In the wake of last year's stock market meltdown, some retirees are looking to real estate to supplement their income.
Monthly rent payments or income from a reverse mortgage can help support a lifestyle otherwise out of reach for those with small nest eggs.
But is it wise to try to tap the earning power of real estate so late in life?
Over the long term, stock market returns historically have trumped those of other asset classes, including real estate. Between 1978 and 2008, stocks averaged an annual return of 12.33 percent compared to 5.92 percent for residential real estate, according to a recent study in the Journal of Portfolio Management.
While stocks may seem like a better investment for retirees, real estate has advantages, too, says Carrie Coghill-Kuntz, a Certified Financial Planner and president of Pittsburgh-based D.B. Root & Co.
"When you look at the risks inherent in real estate, the difference between real estate and almost any other asset is that real estate is a physical asset that never goes away until you decide you don't want it anymore," Coghill-Kuntz says.
"Conversely, company stock is represented by people running a company and you never really know when and if they'll close the door."
Before trying to extract income from real estate, retirees must do a cost-benefit analysis to determine whether the effort is worthwhile, says Michael Fitzgerald, a Certified Financial Planner and president of Fitzgerald Financial Partners in Houston.
3 real estate income options
- Buy a home or apartment building.
- Rent a room in your home.
- Consider a reverse mortgage.
"You have to be able to utilize the asset correctly to produce the right amount of cash flow," Fitzgerald says.
Following are three suggestions for making cash "flow" from real estate.
Buy a home or apartment buildingOwnership of land and property long has been a key part of the American dream. Buying a home or apartment building can be part of that vision, even in retirement.
Recent dramatic price declines in some markets have created new opportunities that didn't exist during the housing boom.
However, retirees shopping for real estate must check their emotions at the door and instead focus on the cold, hard facts about whether the investment is likely to generate positive returns.
"With real estate it's still all about location and it's all about the marketplace," says Coghill-Kuntz.
For starters, retirees who invest in property face challenges unique to their age group and life situation. Real estate is not a liquid asset, an important fact for retirees who someday may need access to quick cash, yet no longer can tap monthly employment income.
In addition, rental properties can drain cash quickly in periods where it's difficult to find renters. This, too, can be more dangerous to a retiree without employment income.
Retirees shopping for rental units also should gauge how long they are likely to hold the property.
"Either your price or your interest rate are the most important components, depending on how long you're going to hold the asset," Fitzgerald says.
Retirees who plan on holding the asset for a long time may find that interest costs become more important than the initial purchase price. Remember that over time, you're going to pay two or three times the original purchase price in interest, Fitzgerald says.
On the other hand, price is more important than mortgage interest costs for retirees who look at their investment from a short-term horizon.
Investors also should calculate how much they can earn in gross rental income, and understand how factors such as annual maintenance and real estate taxes affect their rate of return.