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Why Real Estate Should Be A Part Of Your Retirement Strategy

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What is your definition of wealth? Some might say a wealthy person is someone who does not have to worry about money. She can do as she pleases without ever having to check in with anybody. Others say wealth equals a nice cash hoard and a robust stock portfolio. All are valid definitions of wealth. I’m going to argue that wealth = real tangible assets.

After about five years of diligently saving 50% of my after-tax income by living in a cheap part of town and subsisting on ramen noodles, water, and fruits, I began to question the point of working and saving so much money. Yes, I wanted to achieve financial freedom sooner, rather than later, but there was something very empty watching the numbers pile up in my bank and stock accounts. The more I saved, the less motivated I became.

I was about to give it all up and return to Hawaii to farm mangos until I stumbled upon this two bedroom, two bathroom condo with parking in Pacific Heights, San Francisco. The condo was built in 1970, had 8 foot ceilings, mediocre appliances, and carpet. In other words, it was nothing special except for the location right across from a park. There weren’t any pictures online, but I was attracted by the price. “Only” $580,000!

When I finally stepped into the condo, I was pleasantly surprised to find that it not only had a balcony, but a priceless view of Lafayette Park. You couldn’t see any cars from the living room, just lush greens that made you feel like you were in some nature wonderland. I was instantly sold and told my agent that I would pay $500 over asking to win the bid.

The retired lady accepted and she told me that I would love it here. She was right. I’ve owned the property since early 2003 and never plan on selling. Ironically, the condo renewed my motivation to work hard and make as much money as possible because I now had debt.

Financial Samurai Rental Property

WHY YOU SHOULD OWN REAL ESTATE

Although the 2008-2009 financial crisis rocked the country’s real estate market and practically every other investable asset class, I believe there are incredible benefits to investing in real estate to ensure a healthier retirement. As soon as you find a place you can envision yourself living for at least five years, it’s probably a good time to start your property search.

1) Inflationary asset. I remember thinking to myself back in 1994 how ridiculous it was to pay $1,000 a month for a one bedroom in Boston when I was paying $350 a month to rent a room in a townhouse with my buddy in Virginia. Today, a similar one bedroom is over $3,000 a month. Inflation is a powerful economic force that’s difficult to stop. You want to own inflating assets rather than always be a price taker. Eventually your income will stop growing, decline, or eventually disappear, making survival that much harder if you must continue renting.

2) A hedge against conflict. Whenever there is geopolitical risk, a major natural disaster, or a terrorist attack, notice how US Treasury yields go down due to a flight to safer assets. Housing is a direct beneficiary of lower interest rates due to the common practice of borrowing to own. When interest rates go down, refinancing activity also picks up, increasing the cash flow of homeowners everywhere. I have personally refinanced five times with various properties and am paying $3,500 less in interest a month than 11 years ago.

3) A leveraged play in a bull market. When times are good, assets tend to inflate quicker due to higher employment, rising wages, and rising corporate profits. Real estate tends to be a major beneficiary during a bull market. Earning a 32% equity return in 2013 was fantastic. But earning a 75% cash on cash return on your 20% equity thanks to a 15% rise in home prices is even better.

4) Tax benefits. The US government has deemed real estate part of the American dream with mortgage interest deduction, the 1031 exchange program to defer taxes, and a generous $250,000 tax free gain for singles and $500,000 tax free gain for married couples. It takes a $714,000 return at a 30% effective tax rate to clear $500,000 in profits. Based on my research, I’ve found that the ideal mortgage amount and income combo is $1 million and $250,000 a year based on today’s rates.

5) Much easier for a regular person to understand and manage. Real estate is a relatively easy business to understand compared to investing in stocks. Good location, good tenants, manageable maintenance, and rental growth are all it basically takes to make for a solid real estate investment. Stocks have so many more variables to deal with, including: management credibility, industry growth, competition, politics, regulation, tax policies, inventory turns, margin analysis, operating profit growth, and more. It’s no wonder you’ll find plenty of first generation immigrants focus on accumulating property.

6) Less temptation to sell out too soon. Thanks to still stubbornly high selling commissions, the ability to sell is much more difficult than selling a stock when the markets are crashing. I know plenty of people who just had to get out of the stock market in 2008-2010 because they were scared out of their minds. It’s so easy to pay a $8 commission and press click. But when you’ve got to pay a 5% commission and go through the entire process of marketing a property, you tend to just sit tight and see what happens.

7) Paying back debt with inflated dollars. For people with fixed rate mortgages, their payments never change. 10 years from now you’ll get to pay off the same amount of debt with dollars that aren’t worth as much as when you first took out the mortgage. As your net worth grows, the mortgage liability becomes a smaller part of your overall net worth, thereby reducing any feelings of stress associated with the loan.

