Can rental income pay for your retirement?

Many people believe that investing in residential property to earn rental income can provide comfortable post-retirement lifestyle. We think not. We compare real estate investment with annuity to help you make an informed choice.

Beginning this week, this new column will discuss issues ranging from why you should buy term insurance contracts to how you should protect yourself from people peddling dubious financial products. We hope to empower you with knowledge to make good financial decisions and achieve financial freedom - a state where your investment income is enough to meet your lifestyle needs.

Should you invest in residential property with your retirement savings? Most people do, because they think rental income helps meet your post-retirement expenses. But does it? As you will see, real estate investment may not be your primary retirement-income generator. Rental income can supplement, not substitute, pension products.

Why unstable?

In our investor-learning programs, participants often say that they use their retirement savings to buy residential property. You might agree with them. After all, you receive rental income every month and such income often keeps pace with rising price levels. But there are important variables that you need to consider before you create a real-estate retirement income portfolio.

For one, rentals are not as stable as you think they are. You will, perhaps, remember how rentals fell after the sub-prime crisis in 2008. And that is not an aberration. You will witness more such real-estate volatility, as India canters to become a developed country. For another, you need to spend a proportion of your rental income to maintain your property.

Added to that is the possibility that your property may not be occupied at all times. Besides, rapid infrastructure development in the country means your property may be affected by changes in regulations. This includes forceful acquisition by the government to expand roads or build airports!

All of these factors mean uncertainty in your rental income. And that means your lifestyle is exposed to risk of changes in these variables. Because you expect to earn income from it, we cannot consider capital appreciation in the property. You can either sell or earn rental income, not do both! The question is: Would you like your tenant to decide your post-retirement lifestyle?

Rentals Vs Annuity

You may recall from our discussion in our earlier column, Micromotives, about how retirees need to have stable cash flows to meet their lifestyle expenses. These are regular monthly expenses such as food and clothing to maintain desired post-retirement lifestyle. We suggest that you consider annuities for this purpose, as rental income cannot provide stable cash flows for the reasons mentioned above.

Annuities are pension contracts that you can purchase from an insurance company for a lump-sum payment. Many do not prefer annuities because the traditional annuity does not return the purchase price after the death of the annuitant. If you are one of those who dislike this feature, you can choose to buy an annuity with return of purchase price after your death.

The advantage is that an annuity gives you a stable lifetime cash flow. Importantly, you do not have to worry about finding a tenant, leave alone expecting the tenant to pay the rentals on time! Besides, an annuity compares favourably with residential investment.

If you buy a property worth Rs one crore with your retirement savings, you may receive a rental income of Rs 40,000 a month. That translates into Rs 4.8 lakh income a year or 4.8 per cent return a year. Currently, an immediate annuity with return of purchase price will pay you about Rs 7 lakh for Rs one crore of purchase price, if you are 60 years at the time of purchase. Suffice it to know that insurance companies are able to offer such competitive rates because of “mortality credits”.

You should create stable cash flows to meet your lifestyle expenses to lead a stress-free life, post-retirement. Rental income may not provide you such stable cash flows for the reasons discussed above. You can nevertheless invest in a rental property to supplement your post-retirement expenses.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. He can be reached at >enhancek@gmail.com)

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