Ready For Retirement
Ready For Retirement
Sell, Rent, or Borrow? Best Ways to Use Home Equity in Retirement
Listener Ray is wondering what to do with his home as he embarks on a nomadic, van-life journey in retirement. Should he sell it to finance his travels or retain it for potential appreciation and cash flow?
James explores the nuances of home ownership as an asset versus an investment. He considers cash flow and leverage as he looks at Ray’s three options – sell, rent, or borrow – while emphasizing aligning financial decisions with personal goals and aspirations.
Questions Answered:
Why shouldn’t I consider my home an investment?
What are the key financial considerations for retirees when deciding whether to sell, rent them out, or explore other options?
Timestamps:
0:00 - Ray’s question
1:56 - Why a home isn’t an investment
4:38 - Do you want to be a landlord?
8:22 - The financials
10:14 - Asset appreciation
11:30 - Cashflow
15:04 - Leverage
19:02 - What should Ray do?
20:33 - Reverse mortgage
Create Your Custom Strategy ⬇️
On today's episode we're going to be responding to Ray, who wants to know what he should do with his home as he prepares to retire and travel the country. Should he sell it and use the proceeds to live on to fund some of those travels, or should he keep it, taking advantage of the appreciation over time and potentially accessing the equity in another way? All that and more on today's episode of Ready for Retirement. This is another episode of Ready for Retirement. I'm your host, james Canole, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. So let's jump right in. Ray submitted the following question. He says this Hello, james, I really enjoy your videos. You are a gifted teacher. I'd like to suggest slash request that you consider a video topic called Should I Sell my Home and Invest the the proceeds or continue owning my home and let it continue to appreciate? I'm 65 years old and I'm entering retirement. I plan on either selling or renting my home in approximately two years and then living on the road full time in a converted van. I am puzzled about the sell slash own home asset issue. Thank you for your help, ray. Well, thank you, ray, for that question, and here's why I like it. I like this question because it actually gets to the heart of the matter of your home being an investment or not.
Speaker 1:Because currently Ray owns his home, I would consider that an asset, a fairly substantial asset, although I have no idea how much the actual value is. I'm guessing it's a substantial asset, as it is for most people. I wouldn't necessarily consider it an investment, at least not in the current state, and the reason for that is it's where he lives. It's not necessarily generating cash flow. Yes, there's probably some appreciation over time, but it's probably by itself not a superior investment, at least as compared to what you could do, what other investments of similar values would grow to over time, until you decide to either sell it or rent it out, which is exactly what Ray's asking.
Speaker 1:So when people are living in their home, yes, it's an asset, but I don't truly think of that as an investment. When they're deciding to say, should I either sell this place or should I rent this place, that's when that home, in my mind at least now, becomes something that you could consider more of an investment, and that's when that home, in my mind at least now, becomes something that you could consider more of an investment, and that's exactly what we're going to look at today. But before I do that, why is it that I say a home isn't an investment? And yes, it's an asset, but not truly an investment? Because the first thing that you're probably thinking is oh my gosh, I bought a home 30 years ago and it's gone up in value double, triple, maybe even quadruple for what I bought it for. Or my parents bought their home 40 years ago and it's appreciated like crazy. That's all very true.
Speaker 1:But if you actually look at the compound growth rate between when that asset was purchased and what it's valued at today, most of the time it's not that incredible and there are certainly many exceptions, especially in high cost of living areas, but most of the time it's maybe three to 5% per year growth on the asset itself. The reason the returns are so significant is, one, because of leverage If you used a mortgage, so you borrowed money to get those returns. But two, you just started with a significant value anytime you buy a home, and that compounded over time. But if you look at the Federal Home Financing Agency, so the FHFA since 1991, home prices have grown by about 4.3%. Now, that's good, but if you look at the S&P 500, which, I'll be the first to say, is not a perfect comparison, maybe not even a good comparison, but just for reference points, since that same time the S&P 500 is up 10.2%, the biggest difference being you cannot live in the S&P 500, where you can live in your home. But that's what I think of it as, or why I don't think of it as an investment, because typically, it's a thing that is appreciated in value, but its most important role is that it's providing shelters, providing a place to live, a place for you to raise a family, whatever the case might be.