8) Never have to move again (so long as you pay your mortgage). Moving is a painful process. What’s more painful is having to move when you don’t want to. Many long-time renters are being displaced in cities such as San Francisco because the property owners want to capitalize on the demand. I was speaking to one renter who is being asked to move after 18 years. He has no job, a daughter who is entering high school, and a wife who no longer wants to be with him. He pays $1,990 a month for a place that could easily rent out for $3,800 a month.

9) Passive income machine. Although real estate takes ongoing maintenance, rental income is one of the best passive income sources around along with dividend investing. After the hard work of finding the perfect tenant is done, one should usually expect to collect income for at least 12 months before another tenant may need to be found. The rental income is also partially or completely shielded by non-cash depreciation expense as well thanks to the government.

10) An asset to pass on to your heirs. Everybody has heard a story of some grandparent buying a home for $20,000 that is now worth hundreds of thousands or even millions of dollars. If you can buy a property to live and enjoy, and then pass it down the family to give your children a heads start, what an amazing gift you’ll provide. It’s very difficult for Millennials to buy their own property nowadays. But besides working hard, a massive generational wealth transfer should help support future generations.

BUY PROPERTY FOR THE LONG TERM

A lot of opponents say that property has only inflated at the similar rate of inflation over the long term. Even if the average property is only growing by 2% a year, that’s a 10% cash on cash return if you put 20% down. But more importantly, you’re long an asset that has a good chance of inflating. The return on rent is always -100% every single month.

If you are a renter, you are actually short the property market. You only gain if rent prices go down or if property prices go down. But if prices continue to go up, you’re losing. If you own your primary residence and nothing else, you are neutral the property market. Even if your property goes up 100%, you will only benefit if you’re willing to downgrade in price. You’re only long property if you own more than one.

Hopefully all those who have chosen to rent since the downturn have taken advantage of the stock market instead.

For those of you with property, Personal Capital has come out with a great new feature that will help you keep track of your real estate investments with Zillow. Zillow uses their proprietary algorithm and database of sold homes around your area to come up with a Zestimate. Once you press +Link on the top left, and click Add Home Value on the bottom left with your home’s details, Zillow will update the value of your home three times a week.

Be forewarned that Zestimates are sometimes off by a great deal on the upside and the downside. If your $500,000 house is suddenly worth $1 million according to Zillow, do your best to refrain from buying the latest Porsche 911 Turbo! Chances are high the estimate is wrong.

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Using the Zestimate to look at the historical pricing charts provides for good data on the direction of your market. I just wouldn’t rely on the specific Zestimate completely because a home’s true value can only be determined upon sale. You can continue to manually input a property value in your net worth calculations as well if Zillow isn’t your cup of tea. It’s always better to be conservative than aggressive.

Readers, do you think real estate or equities is a better way of building wealth? Why do you think there are so many more stories of immigrants getting wealthy with real estate vs. through the stock market? What are some of the downsides of owning real estate for the long term?

Regards,

Sam

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Financial Samurai

Sam is the former Managing Editor of the Daily Capital blog. He worked in finance from 1999-2012 before deciding to focus full-time on his online endeavors - FinancialSamurai.com and the Yakezie Network. Sam is an avid tennis fan who loves to travel. He received his BA from William & Mary and his MBA from UC Berkeley.

32 comments

  1. Froogal Stoodent

    That’s an interesting take, and I’m glad that your motivation to work hard was renewed by the purchase of your condo! Having a house you love is truly a great blessing!

    Even if someone can’t afford a home of their own (or already has one!), they can still invest in real estate through assets like a real estate investment trust (REIT)–which I honestly thought this article was going to discuss.

    Good points, though, Sam!

    Reply
    • Financial Samurai

      I like REITs, especially with its diversification and taxation benefits. However, you still can’t enjoy a REIT like you can living in your own home.There’s something about being able to touch what your money can buy that really is something.

      Buying a REIT puts the investment decisions into someone else’s hands. It can be fine if the manager is excellent. I just feel nobody cares more about your money than you.

      Reply
      • Siva

        REITs are a good option for retirement accounts than in your regular investment account because of the tax considerations. They offer very good dividends and a lot of them pay monthly

        Reply
  2. Josh

    Completely agree on real estate, both to live in and as a landlord up to a certain financial networth. If someone has networth more than 10 million, then I believe having primary residence only is a better way to go.

    Reply
    • Financial Samurai

      Depends though. Maybe one has built their $10 million+ net worth by owning multiple properties!

      Reply
  3. Ryan

    In the ‘tax bane fits’ section, you mentioned you had run calculations to arrive at an optimal home price/income level. Could you share you thinking and math to help us understand what your an by optimal? Thanks!

