The rationale for owning real property is simple: there’s a limited supply of land, and they aren’t making any more of it. Add to that the fact that the “American dream” has typically held home ownership as a cornerstone, and it’s not surprising that around 70% of the average American’s net worth is represented by real estate.
Given the above, it also makes sense that as many approach retirement, they regard income-producing real estate—rental property—as a good source of retirement income. And while it’s certainly true that many fortunes have been built in real estate, there are two sides to the real estate ownership coin, especially for those who are looking forward to a “simpler” retirement lifestyle.
Not All Things to All People
At the outset, it’s worth noting that the percentage of net worth represented by real estate varies widely across the wealth spectrum. As mentioned above, the average individual’s net worth is 70% real estate. But consider that according to the US Census Bureau, real estate made up about 28% of household wealth in this country in 2021. In other words, the wealthiest 1% of the population have only about 12.3% of their assets in real estate, whereas the bottom 50% have a much larger percentage. In other words, how much of your “portfolio” consists of real estate depends on where you fall in the category of total net worth.
This disparity brings up the question: how much of a person’s wealth should be concentrated in real estate? Part of the answer may depend on the individual’s circumstances and background. A prospective retiree who has spent her career in real estate and who, perhaps, has accumulated significant holdings in various income properties may feel more comfortable depending on such assets for retirement income. For someone with less experience, however, the answer might be different.
How Hands-On Do You Want to Be?
Many retirees are looking forward to a lower-stress, less-complicated lifestyle in retirement. For these individuals, it may make less sense to be involved in the day-to-day management and administration that often goes along with owning income property. After all, renters come and go; some occupants of rental property leave damage in their wake; repair and upkeep can require a large commitment of time and/or financial resources, and taxation can be complicated. Then, there’s the issue of proximity. If the properties are located in the same vicinity as the owner’s residence, keeping an eye on things may be easier. But if not, the owner may need to hire a manager who can be “on the ground” with the property—and who will likely collect a fee between 10% and 20% of the monthly rental proceeds (cutting into the retiree’s income).
Spinning It Off
For those who have already accumulated significant holdings in rental or other income property and who do not intend to remain active as managers in retirement, selling off the properties and re-investing the proceeds may be a viable option. Of course, the capital gains taxes payable on properties with significant appreciation can be problematic, so such plans should be carefully discussed with a trusted tax expert.
On the other hand, those who desire to maintain exposure to real estate but are reluctant to take the capital gains hit may wish to consider a tax-deferred exchange that allows them to relinquish their owned property in favor of a professionally managed holding like an umbrella partnership real estate investment trust (UPREIT, or 721 exchange) or a Delaware statutory trust (DST). These alternatives allow investors to participate in diversified portfolios of professionally managed properties and maintain deferral of capital gains taxes that would otherwise be payable.
The Whole Picture
As you can see, there are a number of variables that should be considered when deciding whether—or how much—to include income property as part of a retirement income strategy. The individual’s experience with owning and managing income property, their desire—or lack of it—to be active property managers, their overall estate, including their plans for the property after their passing: all of these should be weighed as the strategy is being developed. It’s also important to consider the potential risks of concentrating too much of the individual’s wealth in a single asset class; diversification is almost always desirable as a means for limiting the exposure of retirement assets to market volatility.
For all of these reasons, having access to the guidance of a professional, fiduciary financial advisor can be a big advantage to those contemplating retirement. A qualified financial advisor can help the client take a broad view of their asset base and assess it in light of the client’s specific needs, goals, values, and lifestyle preferences.
At The Planning Center, we specialize in developing individualized, evidence-based strategies for retirement funding and other important financial objectives. To learn more, please visit our website and read our article, “Your Tax Bracket and Your Retirement Strategy.”