Speaker 1:So then, if I even take that one step further, that doesn't even tell the full story. If the price of homes is appreciated by 4.3%, well, what about the expenses paid to live in that home? What if the only expense you had was property taxes and that property tax represented 1% of your home value per year? Well, now, all of a sudden, that 4.3% rate of return is down to 3.3% rate of return. What about when you factor in all the other costs or other expenses of living in that home, whether it's upkeep, whether it's just the miscellaneous things you need to do, whether it's a homeowner's insurance, whether it's HOA fees. When you start to factor all these in, you start to see, okay, this home isn't that much of an asset, until you say I'm either going to rent it out, because then it's also creating some cashflow for me, or somehow access the equity in it another way, which is potentially sell it or take out some type of a loan against it.
Speaker 1:That is the gist of what Ray is asking, and I know I'm kind of getting off track here a little bit, but that, I think, is a helpful picture to paint as we now come back to his question what should he do with his home? And now, as we begin to jump into this, I want to make it very clear that this analysis for Ray specifically, who has explicitly said, hey, I want to travel, I want to live the van life, I want to go do something different Well, this analysis is probably going to be different for Ray than it would be for someone who said, hey, when I retire, I'm just going to kind of take it easy, I'm going to be in my home a lot, I'm going to use it to host people, this is going to be where I live Very different analysis. Even if some of the financials are the same, the actual intended purpose of that home is going to be very different. So let's start by taking a look at Ray's situation and then we'll bring this back full circle.
Speaker 1:For any of you who are asking similar questions of what should you do with your home in retirement, my first question for Ray, before even looking at the financial side of things, which we're going to do in a second but my first question is Ray, do you want to be a landlord using your home as a rental property? So keeping the asset, having someone in it as a rental or as a renter, that can be very profitable, because then not only do you have the appreciation on your home, but you also have the cashflow coming from the property, which I would argue is the most important aspect of that, especially for a retiree. And retirement is not just about, okay, how do I maximize my net worth, it's how do I maximize my cashflow. If you have a giant home worth $10 million but no one's renting it out, I don't care how much it's appreciating year over year, unless there's some type of cashflow coming from that property, it doesn't really do a whole lot for you in terms of your ability to meet your retirement needs. So for Ray, I would first ask do you want to be a landlord? Because, yes, this could potentially be a profitable thing to do to keep your property, but to what extent is that going to get in the way of your ability to do what you want to do?
Speaker 1:You mentioned you want to do the van life. That could look like a whole bunch of different things. Is the van life being off the grid and not having access to cell phone service and not having access to anything that you might need to take care of the property, to respond to requests from the tenants? You could get a property manager. Of course that would dip into the rate of return that you could expect on this and we'll talk about that again in a second, but that would be my first question is what do you want travel to look like? What do you want the van life to look like? And would being a landlord, would having those responsibilities in any way detract from your ability to fully do that? My first guess, without knowing anything about Ray or what specific van life will look like for him, my first guess would be yeah, that's probably not something that you really want to do but that's a question for Ray or are you going to be camping in remote areas without service? It's going to be tough to be a landlord during that, unless, of course, there's a property manager that you are paying to do this for you and to me.
Speaker 1:The reason I'm starting with this is this is a more important question. We're trying to see how do I get the most out of life with my money, how can I maximize my quality of life in the pursuit of what I want to do in retirement? Well, this question of how is this going to fit into your desired retirement goal is more important to an extent than the rate of return you're getting whether you rent this place out or sell it. Because, let's say, you run the numbers, which we'll do next, and you say you know what, if I keep this property, between the appreciation I expect, between the cash flow I expect, between maybe some of the tax benefits of renting this out, a depreciation, all that stuff, maybe you run the numbers and you're targeting a 15% rate of return on this asset while you're gone. Hey, that's great.
Speaker 1:And then you run the numbers and say, well, if I sold it, I'd probably only get six to 7% long-term rate of return on, say, a more liquid investment portfolio. On paper, renting it out seems a lot better, but how is that going to impact your quality of life? So I know I'm now starting to be a dead horse with that, but I really want to start with that because so many of us we start with just the financial side of things and we miss out on which of these options is going to better support our desired lifestyle. With that now being said, now let's start to look at the financial side of things. So the first thing that you want to understand is what return should you target? You know if Ray's running the numbers for himself and he wants to know should I sell it, should I rent it? Well, what rate of return is acceptable? Is it good if you have a 6% rate of return? If you're going to rent it out, does that mean keep it? Is it 8%? Is it 10%? Is it 15%?
