October 1, 2009 in Retirement

3 ways real estate can help retirees

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.”

3 real estate income options
  1. Buy a home or apartment building.
  2. Rent a room in your home.
  3. Consider a reverse mortgage.

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.

“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 building

Ownership 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.

Expenses can eat up a large chunk of profits. Some types of maintenance — such as repairing or replacing systems like central air conditioning and water heaters — can be costly. Fortunately, the Internal Revenue Service allows tax deductions for certain expenses related to investment property.

A decent cost-benefit analysis can help you figure out how much profit to expect from the property. A financial adviser can help crunch the numbers.

Rent a room in your home

Renting a room in your home may make sense for empty nesters who need to bolster retirement income. The option is especially appealing for people who live in college towns where room rentals are in demand.

Before offering little Timmy’s room to a stranger, check the applicant’s credit history and criminal background.

As with any rental, state the rental terms clearly in a written lease. Things like kitchen privileges and common area usage should be spelled out. Generic lease forms can be found at local office supply stores or online. You’ll also need to bone up on your state’s fair housing laws to find out what your responsibilities are as a landlord.

Check local ads to get a feel for what room rental rates are in your area. Then, determine how you compare, remembering to consider any amenities that might factor into your rental rate.

For example, amenities like a private entrance, a pool or off-street parking are all excellent selling points that may garner a higher rent.

Consider a reverse mortgage

With housing prices tumbling back down to earth and retirement accounts remaining bruised, retirees are looking to other sources to squeeze income out of real estate.

Enter the reverse mortgage.

If you’re 62 years or older and own your home outright or have a small mortgage to pay down, you may qualify for a reverse mortgage. The older you are, the higher the amount you can generally borrow.

For 2009, homeowners can borrow up to $625,000, depending on how much your home is appraised for, your age and current interest rates. In 2010, the amount reverts to $417,000.

The U.S. Department of Housing and Urban Development, or HUD, recently announced a new effort called the Home Equity Conversion Mortgage for Purchase Program that allows seniors to purchase a new principal residence using loan proceeds from a reverse mortgage without having to sell the old residence.

Reverse mortgages have pros and cons. On one hand, they provide a steady income stream for those who remain in their primary residence. On the other hand, closing costs and fees can be expensive.

Such costs may add up to thousands of dollars, potentially negating the benefits of reverse mortgages, especially if you don’t expect to stay in your home for a long time.

Reverse mortgages have other potential negatives, says Julie Jason, president of Jackson, Grant Investment Advisers in Stamford, Conn., and author of “The AARP Retirement Survival Guide: How to Make Smart Financial Decisions in Good Times and Bad.”

“People may not be aware (that) some reverse mortgages have default provisions,” she says. “Let’s say somebody needs to go into a nursing home and they’re out of the house for more than one year — that could be a default.”

For this reason and others, Jason believes reverse mortgages are not a great option for most homeowners.

“Who are they good for? I would say very few people,” she says. “It would be someone who has no other options.”