How to boost cash flow in retirement with real estate

If you’re at the age where you’re craving income, you’ve probably wondered whether owning a rental property is a good way to get it. After all, the yield on fixed-income investments is at all-time lows and stock dividends aren’t much better. Adding a residential income property or two could provide a reliable boost to your cash flow. Problem is, with real estate prices so high relative to rents these days, that won’t be easy. Fortunately, we’ve talked to three seasoned, conservative real estate investors who say it’s still possible to find the kind of properties that generate steady income without taking on too much risk. That might make real estate a good addition to your portfolio if you’re approaching retirement or are already there. While each approach is different, our three investors use a buy-and-hold approach that focuses on simple properties. They all avoid trendy hotspots like Toronto and Vancouver. And they shudder at the thought of flipping condos. “When we hit our 50s we’re looking for much more boring investments,” says Don Campbell, author of Real Estate Investing in Canada. Glenn Kohaly of Kelowna, B.C., and Rui Torrao of Toronto have their own untrendy approaches. Read on to learn about real estate strategies that can give you that reliable income you’re looking for.

Quest for cash flow

The condo flippers are making it tough for real estate investors who just want reliable income. Traditionally, real estate investors looked for a combination of income and price appreciation. But with strong price growth in the last decade or so, that balance has shifted, says Tsur Somerville, director of the UBC Centre for Urban Economics and Real Estate at the Sauder School of Business. Current market prices reflect the fact many investors are willing to accept little cash flow because they expect to benefit from strong capital gains, he says. That’s particularly true of the “condo game,” so investors who value reliable cash flow will need to look farther afield. But where? Each of our three investors has found a different solution to that puzzle. Campbell hunts for small multi-unit buildings in Canadian cities that haven’t had their real estate bid up too high. Some are smaller centres around big cities with growing economies and populations. Others are stable or growing mid-sized centres. They include Hamilton, Cambridge, Kitchener, Barrie and Ottawa in Ontario; Maple Ridge, Surrey and Kamloops in British Columbia; and Edmonton, Calgary and Winnipeg in the Prairies. Campbell—who is also the cofounder and senior analyst at the Real Estate Investment Network (REIN)—likes three-plexes and four-plexes, but his ideal is the six-plex. “I would buy six-plexes all day long in Barrie,” he says. He says this overlooked niche lacks the trendiness of the condo market; the buildings are too small to attract similar attention and get bid up in price by real estate investment trusts (REITs). Although it’s not easy, Campbell says if you’re persistent you should be able to find properties that will generate a double-digit “cash-on-cash return.” That’s the net annual cash flow from the property as a percentage of your down payment (see “Get real about your returns“). Campbell says you’ll often need to spruce up the property at first, so this may only be a realistic target in about the third year. The key is having an eye for rentability. You may need to put a bit of renovation money into your property in the first couple of years to improve its appeal. The priority is first improving curb appeal or outward appearance, then kitchens, then bathrooms, he says. “What I want is a property I can rent to somebody with pride.” One strategy he suggests for someone in their late 40s or early 50s: buy a six-plex with a 25% down payment, then “work your butt off” to pay off the mortgage in 10 to 12 years. If you can do that, you end up with a mortgage-free asset that produces plenty of income for your retirement years. “Then it’s yours for life. If there’s a bump in the real estate market it doesn’t hurt nearly as much if you don’t have that mortgage.” Investors in this age group should also consider a 10-year mortgage to take advantage of low rates and protect against possible rate increases, Campbell says. It’s now possible to get such mortgages with interest rates below 4%, with the added option of being able to refinance after five years, he says. “If this is your retirement investment, lock that puppy in for 10 years.”

