By Bobby Montagne | Forbes Real Estate Council

Even if you manage to sock away a fair amount in your 401(k) every year, it’s not unusual to worry that inflation may eat away at the value of your retirement portfolio. To reduce the likelihood of that happening, you can boost retirement income by investing in real estate.

You’ll gain the added benefit of increased asset diversity and balance in your portfolio. And depending on which real estate investment option you pick, you could also create a retirement income stream that rises in tandem with inflation.
Let’s look at the pros and cons of common ways to invest in real estate:

1. Purchase shares in private lending pools.

2. Invest directly by purchasing rental property.

3. Buy shares in real estate investment trusts (REITs).

4. Cash out home equity.

1. Investing In Private Mortgage Funds: Pros And Cons

Private mortgage funds lend money to real estate flippers who buy, improve and resell properties. (Full disclosure: I am the CEO of one such lending organization.) Since the pool lends money to hundreds of flippers, risk is diversified across many deals.

As a borrower, you can also avoid risks you’d face if you tried to flip a single property yourself, like buying high and selling low, not knowing enough about renovations to do a good job or taking so long to finish the renovations that holding costs eat your profit.

Private mortgage funds are long-term, fixed-rate investments that aren’t as liquid as stocks and bonds. You typically need to commit to the investment for a set number of years and provide many months’ notice if you want to redeem your investment early. They’re also not traded on an exchange, so it’s important to vet the company offering the investment.

2. Direct Investment In Real Estate: Pros And Cons

Direct investment has many upsides. You can buy with relatively little cash, so it potentially has one of the highest returns on investment (ROI) of the three options. Independent home lenders offer investment property home loans with as little as 15% down, so you could buy a $200,000 property with $30,000 cash down. Let’s say home prices rise 5% next year. Your rental property is now worth $210,000, a 33% gain on your $30,000 investment.

Real estate also tends to move with inflation. As consumer prices rise, so do rents, making direct investment in real estate a solid hedge against inflation. Timing your rental property mortgages to pay off by the time you retire creates an inflation-hedged income stream.

Purchasing rental properties is a long-term investment with much less volatility than stocks. Home values change over years, not hours, like equities. After the real estate crisis, median home sale prices hit a low point of $148,000 in 2012. Six years later in mid-2018, the median home price was $231,000, according to Zillow data.

If you buy with a 15- to 30-year mortgage and don’t sell your rental property, home price changes won’t influence you. But if you do need to sell, it can take months, especially in a down market. And when home prices fall, rents may follow suit. The investment that was paying for itself can suddenly start costing money every month. When rents don’t generate enough income to cover taxes, insurance, repairs and the like, you’ll have to pay for those costs out-of-pocket.

Real estate also carries big transaction fees, like sales commissions and transfer taxes, that make it a costly investment to sell. A 6% sales commission on your $200,000 investment property will run you $12,000, quite a bit more than selling shares in a private loan fund or REIT.

3. Real Estate Investment Trusts (REITs) Pros And Cons

Real estate investment trusts (REITS) take money from shareholders to invest in real estate, such as residential or commercial properties, or mortgage-backed securities.
There are hundreds of REITs to choose from and since many are publicly traded, they’re as easy to buy and sell as stocks. The average return for all REITS since 1972 was about 9.7%, according to data from the National Association of Real Estate Investment Trusts.

Since REITs are fixed-income investments, their value may fall when interest rates rise. A REIT that invests heavily in a single class of real estate — say, strip shopping centers or retail malls — can be hurt when that property type falls out of favor. REITs that invest primarily in mortgage-backed securities can see their prices drop when interest rates rise because they hold securities with interest rates below current rates.

4. Cashing In Home Equity Pros And Cons

Since a whopping 78% of Americans own a home by age 65, according to Census Data, home equity may be one of the most consistent sources of retirement income opportunities. To cash out home equity, you have to either sell a home you’ve built equity in, refinance or take out a reverse mortgage.

Selling and moving to a less-expensive home would allow you to pocket up to $500,000 in profits tax-free (married, filing jointly). However, since millennials are postponing homeownership to a later point in life than prior generations, they may be less likely to own homes free and clear by the time they retire.

To do a cash-out refinance, you generally need to have income from investments or employment to show you can afford monthly payments. Reverse mortgages pay you either monthly or as a lump sum. The lender bases your payment on your current home value. You don’t have to repay a reverse mortgage until you sell your home, move out or pass away.

The fees on reverse mortgages can be significant and those seeking income early in retirement will find they typically don’t receive monthly reverse mortgage payments that are as high as those an older borrower can receive.

Source: Forbes