Speaker 1:My simplistic starting point is looking at the S&P 500. And I say simplistic and I say it's not perfect. And, as I alluded to at the beginning of the episode, the S&P 500 versus one single property totally different comparison. The reason I'm using that is if I can stick my money in the S&P 500, I just know, historically my money's grown by about 10% per year, that's over the last several decades of returns. So use that as a starting point. Look, I can just take money, put in the S&P 500, have no responsibilities whatsoever, to attend meetings, to make decisions, to fix roofs, to deal with tenants. I just put money in there and it's going to grow or it has grown, at least historically at 10% per year. You certainly don't get 10% every single year. There's a whole bunch of variation in the year to year returns that you're going to expect, but long-term that's been the target.
Speaker 1:How do we now measure that for a property? So if Ray is saying, okay, I could sell my house, there's going to be some broker fees, there's going to be some taxes, potentially depending upon how much the house is appreciated. But I could then get anywhere between, let's just say, five and 10% If you invest all in the S&P or in some conservative mix of investments. I'm just making that up as a range, as a starting point, so we have something to compare it to. Well, how do we measure the rate of return on a rental property? Well, before leverage and we'll talk about that in a second. But before leverage, the return on your property is going to come down to two things, which is the cashflow that it's generating and the appreciation. So, essentially, how much it's growing by each year?
Speaker 1:Let's start with appreciation. This is tougher to predict. Let's start with asset appreciation. How much is the home going to increase in value by over the course of the time that you're renting it out? This is going to largely just be a guess. For the most part, it's something that's out of your control. Sure, you could do some cosmetic improvements to the home, you can do some renovations to the home that would drive the price higher, but for the most part, the home increase or decrease in value is completely out of your control, just due to market forces.
Speaker 1:Now, as we talked about earlier, since 1991, home prices nationwide have increased by about 4.3 percent per year, depending on what part of the country you're looking at and depending on what time period you're looking at in the country's history. Let's call it anywhere between three to five percent is what the average home has appreciated by, and I'll be very clear here. There are certainly areas of the country that have appreciated far more than this, and there are certainly areas of the country that have appreciated far more than this, and there are certainly areas of the country that have appreciated much less than this. But if three to 5% is the average, let's just say 4% to use a nice round number. So if you have a $600,000 property, a 4% depreciation rate would be $24,000 per year, or that first year at least, if that's what you're looking at in appreciation.
Speaker 1:Now the second thing is cashflow. So the first component of return is how much the home value increases by itself. The second component of return is what cash flow can you expect from the home? Real estate investors will call us net operating income. What's the net income? So the actual gross income that you receive, minus any expenses associated with generating that income. And that is something that is a little bit easier to determine. What you're going to do is you're going to start with expected income.
Speaker 1:So let's say Ray's home is $600,000. I have no idea what part of the country Ray lives in. I actually have no idea how much his home is worth, but I'm just going to use $600,000 as a starting point. And let's assume that he could rent it out for $3,000 per month. Now, really, what you'd want to do is back out any vacancy or time that you expect the property won't be occupied, and a lot of times there's going to be a gap, maybe a month or so, between tenants or maybe some vacancies. So, as you're looking at this, if you knew, okay, I'm going to have the home rented on average 11 months out of the year, out of 12. Well, $3,000 per month times 12 is 36,000, but you're not having it rented the whole time, so you'd back out maybe that month. Now, depending on where you are, of course, you want to back out or you want to assume what is that vacancy rate going to be? But for the sake of this simple example, I'm going to assume zero vacancy, which is probably unrealistic, and just assume $3,000 per month for the sake of this example.
Speaker 1:That's the gross income, that's the cash flow, but there's also expenses associated with the property that will allow you to get that cash flow. So next, you want to add those up. And I'll be very clear here when we're adding up these expenses, what we're not adding in is we're not adding in any financing expenses, aka interest that you're paying on any mortgage that you might have. That certainly is an expense, but it's more of a cost of capital or it's a financing expense. It's not something that would come out of the net operating expense. So what would come out of, or what would be included, I should say, in the net operating expenses? Things like property taxes, things like homeowner's insurance, things like a property manager if you chose to have a property manager manage the property things like utilities, maintenance, repairs, so on and so forth.
