Can I use real estate as a passive income source after retirement?

Published: June 7, 2024 at 6:00 am

Everyone instantly recognizes rental income as passive income – potentially the oldest one. There’s an irresistible allure to real estate, which naturally leads to inquiries about its potential use as a source of passive income, especially after retirement.

We discussed how passive income is crucial to your retirement plan and how to build the ideal retirement portfolio beyond money. Enter a constant source of income that you will likely receive after retirement – a pension or rental income – into the freefincal robo advisory tool. You can see a dramatic drop in the net corpus and, therefore, the investment required.

Indeed, it is beneficial to have rental income as part of our retirement portfolio if that income is generated from inherited property. However, we must examine whether real estate investment is viable for a rental income.

Often, discussions on this topic veer towards home loan interest rates, the potential for property appreciation, and rental yields. Unfortunately, this sidetracking often neglects crucial aspects of goal-based financial planning.

Consider using a straightforward retirement calculator before taking out a home loan for personal use or investment. The harsh truth is we must allocate a minimum of 75% of our necessary monthly expenditures toward retirement savings, including EPF/NPS contributions.

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Additionally, we must account for future child-related expenses subject to higher inflation. This leaves minimal funds for property investment. I’m prepared to bet that most individuals who sign a home loan contract have not contemplated how it might impact their retirement strategy.

(1) We should consider real estate as an investment only after investing enough for our financial goals. Real estate investment is an unnecessary luxury for most retail investors as they do not have enough to invest towards their financial goals.

“Property would always appreciate” is an unsubstantiated claim that is doing the rounds even after the visible slowdown in the real estate industry. Even if we agree that property is not devalued quickly and will always increase, the appreciation rate can be low.

In any case, this appreciation is irrelevant because most buyers are reluctant to sell. I know of six families with multiple properties; at least one is locked up with no tenant; their liquid net worth is not much to speak of, and they refuse to sell the place!

An increase in property value doesn’t matter if the owner isn’t interested in selling. This is akin to theoretical gains from mutual funds or stocks. Many people claim real estate lacks liquidity, but what does this mean?

Firstly, it suggests an emotional connection to property that isn’t present with assets like gold or stocks. Secondly, even when we decide to sell, while we can find a buyer, it’s often difficult to get the desired price. Illiquidity, therefore, doesn’t refer to a lack of potential buyers but rather a significant disparity between the sale and purchase prices.

(2) If a property is purchased as an investment, rental income will likely be the only dividend. There is a massive gap between the home loan EMI rate and the rental yield. EMI outgo could be three times the rental income you get from the place. This will continue for a decade until the loan is closed (pre-closure could mean further loss due to the time value of money).  Rental yields for most properties are comparable to an SBI SB account rate.

If the property isn’t resold at a significant profit in the future, the loan will always result in a loss. Furthermore, issues such as finding tenants, evicting tenants, potential rent increases, and economic downturns can complicate matters. The future is unpredictable: there’s no certainty that we’ll later sell the property – personal circumstances and attitudes can change – and even if we do, the returns might only equate to those of a fixed deposit.

The condition of the real estate market also raises concerns. Purchasing direct equity can be more straightforward than buying real estate. There is no market-determined price; dealings could involve black money. Unless we’re well-versed in the intricacies of construction terms, we’re at risk of being cheated. The initial purchasing risk is far too high for an average salary worker who aspires to invest in real estate (based on informal evidence), particularly if they lack the ability or time to conduct the necessary research to consider the purchase fully.

Assuming you have some spare money (after accounting for your goals), a long-time SIP in gilt funds (assuming you do not want equity risk) will help you get reasonable returns with safety and liquidity. The effective return from your real estate investment could be lower than this simple step!

Want to calculate your existing property returns? Try this free tool: Real Estate Returns Calculator.

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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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