It’s easy to understand why so many people dream of retiring with rental properties in their portfolios. The tenants pay the expenses and the retiree keeps the profits. Considering how many people have built generational wealth through real estate, it’s a worthy aspiration for anyone who dreams of financial security.
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But to realistically retire on rental income, one property probably won’t cut it unless the rent is incredibly high and your expenses are incredibly low. So the question becomes, how many rental properties do you need to retire early?
It’s a complicated question that doesn’t have a single answer. Each retiree’s financial situation is different, as is the profit an investor can expect to collect from any one rental property. Let’s give finding an answer our best shot, though.
Finding the Formula Is the Simple Part
Each person’s retirement expenses are unique, and each property will generate a different amount of rental income — but there’s a universal formula to identify the right number of properties for you. Simply divide the amount of monthly income you need by the cash flow each property generates.
For example, if you need $2,000 per month to get by in retirement, then you’d need four properties that generate $500 each.
That’s an easy calculation to make on paper, and one that ignores a whole lot of real-world wrinkles. In all cases, however, the formula starts the same way — determining how early you want to retire and how much you’ll need per month.
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According to T. Rowe Price, most people spend less when they retire, their tax obligations typically decrease and they can stop saving a portion of their income in a retirement account. Therefore, the firm suggests shooting for 75% of your current income to sustain you in retirement. If you earned $100,000 in your working years, plan to live off of $75,000 when you retire.
But early retirement compounds your financial considerations. For example, if you retire at 55:
- You’ll have to pay for private health insurance for 10 years until you’re eligible for Medicare at 65.
- You’ll have to wait seven years until you’re eligible for Social Security at 62.
- You’ll have only five years to make catch-up contributions to your 401(k) or IRA after you turn 50, instead of 17 years had you waited until the full retirement age of 67.
You’ll also be more likely to be paying down a mortgage or funding a child’s college education if you retire early. Balancing the scale, however, you might have annuities, dividend stocks or other passive income that reduce the amount you’ll need your rental properties to generate.
Before you make your calculations, avoid the common mistake of overestimating how much profit you’ll take from the rent you charge.
According to Morris Invest, you should estimate 40% of your rental income will go to expenses like insurance, property taxes, potential vacancies and property management. However, don’t assume you’ll pocket the other 60%.
The government taxes your profit separately from the property taxes you already paid, and unless you own the property outright, you still have to make a monthly mortgage payment. For example:
- If you charge your tenant $2,000 a month, you’ll get $24,000 per year.
- Accounting for expenses, you’ll subtract 40%, or $9,600, leaving you with $14,400 per year or $1,200 per month.
- If your monthly mortgage is $500 per month, you’ll be left with a monthly profit of $700 — but keep in mind those are pre-tax dollars.
In the previous example, the retiree with a $100,000 salary who planned to live off of $75,000 would need $6,250 per month.
With this example as the baseline, the retiree would need nine rental properties to retire early. But in 12 years, after reaching full retirement age, the addition of Social Security and Medicare might allow the retiree to sell one of the nine properties, live off the income from the remaining eight, and invest the windfall from the sale. Hopefully, your property’s value will appreciate during those dozen years and you might pay off the mortgage of one or more.
Investors who buy rental properties with unrealistic profit expectations are setting themselves up for failure in retirement. The trick is to distill the numbers down to your return on investment (ROI). ROI is the gain on your investment minus the cost of your investment. Only then can you predict how much money you’ll actually keep after all the expenses and taxes are paid.
It all starts with a cash flow statement. Here’s a basic example from Stessa, which is part of the Roofstock network, for a property with a $100,000 purchase price and a $25,000 down payment:
- Projected gross rental income: $900
- Vacancy loss: 5%, or $45
- Effective gross income: $855
- Repairs: 5%, or $45
- Property management: 8%, or $72
- Other expenses, including property tax, insurance and HOA: $180
- Mortgage principal and interest: $320
- Projected monthly pre-tax profit: $238
It’s important to note that this is a cash flow statement in its most basic form. It omits many risks and other considerations. Stessa and many industry experts suggest using a pro forma income statement, which uses hypothetical data and assumptions about future values to more accurately project your property’s likely performance.
If you’re planning to retire on rental income, however, the best investment you can make is the advice of a professional who specializes in real estate as a retirement plan.
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