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Investing In Real Estate Is Better For Retirement – PERIOD!

by Brad Johnson on May 27, 2014 · 13 comments

  
Real Estate Retirement

I talk to a fair amount of baby boomers who are preparing to retire.

I’m often surprised how many of these individuals, including some very wealthy people, have no idea whether or not they have saved enough to fund their desired lifestyle through retirement.

You can hear the anxiety in their voices when they start going over the math, “well if we live until age 85, and earn 8% a year and take a 4% yearly withdrawal rate …we should run out of money a few hours before kicking the bucket.” I asked one such retiree, “Ok, but what’s the backup plan if you live to be 100”? He replied, “move in with the kids”.

This is a stressful and depressing approach to retirement planning. The golden years should be spent enjoying grandchildren, hobbies, traveling and beginning new adventures, not obsessing over retirement calculators and secretly hoping you pass peacefully in the night before the last check bounces.

Related: Frankly My Dear, Retirement isn’t as Bad as it Now Appears (at Least not With the Help of REI!)

Admit it, You Are Not Warren Buffett!

Many baby boomers will enter retirement watching the stock market like a hawk, walking around on cloud nine and taking numerous vacations during bull markets then panic and clip coupons during bear markets.

Furthermore, with a lot of free time on their hands, many retirees will get antsy and start trading based on short-term volatility. We’re all fooled into thinking that a little homework and thoughtful action will drive superior stock market returns.

Why Direct Real Estate Investing Is Ideal For Retirement Planning

The research shows the average investor would be better off buying and holding an S&P 500 index ETF. Of course, no one will admit they’re an average or below average investor, so they’ll listen to hot stock tips, ride momentum stocks, trade too often and erode returns with transaction costs.

These investors are their own worst enemy. They made their money through hard work and action, so it’s hard to accept that they can’t out hustle the market. But aren’t retirement savings too precious to be exposed to investors’ animal spirits and overconfidence?

1. A Buy And Hold Strategy Is A Lot Easier To Execute With Real Estate Investments.

You won’t be bombarded with real time price quotes on your real estate assets and Jim Cramer and other TV experts (charlatans) won’t yell in your ear to sell, sell, sell one week and then buy, buy, buy the next week.

Furthermore, real estate transactions move painfully slow. You can’t simply call your broker to dump all your real estate holdings during a moment of despair or after your buddy tells you the sky is falling and he’s moving his entire portfolio to Bitcoins.

2. Tremendous Tax Advantages:

You can shelter retirement savings via a 401K or standard IRA, but you’ll have to pay the tax-man when you start withdrawing.

With real estate you can take depreciation (paper losses) and mortgage interest deductions, which could result in tax-free cash flow until an asset is fully depreciated and the mortgage is paid off.

At which point, an investor can sell the property and “trade” into a another property via a 1031 exchange and start the cycle over again. I know real estate investors that have done this 30+ years without mailing Uncle Sam a check.

3. Real Estate Offers Inflationary Protection:

You might have a large bond / stock portfolio that meets your income needs, but you are likely losing money in real terms thanks to inflation.

This is less of a concern with real estate investments, as the ability to increase rent and pay down fixed interest debt with “cheaper” dollars hedges the investors exposure to inflation.

4. Ability To Influence The Investment Outcome Through Effective Management:

Despite your best efforts, you’re not going to be able to impact the success of your Chipotle stock (no matter how many burritos you put down a year).

5. Direct Real Estate Holdings Typically Offer Higher Cash Flow Yields Than Stocks (Dividends) Or Bonds (Interest Payments):

This obviously depends on buying the right properties in the right markets.

However, all things being equal, the illiquidity premium, management factor and the ability to use substantial leverage with accretive debt all translate to higher returns relative to most retail investors’ stock & bond portfolios.

Additionally, while I certainly don’t believe that the stock / bond market is completely “efficient”, real estate pricing is less transparent and offers savvy investors more information asymmetry advantages than the stock market.

Related: Real Estate is Better than Stocks – Fact, Not Opinion.

This last point is where real estate truly stands out from a number of other investment options in term of funding one’s retirement.

The ability to generate double digit, after tax cash flow returns enables holders of real estate portfolios (that don’t over-leverage) the ability to live off their cash flow indefinitely.

There are no withdrawal rate calculations to worry about, you’re hedged from inflation, your paying little if anything in taxes, your tenants pay down your mortgage, and you’re slowing accruing appreciation (should you decide to sell instead of gifting your portfolio to your children).

Naturally, individuals who accumulate $20,000,000 in cash, can just put their money in a fixed income investment and live comfortably off the payments without losing principal. However, most of us will need superior returns to retire without worry.

Perhaps the largest downside to using real estate to fund a retirement is the active management component, which may or may not be appealing to you.

Yet, many investors enjoy the semi-retirement, part time work involved with managing a real estate portfolio (assuming one has great team in place).

Purely passive minded investors can remove themselves even further by investing with real estate sponsors who handle the day-to-day management of their direct real estate holdings.

Passive investors can also pay for professional asset management companies to steward their property managers and RE holdings.

I suspect that stocks and bonds will be the dominant retirement investments for centuries to come. Therefore, they should be a component of every diversified investment portfolio.

However, rather than worrying whether your money will last as long as your retirement, you might want to consider amassing a portfolio of appropriately leveraged, cash flowing properties that can generate enough cash flow to fund your retirement indefinitely.

How do you feel about real estate as a retirement vehicle? 

