It's likely rental property isn't the first investment to come to mind when you think of retirement. After all, there is a lot of active management and responsibility tied to being a landlord -- the exact opposite of what most people are looking for in their golden years.
But rental real estate can be an incredibly powerful way to help grow and sustain your retirement outside of traditional stock or brokerage investments. So if you're looking to level up for retirement, here are some key reasons why investing in rental real estate is one of the best moves you can make.
Create passive income with the ability to grow
The ultimate goal of retirement is to have diversified sources of income that provide you with more to live off of for longer. Ideally, you'll have saved a sizable sum of money in a traditional retirement account or through your company's 401(k), that will complement Social Security or any pension you may be eligible for. But rental real estate can be another vehicle for creating substantial passive income in retirement.
If you properly purchase a rental property, the rental payments should not only cover the property's expenses but leave you with extra cash. For example, if you rent a property out for $1,500 and your related costs, such as property taxes, insurance, HOA fees, management fees, repairs, and upgrades, as well as any related debt such as a mortgage, come to $1,200, you earn $300 cash flow per month from the property.
Plus, if you use the cash flow ($300 in this example) to pay down the mortgage, you can pay off the mortgage early and net even more from the property when it comes time to retire. That $300 could easily become $800 or more, depending on the amount of your mortgage payment.
Benefit from appreciation
Real estate, generally speaking, appreciates over time. In normal conditions, appreciation is in the range of 4% annually, meaning for most properties, you can expect the value to increase around that much each year. However, some markets appreciate at faster rates than others. Right now, we're seeing overall home appreciation rates of 19%. And if you purchase property in a bull market, as we've experienced over the past 10 years, you have the major added benefit of appreciation over the long term.
If you purchased a rental property in October 2011 for $150,000, based on the appreciation rate over the past 10 years according to the S&P CoreLogic Case-Shiller Home Price Index, that home would be worth close to $295,000 today, just 10 years later, nearly doubling your investment.
And not only did you collect cash flow during that entire time, but if you had a mortgage, your tenant was paying for it, ultimately building your equity in the property. You can use that newfound equity to purchase other investment properties or to live off of in retirement.
Creating a tax shelter
Rental real estate also offers several tax advantages, including depreciation, which can help offset some of your taxable income. Depreciation is the act of deducting a portion of the property's value each year to reflect general wear and tear over time. Of course, depreciation is eventually recaptured on your taxes when you sell the property, but if you plan to hold the rental for the long haul, it's a helpful way to reduce your annual tax burden.
You can also take deductions relating to the management or ownership of the property, including rental repairs and improvements, management fees, property insurance, and more. These deductions help reduce the amount of cash flow you receive, making $300 a month look like $150 a month or less when it comes to taxable income. If an extensive repair like fixing the roof comes up, this can significantly reduce your tax burden for the year.
Rental real estate doesn't have to be active
Many people shy away from owning rental property because they are concerned about managing it. Listing the property for rent, showing the property, signing leases, collecting rent, and if necessary, evicting tenants is a part of owning rental property. But thankfully, you don't necessarily have to be the one to do it. Instead, you have the option of hiring a professional property manager who takes care of its day-to-day management. In exchange for their work, you pay a fee, usually around 10% of the rental income per month, and turn something that is generally seen as an active investment into a passive one.
Rental real estate has massive potential for building a comfortable retirement or helping supplement your current retirement plan. Even owning one rental property can make a notable difference, but owning several rental properties is where you can really see the power of rental income combined. While being a landlord may not be right for everyone, given its benefits and the opportunity to utilize third-party management, it's easier than ever to take advantage of this powerful retirement tool.