a way to reduce your equity stake in your primary residence. Depending on your current financial situation, that could mean refinancing your house, taking out a HELOC, or even purchasing a new property somewhere else. If you plan on downsizing, you might be planning on doing this anyway. Don’t be afraid of housing debt. As we’ve seen, it can be a massive advantage for your retirement portfolio and personal finances.
The Real Estate Niche in Your Portfolio
So where does real estate fit in your retirement savings portfolio?
That depends on several factors, including:
Personal risk tolerance.
Each individual has a unique risk tolerance, based on their age, outlook, history, and personal preferences. Both risk tolerant and risk averse people can pursue meaningful real estate investing strategies, but they must pursue them in slightly different ways.
Age and goals.
You also need to consider your age and personal goals. If you want stable, predictable income, real estate is going to be more valuable than if you want potentially explosive growth.
Affinity for real estate.
Don’t underestimate the importance of your own personal affinity for real estate. If you’re genuinely interested in this field, and you like finding new real estate deals, you should lean into this and take advantage of it.
Other holdings.
Finally, consider the size of your portfolio and your other holdings. If you already have significant holdings in stocks, ETFs, bonds, and other mainstream assets, you should definitely consider including real estate for the sake of diversifying your portfolio.
Accordingly, we can’t make universal recommendations for exactly what percentage real estate should occupy in your portfolio. As long as your portfolio is diversified according to your personal needs, you’ll be in a good spot.
What’s Your Age?
There are some special considerations you’ll need to keep in mind as you age and allow your investing strategy to mature.
20s and 30s.
Early on, you’ll have much greater risk tolerance, meaning you can afford to make some bold decisions in purchasing real estate. This is also a critical opportunity to start snowballing your real estate holdings. One or two rental properties can help you secure financing for a third, then a fourth, and so on.
40s and 50s.
As you begin inching closer to retirement, you can reevaluate your savings portfolio in favor of more conservative, stable assets, like real estate for example. As such, that may include shifting the balance of your real estate holdings and potentially pulling money out of riskier assets like stocks in favor of real estate.
Nearing retirement.
As you near retirement, you’ll have more experience, but you’ll also have less physical potential and less interest in actively managing your properties. It’s a great time to start working with a property management company or shift your focus to REITs to make your real estate more passive.
Active retirement.
In active retirement, you’ll need cash and available liquidity, so exercise caution in keeping too much of your savings portfolio in illiquid real estate assets. Consider rebalancing to afford yourself more financial flexibility.
Real estate can be a powerful asset, even though it carries some risks and downsides. Wherever you are on your path to retirement, you should carefully consider real estate assets as part of your overall savings portfolio.
