Can Rental Income Save Your Retirement?

Q: Is rental income a good way to diversify my retirement portfolio?

A: For some people, yes. “Rental property can provide another stream of income, a hedge against inflation if rental prices rise and an asset that hopefully will appreciate over time,” says Diann McChesney, a certified financial planner at Asset Strategies Inc. in Avon, Conn. But being a landlord isn’t for everyone and not all properties are a good investment, says McChesney.

To get the most out of a rental property, be judicious about where you buy. Like most things in real estate, location is critical. Buy in a place where there is strong demand for housing so you can command a good rent and you don’t have a hard time finding tenants. You may not want the hassle of owning it in your older retirement years, If you plan to sell it down the road, it’s important to own a property that will be attractive to other investors.

A good rental property has many of the same things you look for in a home: A nice neighborhood, well-regarded schools and jobs that attract people to the area. Be careful about buying a fixer-upper. Unless you are handy or have a lot of time to handle repairs, maintenance problems will eat into the income. Today’s low interest rates make taking on a mortgage reasonable but the real key is ensuring that the rental income generates positive cash flow. If you want an income from the property, rent should more than cover your mortgage, property taxes, maintenance and repairs, says McChesney.

Keep in mind that banks require a larger down payment for—20% to 25%—and charge higher rates. It’s also an illiquid asset, so you won’t be able to tap your investment as easily as you can money in, say, an IRA. While you can get a tax break writing off expenses while you hold the property, once you sell it you’ll pay taxes on that depreciation.

The bottom line: A rental property can be a good way to diversify your retirement portfolio and provide another source of income in your later years. But “there’s a lot more to it than collecting rent,” says McChesney.