I don’t know how the real estate market is in your area but here on the Space Coast, it is pretty good. No clearer sign is that in the last six months I have received a number of questions from retirees about acquiring rentals.

For example, “Hi Dan, I am 67 and probably retiring in the next couple of years. I was talking to an agent who says he has a property for sale that would be perfect to rent out. Other houses nearby rent for enough to cover the mortgage plus a couple hundred more each month. Sounds like a good way to get some extra income. Thoughts?”

Owning rental property and collecting income has great appeal to many. It can be great way to generate some cash flow and build wealth but…

Doing well with rentals is not nearly as easy as many people perceive it to be. Most retirees should not invest in real estate through direct ownership of rental properties.

My first question to would-be property moguls is always, “Have you ever been a landlord before?”

Using the word “landlord” is the key. For most people, the word evokes a number of images and thoughts that are far less glamorous than the idea of simply cashing an unending series of checks.

Owning a rental can be a time-consuming job. When the air conditioner fails or the toilet leaks, the owner gets the call. Now, some people love this and have a natural affinity for these tasks. Others don’t have any interest in being a handy man.

If the client doesn’t have the expertise, time or inclination, they can hire help, even a management group. None of those services are free. Regardless, it doesn’t take much maintenance to eat up the potential profit.

Another fun landlord roll is dealing with tenants. Despite all the screening that should be done, tenants can fall behind or stop paying rent altogether. Life happens and things change. The renter loses a job or gets sick. Some have clean background checks and put on a good show to get into the lease but really aren’t good people. I have seen tenants move out in the middle of the night and others refuse to move out even though they had not paid their rent for months.

Also, let’s not overlook the fact that some renters are not as gentle on a property as they would be if they owned it. Those repair bills can add up.

Yes, owners have a legal recourse against bad tenants, but these issues are often not resolved quickly bringing a great deal of stress and aggravation. Clients will need a lawyer and the lawyer needs to get paid. Some of these issues linger for a long time.

Guess what? Neither the mortgage company, insurance company nor the tax man care. They want their money and they want it on time. Ahh, the joys of ownership. 

Even if the tenants pay fully and promptly, it is common for a property to go unrented for some time after tenants move out and before a new tenant moves in. How many months can the client go without rent before an underperforming property stops being a decent investment and becomes a real problem?

If clients truly have the temperament to be a landlord, few have a good grasp on the financial aspects of a rental. It is a lot more complex than just collecting enough rent to cover the mortgage. Most would be rental owners have heard there are “tax breaks” but they don’t actually know how things like depreciation and recapture work. They should work with a good tax person which is another often overlooked expense.

About half the time, clients are looking to tap their retirement funds to buy the property, either through distributions or because they heard they can buy real estate with their IRA money.

It is interesting to me to see how often people underestimate the taxes due from a retirement plan distribution. They forget that if the entire distribution would be taxed in the 25 percent bracket, to net $1,000, they need to pull $1,333. Oddly, it is also common for people to fail to see the taxes as an added expense that affects the net return on the would-be real estate venture.

While, you are permitted to buy some types of real estate with IRA money, it is far from a simple transaction.

You cannot use a traditional mortgage. The property must be strictly an investment property. No personal use is permitted. In fact, neither the client nor anyone in the client’s family can transact with the property. An outside party will need to be hired to manage or maintain it. More expenses.

All maintenance, taxes, insurance and other expenses must be paid out of the IRA, so cash will need to be available in the IRA. Run out of IRA cash and you may have a problem. Remember, we are talking about an IRA so the rules regarding contributions and rollovers apply. Plus, owning a property in an IRA makes the misunderstood tax breaks previously mentioned a mute issue. And lets not forget the rules regarding distributions.

Owning property in an IRA can make fulfilling required minimum distributions challenging. If you have other IRAs, RMDs can be taken from those accounts, but what value is used to calculate the RMD for the IRA that holds the property? The custodian must report a value to the IRS as of each 12/31 resulting in yet another expense.   

Most custodians that will hold a property will provide you with information about the ins and outs but if you read their materials closely, it is likely you will see the ultimate responsibility for complying with all the rules (prohibited transactions, self-dealing and others) rests on the client. We strongly recommend clients retain their own counsel. If there is an error, the entire IRA can be deemed taxable.

Clearly, considering all the costs and potential costs of the property and the professional assistance needed to do this well and protect a client’s interests, the selection of a property is critical. The rent needs to cover much more than the mortgage. Working with a good real estate agent is important as is exercising enough patience to find a really good property.

If clients are still wanting to own a rental, they should consider their estate plan carefully. Here I’m not thinking of taxes at all. I’m thinking of the client and the heirs while they are alive. The client may be fine with all that rentals entail but they will not be able to attend to the property matters forever. What started as a side gig or a hobby of sorts can easily turn into a source of stress when it is least needed.

Is the surviving spouse or other heirs capable and willing to deal with the complexities of owning a rental? Could they handle the ins and outs and lawyers and tax advisors that come with selling a property?

One last observation: Often, clients are presented the opportunity to draw rental income as

an easy “no brainer”—and they must act fast. These are common sales tactics but also classic signs of outright scams. If rentals are an acceptable part of your client’s retirement, they are probably better off learning the ropes and being patient before buying a property. It is highly likely that a good option will arise in time.

Now, don’t misunderstand. We have clients with rentals. Some have done very well. Rentals are indeed good fits for some people. They just aren’t all that simple or easy. I bring up all these negatives because people selling properties for rental possibilities often don’t. Part of my job as a financial planner is to insert the real world into the theory and to make sure clients understand the pros and cons of various courses of action.

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.