Speaker 1:So let's just use a round number again and say you add up all those things property taxes, insurance, maintenance, repairs and assume that $6,000 per year. Well, if $36,000 per year is the gross income, we now need to back out the $6,000 per year of expenses we're planning on and the net income would then be $30,000 per year. So, on a $600,000 property, if you're receiving $30,000 of net operating income or net cash flow, that represents 5% per year of cash flow. It's kind of like having a stock not a perfect analogy, but it's kind of like having a stock and that stock is appreciating each year on average and it's also generating a 5% dividend to you as the shareholder. Well, if you own a property, this is that dividend like return that you're getting from doing that. So on a $600,000 property, that's a 5% rate of return. So if we're using this property as an example and again, ray, I have no idea the actual specifics of your property, the value, the property taxes, the upkeep, the amount that you might be able to rent it out for but as we're looking at this, if we're going to assume an expected depreciation rate of 4%, an expected cash net income of 5%, then we have an expected total return of 9%. Now, this is still a simplistic overview because I have no idea.
Speaker 1:Is there a mortgage on the property? If Ray is getting close to retirement, there's a good chance that maybe that mortgage is paid off. But that's something that you'd want to know. And the reason for that is one of the biggest reasons that people think that homeownership is such a great investment and actually it can be isn't necessarily because of the appreciation of the home in general. It's because of the fact that you're using leverage to get that appreciation. So what does leverage mean?
Speaker 1:Well, let's use another example. Let's assume you buy a home for $500,000 and you only put $100,000 down, so you put 20% down. Well, if that $500,000 home appreciates by 10% over the next year, it grew from $500,000 to $550,000 in terms of the home value, well, your return was much more than 10%. The reason for that is you only put down $100,000 of your own cash, so $100,000 is actually your investment. $50,000 of growth on a $100,000 investment represents a 50% rate of return.
Speaker 1:So when you look at it, no, the 5% may be not super impressive when you compare that to other types of investments, but the fact that, unless you're putting 100% cash down, the fact that when you get that return, it's typically leveraged because of the mortgage that you take out that's why real estate returns oftentimes can be so substantial. It's not just returns of the asset itself and it's not even just the returns of the cash flow that you're generating. It's oftentimes the fact that you take that return and it's leveraged so that as things increase in value, you're getting an even greater return than if you had put the entire amount down as cash. Now this also works in reverse. We saw this a lot in 2008, when there was the housing crisis. People were over leveraged and a little decrease in the value of a property represents a significant decrease in your actual investment value. So, while this can seem great and it does work really well over time, if you're not careful, if you're over leveraged, if you don't have enough liquidity to get you through the storms that will come in real estate investing and other investing, whatever the case might be, can really backfire. But that's the part of the equation here.
Speaker 1:To go back to Ray's example Well, really, I guess the made up Ray example of if we use the example of 9% total return, 5% cash return, 4% depreciation there's some potential tax benefits there with depreciation. There's also some potential leverage benefits here if there's a mortgage. Now the benefits of leverage to the upside typically come if a greater percentage of the property is leveraged. I mean the more money you're borrowing to get these returns, the greater that return to you is going to be. Assuming things work in a positive way, assuming the home appreciates. Now if the home depreciates or goes down in value, then it's also magnified. The return is also magnified, but to the downside.
Speaker 1:So, as you're looking at this, if you're looking at this as a retiree with your specific property, it's going to be a little different than if you were, say, a real estate company or you're running a fund that was investing in real estate properties. That fund is targeted in IRR, an internal rate of return, and what they're looking at typically is they are taking out leverage, they are borrowing properties, they are looking to maybe flip this thing in three, five, seven years, whatever the case might be, and they're looking at the total return component. Now, if you're Ray or if you're another individual who has real estate as part of your retirement portfolio, yes, the IRR is good to know. What's the appreciation, what's the benefit of leverage, what's all that stuff that goes into that? But at the end of the day, the only thing you care about is cash flow. How much is this property generating to me? Now? That cash flow can both be in the form of annual income from having a renter in there, having someone in there paying that cash flow. It could also come in the form of I am going to target some type of an exit from this property. Going to target some type of an exit from this property, say, maybe in three years, five years, 10 years, whatever the case might be, and there's a big cash inflow at that time as well. So you're going to look at it in a slightly different way than, say, a real estate investor would if you're using a rental property as part of your retirement income cashflow.
