Brett Arends's ROI: The downsides of being a landlord in retirement

United States

If you’re thinking of becoming a landlord as part of your retirement strategy, do the math first.

Buying homes, (maybe) fixing them up, and then renting them out is a popular investment for those seeking regular “passive” income after they’ve retired. (It’s seen as a route to wealth for many others, too). By some estimates there are between 8 million and 11 million private landlords in the U.S. Many, no doubt, have had great experiences.

But private landlords on average earn lower returns on their money than those who just own real-estate investment trusts or REITs on the stock market, industry data show.

Meanwhile, landlords also face vastly greater costs, risks and hassles. Some risks can be serious, including legal liabilities and major capital expenses. Being a landlord can take up your time and provide plenty of grounds for stress.

Even the alleged benefits, such as the ability to get a mortgage so you can take on more investment, are often overstated. Unless you lie to the bank and claim the mortgage is for your primary residence, you will end up paying much higher interest rates than you do for a regular homeowner’s mortgage.

Meanwhile, if you are really determined to invest more aggressively, you can do it on the stock market too either through other investments, or even through simple tools like margin loans and call options.

“I just sold my rental property in Austin,” says Matt Bacon, a financial planner in Gaithersburg, Md. “I say buy the REIT.”

He adds, “Tenants are fickle and it takes just one bad one to sour the experience and shred your margins, especially given the eviction moratoriums we’ve seen.” Maintenance costs and taxes will also eat into profits. Factor in a mortgage and you could end up cash flow negative on an illiquid asset. That’s not good. 

Michelle Gessner, a wealth manager in Houston, Texas, summed up the issues last summer in a blog post whose title pretty much gives away the story: “Taxes, Trash, Toilets, and Tenants: Is Rental Property a Good Investment?”

“Many people underestimate the costs associated with owning real estate directly,” she tells me. Those costs include “homeowner’s insurance, umbrella insurance to protect against liability related tenant issues, property taxes, repairs and maintenance, update costs…and of course, income taxes.”

She adds the costs of catastrophic weather, such as this year’s big freeze.

And then, of course, there’s the current crisis. The current administration is taking the battle to the Supreme Court to uphold the “evictions moratorium” introduced under the last administration. But state governments, such as New York, have imposed their own. As this report by Reason TV’s Jim Epstein points out, the losers from eviction moratoriums aren’t just Thurston Howell III or Daddy Warbucks, but include regular mom-and-pop landlords.

According to the NMHC, nearly 7% of renters hadn’t paid their rent by the end of January. That’s far higher than the rate a year earlier, just before the crisis hit, when it was barely 4%. The numbers may not seem huge. But NMHC’s Vice president of Research, Caitlin Walter, points out two things that may not be immediately apparent. The first is that vacant units aren’t included in the calculations. So if the renters just mailed in the keys and moved back in with mom and dad, leaving the landlord with a unit he is trying to rent again, his troubles may not show up in the data. The second is that even this 2.6 percentage point change amounts to about 300,000 housing units.

None of this even gets into the vexed question of activist politics and where those might lead. People are “rising up for real transformation in the housing market,” Cea Weaver, a “#CancelRent” activist, told the New York Times last year. Housing isn’t just an illiquid asset that you can’t move and is hard to sell: It’s also a political asset. Housing, as the activists say, “is a human right.”

Issues like price controls and much tighter regulations can’t be ruled out and by definition can’t be good for landlords’ income.

And what are the returns you earn for all this risk? Naturally it varies from property to property. Individual landlords can do very well, especially if they are able to buy properties cheap and fix them up themselves. Nonetheless the NMHC, using data from the National Council of Real Estate Fiduciaries, estimates that from 1987 to 2016 private landlords earned average returns of up to 9.6% a year for apartments, and 8.7% overall.

The returns from publicly traded REITs over the same period? Try…10.3% a year, according to the FTSE Nareit All-Reits Index.

So you didn’t make extra money in return for all that hassle. You paid for the privilege of experiencing it.

As for today? So-called “cap rates” on real estate—roughly, the current “earnings yield” — nationwide are down to about 4%, says NCREIF. 20 years ago it was twice as much.

Those looking for an easy life and safe, worry-free passive income in retirement might find better opportunities elsewhere.