Many clients are investing in multifamily residences as a way to generate retirement income.
“A common way for people nearing retirement is to buy a triplex or fourplex, live in one unit and rent out the others,” said Keith Baker, a financial advisor and professor of mortgage banking at North Lake College in Irving, Texas. “They sell their home and use the equity they have built up to do this, and if they still owe some debt, it will be paid down more quickly.” Among the best multifamily properties to acquire for supplemental income is one that has separate entrances with no shared common areas so that each family has their own space, according to Michael Foguth, a financial advisor in Brighton, Michigan.
“Townhomes are very popular,” Foguth told Financial Advisor. “Also popular are duplexes where you have one unit on the ground level and one unit on the second level.”
But clients should not spend so much money to acquire a property that their retirement income ends up undiversified. “If the bulk of your retirement income is tied up in one property, you are exposed to natural disasters like floods as well as economic downturns in that market,” said David Reiss, a professor at Brooklyn Law School who teaches real estate finance.
An alternative to buying a property is modifying an existing residence with the intent of renting out rooms on websites like AirBnB or HomeAway. “You would need to make sure that deed restrictions, zoning and city ordinances allow this,” Baker said. “It also will require property insurance and additional liability coverage.”
When a multifamily rental property is also a primary residence, a portion of the mortgage is tax deductible, according to Carla Dearing, CEO of SUM180, an online financial planning service. There may also be the opportunity to leverage tax benefits like depreciation.
“Selling your home and taking out a loan on a rental four-unit apartment complex allows you to deduct from your income the pro-rated interest expense along with the depreciation expense of the portion of the units you don't live in so that much of the income is sheltered,” Baker said.
Over time, the income support received from a rental property can be greater than the interest income from investing in the stock market. “You’re likely to receive a nice stream of income when you are renting to people with guaranteed incomes,” said James Brewer, CFP, in Chicago. Nationally, the average price-to-rent ratio is 11.5, meaning that the average property owner is buying a property for a price of 11.5 years worth of rent, which is an estimated 8.7 percent yield on her investment, according to data from Zillow.
A house that cost $200,000 should bring in $1,450 per month in rent using the national price-to-rent average, according to Matt Hylland, an investment advisor with Hylland Capital Management in Virginia Beach. That’s compared to 10-year government bonds, which yield 1.7 percent and the S&P 500 index, which yields about 2 percent.
“But this 8.7 percent is before any costs,” Hylland noted. In other words, clients who add rental property to their portfolios should also add cash to their emergency funds so that have money on hand to maintain and repair the house. “If the roof needs replacing, do you have $5,000 available to fix it?” asks Hylland.
Ideally, a multifamily acquisition will be move-in ready. “Homes that require construction or renovation can easily turn into a money pit, costing twice what you estimate up front,” Dearing said.
Expect to pay taxes on the rental income even though it derives from renting part of a primary residence. “Typically, owning a multifamily residence near a college or university can insulate you from the challenge of tenants who lose their jobs and don’t pay the rent, which is your income,” Brewer said.
In worst-case scenarios, eviction proceedings may be in order when a tenant can no longer pay rent. “Eviction could take a while and meanwhile you are not only out the rent, but you now have legal costs on top of it,” said Brewer. “If the property has a mortgage you are still on the hook for, you can become strapped for cash fast and the danger is foreclosure when you can’t keep up mortgage payments.”
To avoid testy situations with tenants, hire a management company to screen tenants, manage the property and maintain the rental on your behalf. “A property manager’s pay will be about 10 percent of the cost of the home,” said Hylland. That’s a small price to pay for freedom from the day-to-day headaches of being a landlord. “Your time will be your own and you’ll be free to work and travel without worry,” said Dearing.