Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question. Terry from NE asks: Hello Brian, I’m not new to residential investing. I bought my first rental house in 2012 and currently own 5 single family rentals. I’ve sold two problem houses (low net income) and replaced them with better performing houses. I also work full time. Rentals are a side income for me and I have more of my retirement savings tied up in houses than I have in my 401k. I’m also 55 years old and starting to seriously think about my retirement years. The two basic questions that I have are:
1. Will rental houses continue performing as well as they have for the past eight years?
2. What’s the best real estate strategy for my retirement years?
Answer. Hi Terry. Those are a couple of big and tough questions but based on your eight years of experience I’ guessing you have pretty good answers for your own situation. Regarding your first question, no one has a crystal ball to predict what will happen with the single-family house rental market in the future. What we do know is that it will change. Most indications are that it will remain a strong market for the near term. However, there are more uncertainties at the moment than there have been the last couple of years. These include the economy, elections, interest rates, and other unknown variables.
Keep in mind that rental houses are a very local investment. Mostly you want to keep an eye on how these big picture issues are likely to affect you at the local level. If your local economy is stable or growing, a slight economic downturn (which is overdue) won’t likely impact your local real estate market as much as a local market that hasn’t had a strong rebound. Current interest rates look to remain stable at least going into the new year. Also, keep in mind that the only real direction interest rates can go is up. As a landlord, you probably want to think about this from two points of view. Home buyers are still having trouble affording their first home. If interest rates go up, it will strengthen your rental business because vacancies will remain low. Also, it will favor rent increases to improve your cash flow from properties that you already own. That brings up the other side of the interest rate coin. If you’re considering investing in more rental houses in the near future, the timing for that is probably now rather than later if you will be borrowing money.
Terry, the past eight years have been strong for real estate investors and the near term future looks to remain that way. But you need to always expect change to happen. The good thing about real estate is that it has a long track record of being a stable and profitable investment. The past eight years and a long history tell us that the trajectory of real estate values will continue going up. This history makes it a good hedge against inflation. There is a lot of noise about houses becoming more unaffordable but that is still a local issue. There are lists of big cities where average prices are above $400,000 and still going up. But those are short lists and don’t represent the vast majority of the market where average prices remain closer to $200,000 and many places where the averages are lower. That means in most local markets, landlords can still afford to purchase houses at a price they can rent for a profit. Healthy local economies maintain a balanced market.
Your other question was about rental houses as a retirement strategy. The short answer is that a lot of people have been very successful with this strategy for many generations. Nothing has changed significantly. The fact that rental income tends to be stable and that value appreciation is an effective hedge against inflation continues to make rentals a good retirement strategy. There are a couple of things that you might want to start looking at to better position yourself as your retirement years approach. One is the tough issue that most landlords deal with – repairs and upkeep of the property. You want to start positioning yourself to turn the rentals into passive income sources. This means hiring and relying more on property management professionals. This can be expensive for single income properties. You may want to look at adjusting your portfolio more towards duplexes, triplexes, and other multifamily properties, including small to medium apartment buildings. This will reduce your property management costs as a percentage of the total income.
Something else you can take a look at is moving your property holdings into a self-directed 401k retirement account. This will mean that you’ll no longer be able to supplement your current income with the rental income. But the tradeoff can be financially rewarding for your retirement account because all of the rental income is tax deferred. It also opens up other possibilities. For instance, if you did something like seller finance the sale of one of your rentals, a large down payment would go into your retirement account tax free instead of you paying taxes against it in the current tax year. Something else you can do with a self-directed 401k is borrow up to $50,000 from yourself. You have to pay back the money but you repay it to your retirement account including the interest. These retirement accounts can also take out nonrecourse loans if you want to finance another rental purchase. There are a lot of options you have with a self-directed 401k that you don’t have with an employer sponsored 401k. The allowable annual contributions are much more generous than for an IRA. In 2020, you can contribute up to $63,500. This includes a catch-up contribution available to people over age 50. If you are married, you can double that contribution limit to $127,000.
Terry, as I started with, those are big and tough questions. Every individual has his or her own circumstances to consider. But residential real estate investing remains attractive both for current cash flow and as a source of retirement income.
Please share your thoughts by commenting about what you think is important in today’s small investor rental market.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].