Be sure to leave your comments below!

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{ 13 comments… read them below or add one }

Adrian Tilley May 27, 2014 at 11:12 am

I just have to quibble with one point. You state that REI is easier than stocks, then go on to state that you can increase value through effective (presumably active) management. There is no way that actively managing an REI portfolio is easier than sitting on a bunch of stocks/bonds. Then you state that active management is not a downside, it’s fun.

I think the answer here is that REI is better for those for whom the work/risk is worth the reward, and/or for those who think that active management is fun. Simply stating that REI or stocks are categorically better for everyone is just being silly. My $.02

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Brad Johnson May 27, 2014 at 11:40 am

I actually agree with you, hence “Perhaps the largest downside to using real estate to fund a retirement is the active management component, which may or may not be appealing to you.” I don’t recall saying REI is “easier” than stocks.

The title wasn’t my choosing, but the folks at BP know a lot more about blogging than I do… so at least it got your attention. Clearly, the issue is more nuanced than the title would suggest. There are very few absolutes in this world.

The larger point, is that a diversified portfolio of cash flowing real estate can be an extremely effective retirement vehicle, one that is often overlooked by retirees who (I would argue) are under-allocated to REI and over-allocated to stocks and bonds.

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stephen May 27, 2014 at 11:30 am

Well; I have a few thoughts. I invest heavily in the stock market and tend to trade very seldom. But I am always grateful for for the people who are the ones who act on hot stock tips, ride momentum stocks, trade too often, and erode returns with transaction costs – because without them the opportunity for my bargain priced purchases would be far less. The Market is like the Tao – it doesn’t pay to fight or outsmart it.

So I disagree that a Buy And Hold Strategy Is A Lot Easier To Execute With Real Estate Investments. I own shares which I bought in the 1970′.

Jim Cramer: Goldman Sachs has the best minds on the planet continually working to make a profit. GS repeatedly refused to hire Jim Cramer. You may draw your own conclusion.

The above notwithstanding; I do like real estate as a retirement vehicle.

stephen
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Sharon Tzib May 27, 2014 at 11:41 am

I’m 100% using real estate to fund my retirement, so I agree w/ everything you state here. Here’s a couple of interesting articles for people who still want to diversify and use both real estate and stocks to help them achieve some perspective:

http://orcamgroup.com/wp-content/uploads/2012/10/The_Investment_Myth3.pdf

http://pragcap.com/why-you-likely-trade-like-a-loser

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Jason May 27, 2014 at 12:30 pm

Nicely done.

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Lisa Phillips May 27, 2014 at 2:09 pm

I agree!

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Mark Ferguson May 27, 2014 at 3:01 pm

I am basically 95% invested in real estate for my retirement. I think RE is fun and I love being able to control my investments, not hope the market does well.

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Eric May 27, 2014 at 6:35 pm

I started investing heavily for rental properties in 2008. I actually started looking prior, but no deals were available that suited me.

I have replaced my work income, and it is allowing me to retire at least nine years earlier than most people. Truth be told, I could do it now. Doing the maintenance and showings are not bad at all, and it is rather enjoyable.

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James Pratt May 27, 2014 at 7:34 pm

P.S. Why are you showing a picture of Brandon for?

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James Pratt May 27, 2014 at 7:32 pm

Brad, you didn’t talk about all the fee’s one is charge for having someone managing their stocks or high taxes they’ll have to pay. As for me, I retired at the age of 42 due to my real estate investments. Diversify like the stock brokers tells one to do and bought some stocks, lost 90% of my money- twice.

With real estate, one can add value, raise rents, refinance, whatever and sleep at nights knowing it’ll still be there in the morning. Pay very little in income taxes if any, got a great CPA.

The market can do whatever it wants, my rents keeps coming in with very few hiccups. I control 100% of my retirement not dependent on others and their whims. No hot flashes here.

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stephen May 27, 2014 at 7:55 pm

Stock brokers are salesmen who get paid whether you win, lose, or draw. They like to call themselves investment counselors or something like that now. I have never met one who seemed to know a damned thing about how to make money in the stock market. Well; except for themselves. Diversification is nonsense. Brokers preach it because it helps them cover their asses better. I always love how the market goes up and they are genius grade stock pickers – but when the market goes down it’s never anything to do with them.

Funny how that works, isn’t it?

stephen
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Sara Cunningham May 29, 2014 at 7:46 am

I agree. Our REI won’t fund our retirement as much as some people but it will definitely make it easier to go to 5 star hotels and keep our standard of living without having to worry about pitching pennies.

I already gave up my job 4 years ago and my husband could retire too if he wanted to but we love what we do. Nice to have the choice though.

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Chris May 30, 2014 at 1:11 pm

If investing in RE keeps one from gambling on the stock market and thinking they can day trade, then fine. A better strategy is to learn how to control emotions with investing in paper assets IMO.

Stocks also provide some inflation protection. Coke stock is going to go up with the price of Coke, generically speaking. However, you can’t just raise the rent to nullify inflation. The market has to support it, which to me means your target renter has to get a raise that matches inflation. Nobody knows how this will play out over the next 30 years. “Buying in a hot market” is speculation, not inflation protection. Big difference.

I believe it’s a bad idea to go all-in on any one thing. Black swan events seem to target those people. There’s nothing wrong with having a mix of investments. I’m about 50 / 50 between RE and some Vanguard funds myself. I basically don’t check the price of either on a regular basis as the funds auto-balance to my AA.

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