Rentals (commercial or residential) are a great way to accumulate wealth, snag some tax advantages, get some diversification from the crazy stock markets. But once a person clicks over into retirement phase \u2013 are those rentals (along with the tenants and toilets) really the best? For steady income in retirement can you do better by selling that rental and using other financial instruments?<\/p>\n\n\n\n
Let\u2019s Compare<\/p>\n\n\n\n
The first thing we need to do is calculate an honest version of the house\u2019s yield using something known as net operating income or NOI. The NOI is a calculation used to analyze the profitability of an income-generating real estate investment. The NOI is equal to revenue from the property minus all reasonably necessary operating expenses for the house. NOI does not include mortgage or debt payments, that\u2019s not an \u2018operating expense\u2019 of the rental.<\/p>\n\n\n\n
Using a hypothetic rental house (in my area), with a value of $430,000 and rent of $1,800\/month. If you subtract<\/p>\n\n\n\n
So total operating expenses for our example are $349 a month, which nets our gross rent down to $1,451 per month or $17,412 annual. If you are using a property manager at a normal 10% your NOI drops to $15,252 per year.<\/p>\n\n\n\n
The key word above is \u2018honest\u2019 \u2013 landlords\u2019 kid themselves that \u2018this house is never vacant\u2019. Or \u2018I\u2019ll do all the upkeep myself.\u2019 If my factors above prove too conservative, so much the better \u2013 but the NOI needs to be an honest reflection of the real costs. <\/p>\n\n\n\n
This NOI of $17,412 represents 4.05% yield compared to the market value; or 3.55% if you are using a property manager<\/strong>. But can an income seeker do better?<\/p>\n\n\n\n Choices Choices<\/p>\n\n\n\n Although it may seem like a foolproof source of income, rental properties may not the best path to create income for your retirement. Not to mention \u2018tenants and toilets\u2019 right off, but rentals do need attention. A \u2018snowbird\u2019 routine of extended multi-month travel may not lend itself well to collecting rent and generally keeping an eye on your asset. Commercial properties can be more hands off with triple-net rent and longer lease terms \u2013 but they have more risk of (long) vacancy at turn-over and expensive repairs (think flat roofs, large HVAC units, etc.).<\/p>\n\n\n\n Again, you can add a property manager to \u2018handle all of the hassles\u2019 but this will dimmish your (net) yields by 12 to 15%, AND your repairs will be \u2018handled\u2019 at retail costs by your managers \u2013 they are busy and have no energy for shopping your fixes\/repairs to get great value.<\/p>\n\n\n\n So what choices do we have?<\/p>\n\n\n\n DSTs<\/p>\n\n\n\n One is a Delaware Statutory Trust or DST. This is a security purchased in a brokerage account that as of this writing is able to accept 1031 exchange real estate dollars (i.e. no capital gains tax or depreciation recapture is paid when you sell the rent home and \u2018buy in\u2019) into a certain pool of apartments, Walgreens stores, or old folks homes – that then will pay you monthly dividends that will feel a lot like rent. The yields are in the 4\u2019s perhaps low 5% – but they have very low liquidity, so your money is not accessible to you generally for several years. This needs to be a long term decision. <\/p>\n\n\n\n Moreover, the four-color brochures won\u2019t make much mention of the risks inherent with their batch of real estate, that being the dividends are not in any way guaranteed. So when Covid came round, the Marriott DST\u2019s quit paying dividends, because the hotels weren\u2019t able to operate and kick out rent payments to that DST. If your strip center focused DST gets gutted by Amazon, your net dividends will sink. DST\u2019s are still real estate remember.<\/p>\n\n\n\n The \u2019A\u2019 word.<\/p>\n\n\n\n If you haven\u2019t looked at modern annuities lately \u2026 then you probably don\u2019t know what the latest generation can do for you. Yes they lack liquidity or full access to your account value in the early years \u2013 but so does your rental, the DST\u2019s above or REITs, etc. etc. <\/p>\n\n\n\n High lights: <\/p>\n\n\n\n The key here is to get the right product that is good at kicking out income \u2026 you then compare that to how you feel your rentals will be performing (NOI).<\/p>\n\n\n\n CRUT\u2019s<\/p>\n\n\n\n Those letters stand for Charitable Remainder Unit Trust. This is not a new idea, but a little-known idea. Here you \u2018donate\u2019 your appreciated real estate to a special trust that does two things \u2013 it pays you\/spouse income (in the 5 to 6% range generally) for as long as you live; then it gives the \u2018remainder\u2019 to a charity of your choosing. This charity can be a church, humane society, or school; but it can also be a family foundation, organized and run by your family for charitable work.<\/p>\n\n\n\n Why do this? One if you have a charitable bent and want to benefit some group or cause \u2013 and two taxes benefits dude! The benefits are pretty awesome. <\/p>\n\n\n\n First you get an upfront Income tax deduction of 30 to 50% of the value of the property you shifted into this trust. So, a $1 million strip center yields an income tax deduction of $300,000 to say $450,000. This deduction (check for IRS rule changes that occur from time to time) can be used over 6 years against earned and passive income. Next the income being kicked out of the trust is not 100% income taxed \u2013 there are provisions with the IRS as to how \u2018charitable\u2019 the trust is written that can result in only part to that income flow recognized on your return.<\/p>\n\n\n\n Lastly, you paid no capital gain tax and no recapture.<\/p>\n\n\n\n The disadvantage is you skewed the legacy away from family towards the charity you choose. So the family won\u2019t be inheriting that strip center at your death.<\/p>\n\n\n\n REITs<\/p>\n\n\n\n I won\u2019t discuss REIT\u2019s here as there is no way I know of moving real estate equity into a REIT on a tax favored basis. So why sell real estate then go buy REIT\u2019s with the net cash? The numbers rarely work in your favor.<\/p>\n\n\n\n Moreover, they have been through some tough times lately with regulators clamping down on how the accounting is done, repricing of the assets from year to year, and other practices that were perceived to be a little scamy. And they don\u2019t walk on water, many REIT\u2019s that owned Marriott (type) hotels quit paying dividends during Covid. Many old folks homes REITs are hating life just now and not paying dividends AND tanking in valuations. <\/p>\n\n\n\n Conclusion<\/p>\n\n\n\n In conclusion, rental properties can be an excellent addition to your investment savings while you work, but as you approach retirement, rental properties are just not as efficient kicking out income as several other strategies; and not convenient for many in that phase of life.<\/p>\n","protected":false},"excerpt":{"rendered":" Rentals (commercial or residential) are a great way to accumulate wealth, snag some tax advantages, get some diversification from the crazy stock markets. But once a person clicks over into retirement phase \u2013 are those rentals (along with the tenants and toilets) really the best? 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