Speaker 1:But I did want to break down some of the differences there. So, going back to Ray, and what should he do At the end of the day? Ray, of course you want to run the numbers to see what's best for you, but one of the questions I would ask is how long will you live in the van for? Starting to tie this all back together, if this is, hey, I want to live the van life and I want to do it for 12 months, 24 months, 36 months, maybe, just as long as I enjoy it. But then I want to come goes back to my point of what's best for you personally, what's best for the vision of your retirement that you want to have.
Speaker 1:You might consider keeping that home, even if you run the numbers and it's not a great cash flow producing asset. Well, to sell it, to pay the broker fees, to pay potential taxes, to then fund your retirement goals for a couple of years and then have to buy that home all over, you may have been much better off just keeping the home, probably having a property manager to deal with all the stuff for you, so that you can be out in the van doing what you want. But that would be a big consideration of when, or, if I should say, you sell, do you intend to ever come back? If so, probably, at least in my opinion I'd more heavily wait, maybe keeping that asset instead of selling it, regardless of what the numbers look like in the meantime. Assuming, though, ray does not want to move back to this home, then it really does become a financial question of which option between selling or renting it out is going to best fund his desired lifestyle, and it's going to be a personal decision, as we've already talked about, which option is best going to support what he wants that van life to look like.
Speaker 1:One option we really didn't discuss too much in this episode, but it's certainly relevant for those of you, especially those of you who don't look at your home as something that you want to maybe pass down to children or grandchildren, wherever the case might be. Maybe you don't have kids, maybe you don't want to leave anything to kids, whatever the case might be, a reverse mortgage could be another good option, or at least a plan B. So, if we go back to the equity in your home and the principle at least my opinion being, it's not really an investment in and of itself. It is an asset, but unless you either sell that asset, rent out that asset or borrow against that asset. It's not really creating cash for you, which is what matters as a retiree Borrowing against that asset. The last option I just mentioned there doesn't just have to be in the form of a hey, I'm going to go do a cash out refi. I'm going to go take out a mortgage against my home. You could do that, but then you're making payments the rest of your life, or at least for the first 15, 30 years of that mortgage.
Speaker 1:Another option that works on a lot of people's plans if they want to maximize all their assets, to say, how can I squeeze the most out of my home equity, my portfolio, social security, whatever it might be considering a reverse mortgage as an option, maybe not the first option, but certainly a plan b, b or C, whatever the case might be. That gives you the ability to borrow against the value of your home. You don't have to make any payments to the mortgage company. But what happens instead is, say, you borrow 400,000. Well, that 400,000 becomes something that you owe to the bank and, instead of having to make payments on it, that 400,000 grows each year by an interest rate. So it goes from $400,000 to say $420,000 to $445,000. So it's growing. And as long as you live in the home you don't have to pay it back. You don't have to pay it back until you leave the home. So that is something that you have to be mindful of.
Speaker 1:If you ever think that you're going to leave the home, you may want to second guess this. But if this is your forever home and you want to tap into the equity value of your home, a reverse mortgage could be a way to do that, to maximize your retirement spending ability while also being able to live in your property. So selling a home, renting a home, borrowing against your home can be the three ways that you can actually access that, that equity to live on. But all these tie, of course, to your personal goals and what makes most sense for you. So, ray, thank you very much for your question. I hope this is helpful. I know we're not providing specific feedback here, but I hope that just exploring some of these options maybe helps to answer that question for you. So thank you, ray, for that question.
Speaker 1:Thank you to all of you who are listening. If you've enjoyed this podcast and you're listening, say, on Apple Podcasts or Spotify, we'd really appreciate it if you take a couple moments. Just leave a five-star review if it's something that's been valuable to you. If you're listening on YouTube, make sure that you give it a thumbs up and subscribe if you haven't already. And if you know someone that you think might benefit from some of this of their preparing for retirement have some of these questions. We'd appreciate you sharing this episode with them Really want to make sure we're able to impact as many people as possible, and all of you sharing the message or sharing these episodes is a great way for us to be able to do so. So thank you for listening and I'll see you all next time.
Speaker 1:Hey everyone, it's me again. For the disclaimer, please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom and click start here, where you can schedule a call with one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.
