6 Tips for Investing in Real Estate

Rental real estate can supplement your retirement income, but only if you know what you're doing.

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If you're fed up with the paltry returns you get on bonds, the insulting interest rates paid by banks, and the frenetic fits of the stock market, you might consider turning to rental real estate to supplement your retirement income. But it's not for everyone. Walk through these six tips to see if real estate can help you construct a sound retirement portfolio. If the idea still seems solid, the next step is to do your homework.

1. Assess your goals. The days of buying real estate and flipping it for a quick profit are long gone. Rental real estate can provide a steady, long-term income, but it takes work. Are you prepared to do lots of research to secure a property in a good location that will be attractive to people in the rental market? Are you ready to crunch the numbers to figure out if a property will work out financially? Are you able to manage your own property, which may include fixing the plumbing, cleaning the carpets, and applying a fresh coat of paint for new tenants? If not, you will need to hire someone else to do it for you.

2. Know the neighborhood. Surely, you've heard the old maxim about the three important factors of real estate: location, location, and location. If you're buying real estate you need to know what you're getting into. Is there something special about the property, such as a view or proximity to waterfront or public transportation? What are the zoning laws? Is there a new highway on the drawing boards? You can never cover all the unknowns, but you can find out if the rental market is viable. Check with real-estate agents, go online to Zillow and Craigslist, and talk to people in town. You can't accurately predict what the property will be worth in five years, but you should know if you can rent it next month, and at what price.

3. Buy local. There's no neighborhood you're more familiar with than your own. I know one couple who live in a lake community in Pennsylvania. They bought the house next door to them. They break even renting it out for the summer. They make their profit on what comes in during the shoulder season. And when it's empty they don't have to worry, because they can look out their window and make sure everything's okay. The farther away you are from your rental property, the harder it is to do your job as a landlord. If it's too far, you can't do it at all. You will have to hire a property manager who will do the job but eat up your profit in the bargain.

4. Best bet: a one bedroom condo. Outside of vacation properties, the sweet spot in the rental market is for single people: young singles, divorced middle-agers, and retired widows. Most of these people do not need, and will not pay for, a larger unit. The one bedroom condo is the Honda Civic of the rental market. There’s nothing sexy about it, but for most people it offers the best value, and is the easiest property to manage.

5. Buy at a good price. An old rule-of-thumb says if you can buy a property for 12 times the amount of its annual rent, then you're getting a good deal. These days you can do better than that—maybe nine or 10 times the annual rent. Of course, there are always variations, depending on the type of property, location, and the prospects for appreciation. But, remember, there's no pressure for you to buy. You don't pay up because you "fall in love" with a place. If you've done your homework, you have a pretty good idea what your monthly rental income will be. Don't pay more than what your monthly cost is going to be. That amount is your limit for what you should pay

6. Make sure you have some reserve cash. If you already own your own home, you know that at some point you'll inevitably face an unexpected expense—the dishwasher breaks, the roof leaks, or the condo association hits you with an assessment. You need to keep a cash reserve to take care of any surprises, including the possibility that your unit might be unoccupied for a (hopefully short) period of time. You also need to build these irregular expenses into your financial equation to help you decide, in the final analysis, if the whole project is worth it.

Tom Sightings is a former publishing executive who was eased into early retirement in his mid-50s. He lives in the New York area and blogs at Sightings at 60, where he covers health, finance, retirement, and other concerns of baby boomers who realize that somehow they have grown up.