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How clients can use investment properties to seek passive retirement income – InsuranceNewsNet


The current state of the market is likely causing investors and their advisors to re-evaluate existing plans for retirement.

Rob Johnson

The U.S. gross domestic product shrank for the second quarter in a row, potentially signaling early signs of a recession. Inflation levels recently hit a 40-year high and seem to show no signs of slowing as quickly as once predicted. Several interest rate hikes continue to increase the amount it costs to borrow money, with an additional rate increase expected in September.

Real estate is traditionally a hedge against inflation and an asset that has historically appreciated over time, which is why it may be in a client’s retirement portfolio alongside traditional asset classes such as stocks and bonds. Home prices are still high for the time being, which may make the current market the time for investors to sell their investment property to harvest their profits.

What does it mean for your clients who may have some of their retirement wealth trapped in their investment properties? How can you use these properties to create a comprehensive strategy to help them maintain the wealth they have accumulated and generate passive income in retirement?

If you have clients approaching retirement who are unsure of what to do with the wealth their investment properties have generated, here are some considerations that may help as you review their long-term goals and strategy.

Should they sell their properties?

Clients who are approaching retirement age may be considering selling their investment properties, either to remove themselves from the financial burdens of property ownership or to eliminate the responsibilities that come from being a landlord. Additionally, they may be inclined to sell their properties outright to unlock the current value they can receive for their investments before the market begins to cool. But without a strategy in place, investors may risk paying up to 40% or more in capital gains taxes, which can erode a lot of the wealth they’ve accumulated over the years. This tax bill could potentially undermine their plans for the future if not handled properly.

For your clients who decide to sell their properties, leveraging a 1031 exchange to defer their capital gains taxes can keep more of their wealth working for them. However, it’s important for investors to understand the costs associated with a 1031 exchange and how those costs may impact returns and other benefits.

Investors who decide to use a 1031 exchange to defer capital gains when they sell their investment properties must identify a replacement property of equal or greater value 45 days after the sale of their original property. Replacing one investment property with another can be challenging in the current market as home prices continue to remain high and inventory remains limited.

However, there are alternative investment opportunities for your clients who want to keep real estate within their portfolio but don’t want the hassle or financial burden that comes with direct property ownership.

What are the alternative investment solutions?

Accredited investors who are completing a 1031 exchange can consider a Delaware Statutory Trust as their replacement property instead of another real property. DSTs offer investors fractional ownership into professionally managed, institutional-grade properties such as multifamily properties, self-storage facilities, manufacturing facilities and more. These properties are managed by professional sponsors who are responsible for the day-to-day operations of the building. This eliminates the financial burden and hassle of having to own an investment property directly.

Potential benefits of DSTs in today’s climate

Investment property owners likely have seen their properties appreciate over time. However, with rising inflation, the expenses and costs associated with operating these properties also have increased. This potentially could erode some of the net income investors receive on a monthly basis. By investing in a DST, the investor not only removes the day-to-day hassle of tenant management, but they also may see a decrease in costs associated with property management as the responsibilities are split among several investors and managed by the sponsor. Sponsors have economies of scale with their property management resources, which can help reduce the direct cost to the investor compared to owning and managing an investment property on their own.

Another benefit DSTs can offer over direct property ownership is a larger potential for rate increases. If an investor owns four rental homes, they will have only four opportunities per year to adjust rents (one for each household). For DSTs that feature multifamily properties, there may be 300 to 400 tenants per building, representing a larger ability to adjust rents as needed to keep pace with market demand and pricing. In inflationary markets like the ones investment property owners are seeing today, large amounts of inflation will hit smaller investment property owners harder than if they had fractional ownership in DSTs that allow regular rate increases.

DSTs can also offer investors geographic diversity in their investment portfolio. Because DSTs are professionally managed by the sponsor, investors are not limited to only investing in properties that are near the investor. This can be potentially beneficial if the investor lives in a state with a high income tax rate or in an area where state or municipal taxes are expected to increase. This tax advantage can help investors keep more of their net income and offer portfolio diversification. DSTs offer investors an option to be strategic with the location of their investments in a way direct property cannot.

Considerations before investing in DSTs

DSTs can be a potential passive investment solution for your clients who are considering selling their investment properties to unlock wealth they have accumulated over the years. However, there are several factors to take into consideration before investing. DSTs are illiquid and have a holding period anywhere from five to 10 years. The DST sponsor also makes all decisions related to professional management and operational decisions, which may be challenging for investors who have typically maintained control over their properties. There are also several fees associated with DST investments, including broker-dealer allowances, offering and organizing expenses, disposition costs and more. As your client’s advisor, these should be weighed alongside the potential benefits to ensure the investment still meets the needs and objectives as your clients approach retirement.

The current state of the economy and real estate market could have many investors curious about whether they need to adjust their strategy or make changes to their retirement planning. By exploring different types of investment vehicles such as DSTs, you can help your clients transition their property wealth into tax-deferred, passive portfolios that can meet their needs as they transition from wealth-growing strategies to wealth-harvesting strategies. In addition, the potential cash flow generated from a DST investment can help adjust your client’s overall portfolio as needed as they enter retirement, giving you the ability to provide a more comprehensive wealth management solution.


Rob Johnson is head of wealth management and chief revenue officer at Realized. He may be contacted at [email protected].

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