    Reply
  4. Linda

    I, too, equate wealth to tangible assets. Stocks are nice and all, but they can disappear in a hurry. Real estate provides a utility. There’s much less funny money when it comes to real estate.

    If you can enjoy the real estate and then make a return in the process, that is the best!

    Reply
  5. Nervous Cat

    I didn’t buy my first condo until I was 42. I rented because I never stayed in one job for more than 4 years (sometimes not by choice) and the areas where I rented were not exactly technology hubs where I could easily find another job in the same area. Renting make it easier for me to relocate as it got harder to find another job within commuting distance. I may have lost out by now owning when I was younger, but when I moved to a large enough metropolitan area, I finally bought a place, refinanced it last year, and feel confident enough that I will stay here even if I lose my job.

    Reply
  6. Danielle Kuykendall

    Good article, and I agree with a lot of what you said, as my father is someone who has the same theory as you. However, the only problem with this is that you leave the reader feeling like that is the only and best solution; to invest in real estate. You don’t list the risks associated with it. A person can also lose their real estate due to natural disasters, as you stated can affect the market. Owning real estate in SF for example puts someone at risk of having significant damage done to their home/rental property in the event of a major earthquake, which a lot of people may not be able to afford earthquake insurance in an area where the risk of that occurring is high. Also, it takes a certain individual to be to deal with renters, and have the patience to go through evictions, etc. So being a home owner is one thing, but being a residential/commercial property owner is a whole other ball game that many people can’t handle on their own. Even if they manage to accumulate a sufficient amount of rental/commercial property and can hire a property manager, sometimes there is not enough cash flow to pay the property manager and still make a profit. While in theory sitting on property and waiting for it to appreciate is great, the reality is people usually need to sustain a cash flow too, which can be difficult to balance for some. Also, if a person is not educated enough to determine when the right time to buy is, they may find themselves underwater with the property and have a hard time getting out.

    Again, I100% agree that people should own property. There are tremendous benefits as you listed, but they should never stop putting money aside to diversify in the stock market, retirement plans, etc. There should be a balance between real estate, emergency cash, retirement plan (401k, Roth, 457plan, etc.), permanent insurance, 529plan, savings for major purchases, and so on depending on the persons goals.

    My last point I want to address is that real estate is not as liquid as other cash accounts in the event of an emergency. If you need money right away it’s extremely hard to sell property immediately and may force a lot of people to take bids lower than their property is worth out of desperation if they needed the funds for some unforeseen event. So while I think this is a good read, I just wanted to point out that diversification is still key, and not everyone has the ability to grow and manage property on their own. So we have to understand people’s limitations as well. Being well diversified helps avoid risks of failure due to economic downturns, natural disasters, emergencies, or bad investment choices, which can leave someone devastated financially.

    Reply
  7. Mark

    My Wife & I have 4 Rental Houses now.

    1. Rents are going up (recent Trulia Artical).
    2. Values where low (and MAY still be in some areas.
    3. We bought 3 of 4 at the right time.
    4. We are overpaying our mortgages so they get paid off much earlier than 30yrs.
    What do you want to know?

    Reply
  8. howard

    Here are some reasons that a home could be a bad investment: Real estate is a very expensive asset class. You’ve got sizable commissions, annual taxes, maintenance, insurance, interest costs. If you’re a landlord, you’ve got the costs of managing the property and the risk of vacancy or bad tenants. It’s tends to be the largest egg in your investment basket, so it’s contrary to diversification. It’s relatively illiquid compared to most financial assets. Historically home values have appreciated at maybe 1% over inflation vs. 7% for equities. A home is a depreciating physical asset, and may lose market appeal as tastes change. Leverage is great on the upswing but equally bad on the down-swing, so it’s risky — you could lose your home along with your credit rating if the market moves against you at the wrong time. You lose the flexibility to easily relocate if say, you get a better job offer elsewhere. For all these reasons, I’m a renter, and invest in stocks, bonds, and even real estate via REITs.

    Reply
    • masterofnone

      Howard,
      You make good points. The author had properties in SF. How long is the price appreciation there sustainable?

      I had a property in Florida that i bought after the 50% off sale and one in Rapid City,SD that I’ve had a long time. The Rapid house is doing ok mostly because of a consistent 5% price appreciation. The one in Florida made maybe 2% annually and that’s without a mortgage.

      And as you mentioned, it is illiquid and those real-estate commissions for sales is a killer.

