Retiring on Real Estate Equity

More and more people are looking towards real estate as an attractive investment – and an even better retirement plan.  Real estate, unlike the stock or bond market, is extremely long term, with most investors holding their real estate for their full working lives and making as many as 360 monthly payments before their loan is paid off.

There are two very basic ways an investor can retire on real estate equity.  The most commonly tapped real estate equity is the equity people have in their own home, the one in which they live.  Secondly is a retirement plan based on multiple homes, or investment homes.  We'll tackle both scenarios as they pertain to your golden years.

Extracting Income from Your Home

In both situations, real estate equity can be extracted very easily, and with methods that are tax-free.  One of simplest and increasingly popular methods is a reverse mortgage.  Reverse mortgages are essentially a loan given against already existing equity.  However, instead of the homeowner paying into the mortgage, the bank pays the homeowner.

Each month, a reverse mortgage entitles the homeowner to a certain amount of money until the homeowner passes away and the real estate is sold and the equity used to pay back the debt.

Consider this example:  Jerry and his wife are 75 years old and own a home worth $200,000.  As their retirement savings run short, they consider a reverse mortgage to tap their real estate equity for a retirement revenue stream.  The bank will most likely allow them to tap up to 40% of their equity, or $80,000 over a period of years, and offers them the opportunity to receive a small loan each month in the amount of $600 per month at 5% per year.

Every month, Jerry and his wife receive a small, $600 loan against their current home that does not have to be repaid until death, or until they decide to sell the home.  The best part about this kind of loan is that it is tax free (since it is a loan, not income), and banks have very few restrictions on who can receive a reverse mortgage.  A person's age, rather than their credit score, will be the biggest factor in tapping their real estate equity.  The older, of course, the better.

There are some downsides.  For one, most banks will cap the appreciation rate of your current home, and take any appreciation over and beyond what is contracted.  Also, there is a risk of outliving the real estate equity, though it is admittedly a very small risk.

Building Real Estate Wealth

On the other side of the coin is the planning stage, whereby people can plan ahead to build extensive amount of real estate equity that can later be drawn for income.  Real estate investing was practically designed for retirement planners, with a term usually lasting thirty years and a payment and wealth building structure that rewards the long term saver and investor.

However, the best part of building real estate wealth is that the investor is rarely the person who pays for it.  In fact, most real estate investors are capable of building multi-million dollar retirement portfolios without a dime of their own money.  Instead, over the course of many years, a number of tenants provide rental income, which pays down debt financing on the home until finally the home is paid off and the landlord owns the property outright.

Real estate also provides exceptional tax benefits through the interest deduction and depreciation of the home.  With proper accounting, the first few years of a thirty year mortgage should provide accounting losses, allowing the landlord to keep the equity and write off the rest of the tenant income.  Over time, this benefit is reduced, as principle payments make up larger portion of the payment than the interest.

Debunking the Myths

There are plenty of misconceptions in the real estate world, most of which have been permeated by gurus and investment kingpins who want to take your money in exchange for their latest new book.  Over the past decade, real estate has changed from an equity investment to an income investment, as people believed they could not only slowly build equity, but also have cash leftover at the end of the day.

There are, however, very few rental properties where the owner will be able to take home cash with each monthly payment.  There properties are so few and far between for one very simple reason: if investors could find them, they would have already purchased them.  Wouldn't you buy a home on credit that you could immediately rent out for positive cash flow and build equity from day one?  Absolutely!

To find these homes, the ones that routine provide for positive cash flow year after year, requires not an investment in real estate, but a job in real estate.  The time investment is astronomical, and not something most passive investors will be able to accommodate.  Also, much of these programs rely on the idea that the property owner will manage the property, but a passive investor will most likely see excellent value in paying 10% for property management.

To put it simply, most passive real estate investors should expect that they see neither immediate cash flow profits nor cash flow losses from their real estate investments, and most likely they'll end each year with a very minor profit over the mortgage payments.  However, they'll also earn significant tax advantages, and at the end of a thirty year term, they'll own a home outright that can be tapped for retirement income via a credit line and simultaneously rented out to a tenant.  Now that is positive cash flow!

Investing in real estate can be as passive or aggressive as you'd like, and it can be a smart retirement plan for many people.  Since it requires very little out of pocket cash, and financing can be obtained by anyone with good debt to income levels and a history of on-time debt payments, real estate is an excellent way to build real estate equity and real, tangible wealth.
Tim Ord
Ord Oracle

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