For those of you who are retired, you already know that cash flow is among the most important ingredients of a comfortable retirement. With a volatile stock market and drastically low CD rates, investing in assets that offer inflation-beating returns is crucial to outlast your money.
Unlike a dozen articles about the retirement saving crisis in the U.S., let us focus on real estate and how adding real estate to your retirement portfolio could help you achieve long-term financial freedom.
Adding real estate to retirement portfolio! Did I hear it right?
Yes, that’s correct. A majority of retirement plans do not offer real estate investments, but the self directed Solo 401k is an exception. It allows investing in a wide variety of assets not only limited to real estate but tax liens, tax deeds, precious metals, private lending, and pretty much any type of qualified investments.
What's more, the process to add real estate to your Solo 401k is exactly the same as any other real estate transaction!
How can you add real estate to a self-directed Solo 401(k) retirement plan?
- Establish a self-directed Solo 401k plan.
- Roll over your existing 401k or IRA funds to the plan.
- Find a property that satisfies your investment criteria.
- Purchase the property with your Solo 401(k) retirement funds.
- The retirement plan will hold the title of the property.
- Pay closing costs and every other expense from the Solo 401k retirement plan only.
- Make sure that any income generated by the property comes directly into the Solo 401k retirement fund.
If you're just starting out as a real estate investor, you need to understand the correct property type for your retirement portfolio. Let's get started with two of the most popular investment property types.
Choose a rental property type for investing
You probably have read a dozen stories about real estate investing. How someone made it big with single-family homes or commercial properties? How your colleague is crushing it with a vacation rental in Las Vegas? It could be really confusing for a beginner investor to choose a property type for investing.
Here is the truth.
‘It is possible to achieve real estate success with any type of property. What is even bigger is that any strategy may work for you, and there is no hard and fast rule that you have to follow a particular strategy to be a successful realtor.’
Classic Single-Family Home Vs Multifamily Units Comparison
This is the first question you will come across, so let’s take a sneak peek into each of these property types.
Single- Family Rentals (SFRs)
- Easy maintenance: If you own one or two SFRs, managing them could be easier, as you can pretty much handle the repairs yourself. Your tenant would be responsible for taking care of the yard and utility bills, etc.
- Higher rents & lower vacancies: It changes from one area to another, but depending upon your neighborhood, you can charge higher rents against multifamily units. Further, the vacancy rates are usually lower than the latter.
- Large pool of potential customers: This is among the biggest advantages of owning SFRs. They are easier to sell and you can always find a buyer for your rental property.
- Decent price appreciation: SFRs appreciate at a decent rate, and even with conservative figures, most of the markets will appreciate at 2%. Make sure to look at your local appreciation rate for a better understanding.
- Risk of losing entire cash flow during vacancy: If your single-family rental happens to be vacant, you lose the entire cash flow along with the liability pay maintenance costs, insurance, mortgage. A single-family home, if vacant for more than a month, could derail your positive cash flow for several months.
- Difficult to manage multiple SFRs: Managing one or two SFRs is comfortable, but how about managing 10 SFRs spread throughout the city. That takes the game to another level, where all you can do is to hire a property manager for that.
- Economies of scale not applicable: Starting with the fact that you have to manage multiple roofs, SFRs don’t qualify for economies of scale. In case of multifamily, you might be able to get per unit discount but that doesn’t happen with SFRs.
- Higher cash flow/cheaper than SFRs: With multifamily units, your net cash flow is likely to be better, and considering that your price per door/unit is lower than average SFRs, your cash-on-cash return will stay higher.
- Rents keep coming even if a single unit is vacant: In case of 4-unit multifamily, even if one is vacant, the other three will cash flow, minimizing your vacancy losses. Single-family units do not enjoy that luxury.
- Limited competition in multifamily market: One of the things you will learn starting out is that multifamily units come with limited competition and the buyer pool is quite limited. You won’t be competing with two dozen other buyers to purchase a multifamily building.
- Economies of scale favor you: You have to manage a single roof, one compound, one lawn, and one parking lot. You don’t have to run around the city taking care of repairs, and it is easy to save on costs when outsourcing maintenance.
- Hard to find buyers: The same benefit goes against you while selling the property. You may have a hard time finding a buyer for your property and you can expect longer on-market periods.
- Comparatively lower appreciation: In generally, multifamily units have somewhat lower appreciation when compared with SFRs. Do understand that every market is different and you may find a different trend in your area.
- Hard to find financing for 4+ units: If you plan to purchase 4+ unit multifamily property, you need a better credit score and financial resources even to get started with investing.
In a nutshell, you have to consider your individual investing goals and create a mix of each of these property types. After all, the ultimate goal is to create a Solo 401(k) retirement fund that provides comfortably for your golden years.