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Real estate as a retirement investment is often overlooked. If you watch enough late-night television, listen to the radio, scroll Facebook, or watch videos on YouTube, I’m sure you have seen an advertisement or infomercial about one of the “easiest” ways to accumulate wealth using other people’s money.
Fast-talking promises of leveraging money to purchase multiple properties, which are then rented out at a profit, are often the promise of these ads. All you need to do is attend a seminar or purchase a book or online course, and your path to financial freedom is set.
Unfortunately, reality quickly sets in, and the risks, rewards, and work to become a real estate owner and landlord become very apparent.
It is important to acknowledge that being a landlord can undoubtedly be prosperous and part of a diversified portfolio. It is equally important to recognize that in most cases, it does not lead to overnight wealth and can present its own set of hardships.
With that being said, we will look at some of the positive and negative aspects of owning a rental property and some of the tools that can be used to maximize profits along the way.
Becoming a Successful Real Estate Investor
There are several ways to invest in real estate. However, the most common method is to own rental properties. One of the first steps is identifying what type of real estate owner or landlord you want to be.
Many landlords who are not happy with their properties are those who never intended to be landlords. This includes inherited homes or those who bought a “starter” house and were unable to sell it later. Being unable to sell starter homes can result in having to rent them out.
This was a frequent occurrence for individuals who purchased a home before the 2008 financial crisis. Many unintended landlords quickly become overwhelmed with the responsibilities and financial obligations of owning a rental property.
Many of the costs associated with owning a rental property, such as maintenance, insurance, realtor fees, and court costs, can quickly become a new source of stress. There is also a lack of diversification in this situation, and the risk/reward is “all in” that particular property.
Rentals as Investments
Another type of landlord is the individual who looks at owning a rental property strictly as an investment. This landlord will generally buy properties at a discounted value and then rent them out for a profit.
Often the goal of the investor-style landlord is to accumulate multiple properties as a way of diversifying, reducing risk, and creating monthly cash flow. This formula can be profitable, but again creates its own set of financial obligations. Costs such as a larger maintenance fund, property management fees, and additional cash to cover properties that may be vacant, just to name a few.
Generally, a seasoned investor is aware of these obligations and better prepared to deal with them.
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Real Estate Investment Myths
It is also important to dispel some of the myths which go along with owning a rental property.
Many marketed real estate systems will highlight purchasing properties using other people’s money. Typically, this “other person(s)” is a mortgage company, and the loans are secured using your credit line.
Without a proven record of profit, this will often limit the available capital to borrow. Most mortgage companies will not merely lend out vast sums of money to purchase multiple properties. Additionally, many lenders will charge a higher interest rate for investment properties, which can negatively affect profit.
Many systems will also teach to use the earnings from a rental to cover expenses. While this is optimal in theory, it does not account for periods where a rental is not generating income or for large unexpected repairs. It also does not consider periods where you do not receive the desired rent due to a down market and may have to take a monthly loss on a property for a while.
Short Term Rentals
The third type of rental property is used for short-term rentals. These are generally located in tourist and vacation areas. In fact, I’m writing this post while vacationing in one on the beach!
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Many are overnight or weeklong rentals and may have a short rental season based on tourism. To reach potential clients, owners will use a service such as Airbnb to rent out the property. Some owners will even rent just a room or two of their primary residence to supplement income.
This type of rental is also facing difficulty as they are becoming subject to much more local government oversight. Many cities are passing ordinances that prohibit these short-term rentals or severely restrict them. While these ordinances may ultimately be overturned, it is still something to consider if you decide to invest in a property for short-term rentals.
Additionally, if you plan on doing a short-term rental, it is crucial to contact your homeowner’s insurance and make sure you are adequately covered. If not, this can create another set of headaches for you down the road.
Keep Cash as Leverage
Whether you own your rental property free and clear or still have a mortgage, it is vitally important to have access to capital for unforeseen expenses, or real estate investing is only not going to work long-term for you.
The adage “cash is king” comes to mind when describing the needs of a property owner. There are several traditional ways to access liquid capital, including a standard loan from a bank, line of credit, or a hard money loan. In some cases, you may be able to obtain a home equity loan or home equity line of credit if you have enough equity in the property or properties that you currently own.
Many landlords will often use their capital to avoid having any further loans or financial liabilities. Usually, this money is held in a savings or checking account, earning minimal interest, which will hardly even pace inflation rates.
Leveraging Life Insurance as an Investment for Real Estate
This next statement might sound odd initially. However, an often-underutilized method of accumulating and leveraging capital uses the cash value component of a whole life insurance policy. This method of accruing liquid cash for real estate investing is becoming increasingly popular in real estate investing and for a good reason.
Let’s look at some of the advantages.