      Reply
  9. Eric

    The thing that prevents me from taking the plunge is not being able to take a dream out of state job opportunity, or at minimum taking a huge financial hit for doing so. For someone who isn’t sure of their location, do you think buying a rental (rather than buying primary residence) is a good plan. Or buying a primary residence that is in a healthy rental area if you know you are going to be around for at least a year or two, and using a property management company after you move out of state?

    Reply
  10. No Nonsense Landlord

    Real Estate is definitely a major part of my retirement. I own and manage all my rentals, and it can be a great experience if you understand how to screen tenants.

    Reply
    • Joe

      Any tips you can share, in terms of tenant screening, would be greatly appreciated!!

      Thanks in advance.

      Reply
      • No Nonsense Landlord

        Use credit score and income. I have many of the details on my own blog.

        Reply
  11. Anonymous

    Hmm. This feature is a welcome addition, but it feels half-baked. Is there any plan for Personal Capital to allow linking a mortgage to a property, so that you can easily see where you stand, projected debt-to-value ratios, etc?

    Reply
  12. Spencer

    I definitely want to be long on real estate in the long run. I think though that until you have a more stable life it’s not a good idea to purchase real estate unless you’re willing to become a long distance landlord or plan to return to the area where you bought the real estate. In the military, there are a lot of assignments to locations in America that I would never want to return to! It’s definitely worth it to me to rent in these places and not create any more ties than I have to.

    Reply
  13. Mark Ferguson

    I have 11 rentals plus my personal house. Real estate has been awesome. One of the great benefits is you can buy below market value instantly gaining equity. My net worth has increased 600k from my rentals in the last 3.5 years thanks to buying cheap, appreciation and cash flow.

    Reply
    • Anonymous

      Did you use an LLC to manage the 11 rentals?? Thanks

      Reply
  14. shaneforest

    Real Estate Investment is the best way to secure up your money on it. I have learned the basic tactic of Real Estate in Idaho, US by Mr Lee Arnold. Lee Arnold is a man who has gained a lot of success in the field of real estate investment. He has many years of working experience so he initiated his own training institute to train students who have an interest in courses, certification related to real estate investment.

    Cheers

    Reply
  15. Chris

    Yes inflation can get crazy!If you don’t want to deal with the month-to-month maintenance of your property, you can always delegate any tenant problems to a property management company and just build up equity in the house and wait for it to appreciate!

    Reply
  16. kevin

    Having rentals (in addition to full-time job) allowed me to retire at 57. However Personal Capital does not allow you to reflect the rental assets in the portfolio view. This gives a skewed view of weightings. If the rental assets were shows as “alternatives” of some other category then it would be easier to monitor and balance my brokerage accounts.

    Reply
  17. Mark Henry

    Age of retirement is 58 and so you can plan the real estate strategy for the retirement

    Reply
  18. Olatunde

    Great article. There are many options like real estate when it comes to investing for retirement. You need to make sure that you put your retirement investment at the right place.

    Reply
    • Mark

      People do seem to look at Stocks, 401K’s, etc. A LOT more than Real Estate.
      It could be as simple as owning your Primary Residance Outright.
      The Bank and I own 4-Rentals. I STRONGLY believe in Rentals as part of a persons Retirement but, you have the right mentality for the task. For me it’s easy, but for some it is daunting.

      Reply
  19. My Road to Wealth and Freedom

    After years of investing in financial (paper) assets, I took the plunge and bought my first investment property. I think that the key to long term success with investing is balance and diversification to spread the risk around.

    Reply
    • Tim

      I agree with My Road to Wealth and Freedom about long term success. I have been investing in both the stock market and real estate rentals for about 20 years. I have a hard time buying when the market is down ( which is when one should ) in either real estate or stock market, because of the doom and bloom that comes with it. But there is no secret, success comes from long term steady investing. If you look short term it is very difficult to find profit. I am banking on inflation with my real estate. I make monthly income now but believe inflation will put it over the top when I retire and my payments are the same or paid for.

      Reply
  20. Mark

    Great!
    Finally someone talking about Realestate instead of just the stock market!
    Depreciation is a benefit!
    Having your Tenters pay your mortgage is another! (Thus contributing to your Retirement House Asset.)

    I have 4-Rentals. 1 I bought just as the market was going down (didn’t expect it to ultimately go down as much as it did) and 3-more that I’m already up about $100,000 each on!

    We are doing everything we can to pay them off. They are great income producers and we are counting on that for retirement.

    Reply
  21. Darren Novak

    Success in real estate definitely comes from endurance! You have to keep at it and make sure you do your research on each property you are going to acquire. You should also make sure you pay attention to inflation, like this post says ” Inflation is a powerful economic force that’s difficult to stop” so you can either take advantage of it or let it take advantage of you.

    Reply
  22. Property Management Jobs nyc

    Good points.

    Reply

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