|
Real estate as nest egg tool
|
 |
May 28, 1999: 11:04 a.m. ET
Some say rental properties can pay for your retirement, others say be careful
|
NEW YORK (CNNfn) - If you're a homeowner with aspirations of a well-heeled retirement, Denny Henson says you're halfway there.
The president of First United Realty & Management, a property management firm in Charlotte, N.C., said many property owners can meet and exceed their long-term financial goals by simply tapping into the lucrative real estate rental market.
All it takes, he said, is an entrepreneurial spirit and some self-education.
"You should never sell your properties, because you'll have to pay real estate commission [to the brokers who sell them]," Henson said. "By renting them, you can get 100 percent of your equity without paying that commission."
You'll also benefit from numerous tax breaks, property appreciation and a steady stream of income for as long as you own the home(s), he noted.
"Anybody who doesn't do this just doesn't understand economics at all," Henson said.
The "pros"
As a financial planning tool, income-producing properties aren't exactly taking the world by storm. But Henson said that's because most people don't understand how it works.
"Real estate agents won't tell you," he said. "Why would they? If someone comes to them with a $150,000 home and the agent sells it, they get paid 6 percent commission, or $9,000. They have an incentive not to tell."
The strategy sounds simple enough: Say you buy your first house at age 30 for about $160,000, with an $8,000 down payment. You stay there two years, then decide to rent it out, using the equity you've accrued so far to finance your next property acquisition.
The pattern continues every two years for a period of fifteen years and by the age of 60, Henson said, you will have amassed a collection of five homes and real estate holdings worth more than $1 million.
"That's all off of an $8,000 down payment," he said.
If all goes as planned, the tenants will have paid for the rental properties and you can sit back and collect the income.
Using the example above, Henson said you'd be taking in about $100,000 a year in rent. Knock off roughly 30 percent -- to cover taxes, insurance and property maintenance costs -- and you're still looking at $70,000 profit in your pocket each year.
No free ride
Sound too good to be true? In many cases, it is.
Guy Cumbie, president-elect of the Institute for Certified Financial Planners and a CFP himself, acknowledged that some of the success stories you hear swirling around the rental real estate market are true. But there are just as many that end in disaster.
"I have some clients who do this type of thing and have not only survived, but are making good money out of it," Cumbie said. "I also have some who got totally beat up."
According to him, the biggest problem in the business stems from rental property owners who fail to take the job seriously. Many also set their expectations too high.
"If you are not a good business person forget it, because you are getting into the real estate business here in a big way," Cumbie said.
If you do decide to go for it, professionals say the first rule of thumb is to know the risks associated with rental properties and know what kind of time and money the business venture will demand of you.
"If you are going to make that your primary nest egg you are going to be more speculative than most people like to be regarding your retirement future," Cumbie said. "It's a riskier approach and one that, if you decide to adopt, you need to go in clear-eyed."
For example, he said, most landlords who rent multiple homes -- who have the greatest profit potential -- tend to do so in a concentrated area for convenience sake. Their investments, therefore, are not only tied to a single industry, but vulnerable to local market trends. That's about as non-diversified as you can get.
Be aware, too, that any number of things can turn your rental business on its head.
Maybe you unknowingly overpaid for your property at the outset. The real estate market could hit the skids. Your tenants might stiff you or, worse yet, hit you with a lawsuit. Or, if you have no prior experience with real estate, you may be unable to maintain your properties cost-effectively.
The point is, Cumbie said, don't go into the rental business hoping for a quick buck.
Those in the business who have had the best luck, he said, "milk the cash cow" -- or withdraw some of the equity built up in their properties on a regular basis. They place that money in an insulated and diversified securities portfolio. A highly-rated mutual fund will do, he said.
That way, if the market bottoms out, you haven't lost everything.
"If you experience your first wipe out when it's too late in life to recoup your losses, your retirement goals might go bust," Cumbie said. "There are a lot of entrepreneurial types out there who have had their success. Their confidence level is very high and they don't feel any need to insulate."
His advice: don't listen to them. Same goes for books and seminars that encourage would-be investors to risk all their retirement savings on rental homes.
The breaks
The amounts differ by region, but as a landlord and homeowner, you're entitled to deduct from your taxes a depreciation allowance. The Internal Revenue Service allows you to write off a certain amount on your taxes each year to compensate you for the long-term depreciation on your property.
The write-offs only apply, however, to the physical structure of your home, not the land.
"If you are in the right place in the country, in the right market cycle and you've got the right kind of tenants (who pay their bills), you can actually have your home value appreciate in an economic sense, but enjoy the benefit of depreciation in a tax sense," Cumbie said.
You can also write-off the amount you pay in interest each year, as you would for your principal home of residence.
Food for thought
Before you get into the rental business, Smart Consumer Services, a consumer education group in Crystal City, Va., suggests you sit down with a financial planner or accountant who can help you crunch the numbers. They can (and should) also help you assess the merits of properties you are considering buying.
The group further noted that the price you pay for the rental property is crucial. That alone will affect your ability to charge the rent levels you'll need to cover the costs of mortgage, upkeep, insurance and margin -- if rental properties are part of your retirement plan.
(Click here for a more complete list of things you should consider.)
You should also consider the neighborhood or area in which you are considering renting. Locations near military bases and college campuses often generate a steady supply of reliable tenants. But students can lead to higher upkeep costs.
You'll also want to think about who will do the upkeep and repairs on the property. Do you have the time and skills to handle it on your own, or will you have to hire a company to manage it for you? If so, what will that cost?
The group also said you should get solid legal advice before buying a new rental property, or renting out an existing home.
Lastly, Cumbie said don't forget to factor in the increased cost of financing. Banks that lend to rental properties typically charge higher fees, he said, since the default rate is generally higher than for primary mortgages.
Screening
For those willing to take the risk, Henson offers some final advise.
Always run a background check on prospective tenants
Approve only those tenants that earn four times the monthly rent to minimize the risk of missed payments.
Ask the tenant's employer to verify in writing that his/her stated salary is accurate.
Also, he said, you'll have the best luck as a landlord if you stick with rental homes with a market value on par with local averages. You should also stick with homes that are going to rent for $1,000 a month or more, just to cover costs.
In Charlotte, N.C., he said, his company can usually rent a $130,000 house for enough to cover the first mortgage and the equity line payment, which covers the financing for your second (or third) property.
"In about 18 years, that house ends up being paid for by the tenants and you've got a great retirement program and tax shelter," he said. 
--by staff writer Shelly K. Schwartz
|
|
|
|
|
 |
|