Diversifying Risk With Life Insurance – For a Goal of Purchasing Real Estate
While being more involved in the initial setup than standard savings accounts, a high cash value policy also offers several unique advantages you cannot find in any other financial vehicle. The cash value growth rate or interest is often significantly higher than a standard or high yield savings account.
Again, you must go with a financially stable and reputable company.
You can easily experience a 4% guaranteed growth, plus an annual dividend within your cash value if you structure this properly.
Because it is a life insurance policy, it also offers protection as there is a tax-free death benefit. The death benefit can be used by a beneficiary to pay for costs associated with the properties and avoid foreclosures or other financial hardships.
These particular types of policies allow you to take a loan from the insurance policy’s cash value component. This means you will have access to your money, and you set the repayment schedule. You can pay it back slowly, quickly, or never.
Yes, that is correct. Any unpaid policy loans will be paid off by the death benefit at the time of the policyholder’s death. You can also take a policy loan for any reason and without restriction. You do not have to explain to the insurance company why you need the cash, because it is yours. You are acting as your bank.
Another key is that if you take or even default on the loan, there is no credit reporting, although the policy may lapse. The cash value is also often protected from debtors and creditors (in most states).
Life Insurance Advantages by the Numbers
Currently, a typical interest rate on a policy loan is 4%. If your cash value is earning 6% (guaranteed interest rate plus dividend), you not only have your money working for you in real estate, but you have also received a 2% spread on your policy loan.
You become your own personal banker and are now making money exactly how the bank does when they sell you a loan! Oh, and by the way, your 2% spread on your policy loan is a 50% annual profit on your cash value.
Let’s break this down a little more and see exactly how it works.
Whole Life Insurance Dividends
One of the single most significant advantages of the whole life cash value is the ability to be paid dividends on money that has been taken as cash through a loan. So, essentially you’re still earning interest and dividends on borrowed money while also getting to use it for real estate.
Let me ask you a question.
Does a bank or lender pay you interest on the money you’ve borrowed from them? Most certainly, the answer is no.
This is called a non-direct recognition loan. For example, let’s say you have a cash value in your policy of $50,000. If that money were to be held in a savings account, you would receive interest on $50,000 for the account.
However, if you were to take $40,000 out of the account, you would only earn interest in the remaining $10,000.
Now let’s look at the same scenario with a properly structured whole life insurance policy with a $50,000 cash value. While the cash value is $50,000, you would receive dividends or interest based on the $50,000 even if you took the same $40,000 as a policy loan.
Instead of withdrawing cash from the policy, you take a loan against the plan for $40,000. You will still receive interest or dividends based on the $50,000 figure. In the savings account example, your $40,000 is spent, gone. In the whole life cash value example, your $40,000 is earning interest as if you never took the money out of the account.
Your money is now working in two places at the same time.
Using Whole Life Insurance to Fund Real Estate Investments
You can make interest off the cash value while it is being utilized as liquid cash in your real estate investments. This is simply not possible with money held in a traditional bank setting. You now become the banker.
In paying your policy back rather than a lender, you can now re-leverage the same money. By doing this, each time your cash value is more significant and more substantial due to the non-direct recognition loans that allow you cash to work in two places at once and act as your bank.
Therefore, instead of paying a bank or lender 5-12%, why wouldn’t we give ourselves the spread and earn 50% on our cash and still use that cash to invest in real estate?
Additionally, these loans are tax-free, and there is no credit check involved. This can be a potent tool for property owners. Since the insurance company does not care what your policy loan is for, they will not charge you a higher interest rate because it is for an investment property. The policy’s cash value can also act as a great emergency/repair fund for your properties.
In closing, it is essential to speak with a financial professional to set up the policy correctly as the plan needs to be structured to maximize cash growth and have this unique loan feature. Not all life insurance companies offer this setup, and a standard life insurance agent will not provide this type of structure, nor will they be familiar with the process in doing so.
I have designed several policies like this for myself for real estate investments. There is simply no better way to currently utilize leveraged money and get a phenomenal rate of return on your investment.
Disclaimer: structuring a whole life policy in this way dramatically reduces the commission for a financial professional, so they typically will not offer to do this or have much knowledge of it.
In conclusion, owning real estate can be a great addition to your retirement portfolio. It is imperative to be aware of the risks and utilize tools available to you to maximize profit. Be sure to have a reliable, long-term plan before investing so you increase your chances of success and maximize your return rate.
Ryan Luke is a father of three, a husband, a finance blogger, and a full-time police officer. Through proper budgeting and money management, they have been able to live off one income and build wealth at the same time. As an active member of the personal finance community, his goal is to educate and help people get out of debt and build wealth! Come join him in an active conversation about all the best personal finance information available at ArrestYourDebt.com!