RETIRING ON REAL ESTATE -- PERFECT PASSIVE INCOME OR PIPE DREAM?

Monday May 18, 2015 | by Hal M. Bundrick, CFP, The Street

NEW YORK (TheStreet) -- “Mailbox money.” That’s what investors often call the passive income generated by real estate assets. It could be from rental incomehouse flipping profits, even dividends. The thought is, buy some property and wait for the checks to start rolling in. Can that still be done, or are such scenarios a pipe dream from a pre-recession world?

 

Steve Olafson of Scottsdale, Ariz. is a former plumber, auto mechanic and tech manager who now works real estate deals full time. The 2008 crash is still fresh on his mind.

 

“In 2007, I had over 1,000 apartment units,” Olafson says on the BiggerPockets.com blog. “The cash flow was very high. All of that was wiped out by the crash.”

 

But it gets worse. After going on a major apartment complex purchasing spree in Phoenix during ’04 and ’05, he decided to diversify geographically. Olafson began buying units in Houston, Texas. A couple of years later, not only was the economy beginning to “drop a bomb” on Arizona, but a hurricane hit Houston.

 

“Gross incomes on my properties dropped by more than 50%,” he says. “I was lucky to pay expenses for a while. There was nothing left to give the lenders. I fought like crazy for a couple of years and finally got the income back up to where the full payment could be made." 

He ultimately had to put all his reserves into the property and had nothing left to catch up the arrears that had accumulated. 

"This is when the lenders foreclosed,” he said.

 

It's not all bad news, though. Chris Morley, founder of Bien Realty in Manhattan, still sees people who are willing to take on at least a little risk in real estate.

 

“I have sold investment properties [in the city] to people currently living in the suburbs,” Morley says. “Their intention is to rent it out and get it paid off, so when their kids leave for college, they can leave the high taxes in the suburbs and live in NYC with no mortgage and less taxes.”

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And then there is Dale Degagne, a financial planner from Ontario, Canada, who travels the world with his wife -- on his profit from real estate investments. Currently living in Thailand, he says he bought his first rental property at age 21.

 

“I have mainly stuck to rentals, but I have owned multi-units, single families and student rentals," Degagne tells TheStreet. "I have also done flips. Currently, there's little money in commercial [real estate] at my price range.”

 

He says he "retired" at age 28 with five properties, hired a manager and hit the road. But before jumping into the real estate game, Degagne says investors should consider three keys to success:

 

1. Pay off the mortgages. “Assuming you purchase property that is profitable from the start, not having a mortgage every month can significantly increase your profit," Degagne says. "I know for me, [my profit] will double in 20 years when all the mortgages are paid off.”

 

2. Hold the real estate for at least ten years and keep good books. “In real estate you have good years and bad years, just like you will in any business and almost any retirement investment strategy," Degagne says. "In a ten-year time frame you should see a) A trend in your real estate -- prices, costs, profit b) What your worst year was, and c) From there you should be able to figure out a solid number that you can rely on. This is by far the most important point.”

 

3. Have an exit strategy. “This involves planning how [the properties] will be taken care of when you're still alive, but don't want the bother of making any decisions on them," Degagne says. "For this, my suggestion is training someone who will eventually inherit them to make the decisions. Bookkeeping and day-to-day management can always be outsourced. There’s no need to be fixing toilets in the middle of the night at 70 years old.”

 


Word to the wise: to invest in real estate, you don’t have to have a tool box and plumbing supplies. In fact, in some cases, you’re not allowed to manage or perform maintenance on such investments. For example, property can be purchased and placed in a self-directed IRA, but financial and maintenance matters should be handled by a property manager. Performing work related to the IRA asset yourself is regarded as a "prohibited transaction" by the IRS.

Nuts and Bolts of Opting for a REIT

And for those who aren’t handy, real estate investment trusts (REITs) may be a way to gain exposure to property income.

 

 

“A real estate investment trust is a company that buys, develops, manages, and/or sells real estate such as skyscrapers, shopping malls, apartment complexes, office buildings, or housing developments,” says Thomas Marino, a financial advisor in Cherry Hill, N.J. “Rather than investing directly, investors in REITs put their money into a professionally managed portfolio of real estate.”

 

REITs make money from rental income, profit from the sale of a property, as well as other services provided to tenants, Marino says.

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“Because REITs are required to pay out 90% of their annual income in the form of dividends, you can expect to receive income from your REIT investment,” he adds. “A REIT may trade on the major exchanges, just like stocks, or be what is called a ‘non-traded REIT.’”

 

While Marino says non-traded REITS can presently pay a dividend between 6%-7.5%, depending on the quality and the assets held, they are not considered as liquid as exchange-traded REITs, and can be very difficult to sell on the secondary market.

 

“Because non-traded REITs may involve substantial redemption fees, they are best suited for long-term investors who will not need access to their invested capital in the short term,” Marino adds. “Also, distributions are not guaranteed and can be suspended or halted altogether.”

 

But no toolbox is required, either.