Nothing to brag about

Glenn Kohaly gradually built up most of his nest egg by investing in real estate. “It appealed to me that my tenants would be paying off the mortgage and then some day I would be mortgage-free and would have a capital asset,” says Kohaly, now 65. He sold most of his properties in 2007 when he thought the market had become too pricey. But a few years ago he looked to get back in with a portion of his money—if he could find the right deal. Kohaly had done some looking in Calgary but considered all the properties he saw to be overvalued. Then in 2010 he found what he was looking for: a Calgary seniors’ complex. It seemed to be a neglected niche in the market. “It’s not cocktail party conversation,” says Kohaly, who continues to work part-time doing writing, photography and selling ads for boating magazines. The complex provides services to the seniors who live there, so this isn’t a pure real estate deal. But after doing his homework he became comfortable with all the risks. It is well-managed, produces steady cash flows, “and we do have a steady line of seniors coming along.” He now owns two apartment-like units in the 182-unit complex. With real estate prices so high, Kohaly believes “the heady days of capital growth in real estate are behind us—for the time being anyway. Right now what I’m looking for is cash flow. It’s come back to basics. Do your rents exceed your costs?” While a younger Kohaly had most of his investments in real estate, now his overall portfolio is about equally split between the seniors’ complex, stocks and fixed income. “The new me has a good asset allocation and a good mix so I’m not vulnerable to any one thing.” He also avoids debt altogether now. “If it’s at the risk of your future, I don’t think a 65-year-old should be using leverage, in my opinion. It’s just sensible money management.” And Kohaly is careful about avoiding big losses. “My best earning days are behind me. I can’t assume too much risk because my ability to replace those funds is limited.”

Cross-border shopper

Rui Torrao, who’s in his early 40s, has been investing in single-family homes for the cash flows since 2001. He likes that this market is relatively stable compared with condos, since it is dominated by owner-occupiers rather than investors. Torrao bought five units in Toronto in the early 2000s, but after real estate prices continued to climb, hasn’t been able to find any new properties that generate the level of income he expects. While he’s kept those properties, he’s had to look farther afield for new purchases. After the steep fall in U.S. home prices a few years ago, he bought three properties in Phoenix in 2011 and 2012. But with the subsequent market rebound, “I’ve been priced out of the Phoenix market.” Now he thinks he might find properties in Florida that meet his requirements because that market hasn’t rebounded as much. In considering a property, he looks strictly at cash flows. He targets a 10% “capitalization rate,” which measures cash flows —not including financing— as a percentage of purchase price (see “Get real about your returns“). “My philosophy is once I’ve purchased a property, I don’t care too much if it goes up or down in value. If it goes up, that’s a bonus.” Torrao, who has the Chartered Financial Analyst designation, invests his money primarily in real estate. He is retired from his former job as a pension consultant and uses his property income to support himself. He acknowledges that for most people it may make sense to adopt a more balanced approach by allocating money to stocks and bonds as well as real estate. But he feels he has developed the in-depth specialized knowledge in real estate that justifies more concentrated investments. “I realize I have extra risk exposure to real estate but I’m comfortable with that. I feel I’m being compensated for it and I’ve been prudent in my approach. Even if real estate values went down 20% or 30% I would not be tremendously harmed by it.”

Two yellow lights

If you’re in your 50s or 60s and just getting your feet wet in real estate, you need to be prudent about how much you invest, and you need to be careful about leverage. “Leverage is great in real estate, but it’s a drug,” says Somerville, the UBC professor. “It’s one of those drugs where a little bit is a very useful thing. A lot may make you feel good for a while, but it can really do some damage.” You should make sure your rents more than cover your mortgage payments as well as all operating costs. One good conservative strategy is to plan to pay off your mortgage by the time you retire. You should also limit the amount of capital you allocate to real estate. Seasoned investors might be able to justify putting the majority of their wealth in property if they have developed superior skills over many years. (Even then it’s easy to delude yourself about your skills because soaring real estate values over the last decade made it easy to make money.) But if you haven’t got a track record, go easy. Keep the lion’s share of your portfolio in more traditional investments. If you plan a conservative strategy, manage risks prudently, and do your homework carefully, the rewards can be great, as Campbell, Kohaly and Torrao have found. While that might be considered boring by some, it can also provide ample means for a comfortable retirement. David Aston, CFA, CMA, MA, writes about personal finance. If you’d like to share your retirement spending experiences, write him at [email protected], He might include your experience in a future article.