Is Leveraging Real Estate Equity A Good Idea For Retirement?

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A reader asks, “I’m 61 nearing retirement and a lot of financial gurus say I should leverage my rental property equity to buy stocks, real estate, etc.,  for retirement. Is it a good idea?”

There are two answers to that question – the scientific answer and the realistic answer…

The scientific answer is that you should do whatever provides the highest after tax return net of all fees and expenses. Science says that if leveraging up provides a higher return then it is theoretically a better choice; however, THERE IS A HUGE DIFFERENCE BETWEEN SCIENTIFIC THEORY AND ACTUAL PRACTICE.

I’m not a big fan of anyone nearing retirement re-leveraging equity to be reinvested in other fluctuating assets for the following reasons…

1. It incurs lots of fees and expenses creating an immediate loss. This might good for the salesman in search of commissions pitching the idea but it all comes out of your pocket creating a hurdle to overcome before you ever get out of the starting gate.
2. Increased leverage equates to increased investment risk profile meaning you have little room for error. Your additional investments must provide a compounded (not average) return in excess of interest costs and expenses before ever adding a dime to your pocket. Most people lack the investment skill to reliably achieve that goal. Generally not a good idea for retirees.

Actual practice shows there are historical time periods where a high leverage strategy would have worked out well and there are historical time periods where it would have been a miserable failure. Whether it works to your advantage or not is completely dependent on future asset returns which is completely unknowable. The only thing you know for sure is your risk profile and expenses will increase, but you cannot know if your future returns will increase as well (no matter how much the salesman pitches you with historical return evidence to support his ideas).

The whole problem with this strategy rests on the fact that future returns are unknowable. That is the chasm that separates theory from practice that cannot be crossed. Unless you can forecast expected returns with a strong degree of confidence then you have no basis for increasing your risk.

In fact, I’m hard pressed to think of a circumstance where I would implement such a strategy in my own portfolio. They exist, but are extraordinarily rare. It generally doesn’t make sense to re-leverage your rental real estate equity and increase your risk profile as you near retirement.

Your retirement objective should be sustainable cash flow in excess of expenses that adjusts for inflation – not maximum wealth. Real estate equity provides the former and leverage is targeted for the latter.

The pitch to apply high leverage strategies primarily exist because salesman are highly motivated to earn double commissions both on the mortgage refinance and on the reinvestment of the proceeds from the refinance into other assets. It is a double-down for the salesman… but a high risk play for the retiree.

Others may disagree, but that is my two cents worth. What do you think? Tell us in the comments section below…

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