For the most part, decisions about retirement are not made overnight. Whether you like it or not, retirement planning is a life-long process. That’s why it makes sense to have a good idea about what you want your retirement to look like before you determine how much you’ll need to save for the future lifestyle you envision.
While adding real estate to a traditional investment portfolio can be appealing as a cash flow generator and to complement stocks and bonds as a hedge for inflation, it’s not as simple as navigating and negotiating your way around the classic board game of Monopoly®. To help prepare for the numerous challenges you may encounter if you’re thinking about making such a move, it’s a good idea to consider the pros and cons before jumping into the rental market.
Here’s a bit more insight to ponder. Domestically, residential real estate values continue to boom amid tight supply and extraordinarily high demand. In April, the median price of a U.S. home was a record $391,200 — up 46% over the past three years — according to the National Association of Realtors. However, some would-be home buyers have been pushed out of the market due to affordability challenges, particularly as interest rates climb, which in turn has led to the recent slowdown in home sales.² For many Americans, renting an apartment or home is the only option they can afford.
Is rental real estate a real-life opportunity? In the game of life, there’s one way investing in real estate is very similar to the game of Monopoly. The price of a property — and its ability to command above-market rental income — is related to perhaps the three most important factors in real estate: Location, Location, Location. In real estate, just like Monopoly, you can always change the features of a building or the layout of a property by adding houses or hotels. But you can never change the location of a property. You cannot turn Baltic Avenue into Boardwalk or Park Place.
Considerations before purchasing rental property Before adding real estate to your investment portfolio, it’s wise to develop a plan based on your goals and what you hope to accomplish with your investment. Answering a few basic questions below may help guide the planning process: • Are you purchasing an older home or building to rehab and flip or rent? • Do you want to buy a house in a quiet neighborhood, or a condo or multi-family unit near a university or city center? • Are you interested in owning a second home in a vacation community to rent weekly or monthly when you’re not occupying the property? • Do you prefer investing in an older building in a commercial area to potentially rehab as loft living spaces or for small business occupancy?
Regardless of your long-term objective for adding real estate to your investment portfolio, it’s important to seek objective advice from a licensed real estate professional who can help you answer the following questions and address any concerns you have in order to avoid unnecessary future costs or significant losses. For example: • What documentation on the property can be accessed from local/county government records? • Are there any outstanding liens or delinquent taxes due on the property? • Is the property located in a flood plain? • Does the structure require extensive plumbing, carpentry or electrical repairs in order to pass inspection? • If there is a Home Owners Association (HOA) fee, what does it cover and is it in line with similar communities in the area? • Does the HOA impose rental restrictions related to pets, maximum occupants allowed at one time, or limits on the number of times you can rent the property per year? • Is the location of the property in an area or neighborhood where you or a loved one would feel safe living? Letting children play in the yard or common area? Walking a dog around the block after dark? • What external factors might detract from the property’s appeal (e.g., railroad tracks, traffic noise, busy roads, insufficient parking, minimal outdoor lighting)? • Is the property within walking distance to the downtown area, parks, schools and shopping? Is it located in a sought-after school district?
Answers to some of the questions above could have a significant impact on the rent you might be able to command from tenants. But perhaps the most significant factors to consider revolve around your commitment to the property itself. For example: • Are you willing to give up a variable portion of time from your busy life to manage and perform ongoing maintenance or tend to emergency situations like a leaky sink at midnight on a holiday weekend? • Will you manage lease agreements and rent collections, or will you hire a property management company to handle administrative details? • Can you readily access cash or borrow funds for emergency repairs or damages to the property if required? • Can you gather a team of professionals to assist you with your investment when necessary (e.g., real estate attorney, CPA, tax advisor, property and casualty insurance agent, and financial advisor)?
Individuals who invest in real estate say they enjoy it because it’s a tangible asset — not just three letters that represent ownership in a share of XYZ corporation. However, you have to do your homework and decide if owning and managing rental property is the right move for you.
Look into other real estate investment options If you’re not handy and don’t have the time, interest or ability to maintain property on an ongoing basis, there are other options for adding real estate to your portfolio. Talk with your financial planner about investing in real estate exchange traded funds (ETFs), mutual funds, or real estate investment trusts (REITs) — all of which provide portfolio income and a similar hedge against inflation without requiring you pick up a hammer, draft a lease agreement, or fix a leaky faucet on a holiday.
Paying for rental property Adding real estate to your investment portfolio is a complex decision that should align with your longterm financial goals. With the help of a financial planner, you should weigh the possible return from investing in real estate as compared to other investment alternatives, most notably the stock market. Your tax advisor can also help you project the tax implications of real estate investing.
Should you decide to finance your rental property rather than pay cash, we can help. Financing alternatives include placing mortgage debt on the subject property or using equity in your residence for either the down payment or entire rental property debt. Home equity lines of credit or lines of credit against an investment account are attractive options if you plan on reselling the property.
We offer conventional mortgages, home equity lines of credit — or depending on the terms of an existing first mortgage, a refinance cash-out mortgage on your primary residence. Contact Commerce Financial Advisors today for more information.
¹ Renting Statistics : Facts & Trends in Rental Market (ipropertymanagement.com), updated July 14, 2022. ² Commerce Trust Company, “2022 Midyear Outlook: Surging Inflation, Shifting Markets,” July 2022.
Commerce does not provide tax advice or legal advice to customers. While we may provide information or express general opinions from time to time, such information or opinions are not offered as professional tax or legal advice. Consult a tax specialist regarding tax implications related to any product and specific financial situation. This material is intended to provide general information only, may be of value to the reader and audience, and is reflective of the opinions of Commerce Trust Company. Commerce Trust Company is a division of Commerce Bank. Securities and Advisory services provided through Commerce Brokerage Services, Inc., member FINRA, SIPC, and a registered investment advisor. Insurance products are offered through Commerce Insurance Services, Inc. Both entities are subsidiaries of Commerce Bank. This material is not a recommendation of any particular security, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional. The information in this commentary should not be construed as an individual recommendation of any kind. Strategies discussed here in a general manner may not be appropriate for everyone. Diversification does not guarantee a profit or protect against all risk. Past performance is no guarantee of future results, and the opinions and other information in the investment commentary are as of August 17, 2022. Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product or specific financial situation. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed, and is subject to change rapidly as additional information regarding global conditions may change. All expressions of opinion are subject to change without notice depending upon worldwide market, economic or political conditions.
Securities and Advisory services provided through Commerce Brokerage Services, Inc. Member FINRA, SIPC, and a registered investment advisor. A subsidiary of Commerce Bank. Securities and Advisory services provided through Commerce Brokerage Services, Inc., member FINRA, SIPC, and a registered investment advisor. Insurance products are offered through Commerce Insurance Services, Inc. Both entities are subsidiaries of Commerce Bank. Not FDIC Insured | May Lose Value | Not Bank Guaranteed | Not Insured by Any Federal Government Agency