Many investors wonder how many rental properties they need to generate enough income for retirement. It's a complex question with no one-size-fits-all answer.
It depends on a few factors, including how much you need each month to cover expenses and the types of properties you own.
In this article, we'll break it down step by step so you can create an investment plan that fits your goals and lifestyle.
Benefits of Using Real Estate for Retirement
Real estate investing has long been considered a viable way to build wealth and achieve financial freedom. Compared to traditional retirement assets like stocks and bonds, owning rental property offers unique advantages that make it attractive for many investors.
There are five reasons why investing in real estate can be an excellent option for those looking to retire comfortably.
- Steady cash flow: Rental properties can provide a steady stream of income that continues throughout retirement, unlike stocks or bonds with fluctuating dividends and volatile values.
- Appreciation potential: Real estate investments have the potential to appreciate over time, allowing investors to build equity and increase their net worth to pass on to their heirs. According to the Federal Reserve, the median sales price of houses has increased by nearly 400% over the past 30 years.
- Tax advantages: Real estate investors can use various tax deductions such as repairs and maintenance, mortgage interest, property taxes, and depreciation to reduce taxable net income. By leveraging these tax advantages, investors can maximize their retirement income.
- Inflation hedge: Real estate investments have historically acted as a hedge against inflation, since rents tend to rise with inflation rates. For someone who plans to retire by owning rental properties, inflation can erode the value of their rental income over time.
By hedging against inflation, investors can ensure their rental income keeps up with the rising cost of living and maintains purchasing power.
- Tangible assets: Unlike stocks or bonds, real estate is a tangible asset you can see and touch. This can provide peace of mind for investors who prefer physical assets they can control.
Rental Property Retirement Formula
The rental property formula is relatively easy to use, and it looks like this:
Income = Money x Cash-on-Cash Return or I = M x C
I is the income you would like to retire on, M is the money you invest in a rental property, and C is the cash-on-cash return. While the first two numbers are fairly easy to understand, investors sometimes get confused about the cash-on-cash return.
Cash-on-cash return is a metric that measures the annual return on investment (ROI) of a rental property based on the amount of cash invested. Specifically, it calculates the percentage of the initial investment returned in a given year as cash flow.
The higher the cash-on-cash return, the more income the investor will generate from their rental properties, potentially reaching their retirement goals faster.
For example, if an investor purchases a rental property for $250,000 and generates $20,000 in cash flow per year after expenses, the cash-on-cash return would be 8%. In other words, for every dollar invested in the property, eight cents are returned as cash flow each year:
- M x C = I
- $250,000 x 8% = $20,000
Your cash-on-cash return will differ if you use financing to purchase a rental property. M becomes your down payment amount, while the mortgage payment and interest expense will reduce the cash flow generated by the property.
To illustrate, assume an investor makes a 20% down payment on the above rental property and finances the balance, which reduces the cash return to $2,500. In the formula below, M is the $50,000 down payment, C is the 5% cash-on-cash return, and I is the $1,000:
- $50,000 x 5% = $2,500
Using leverage (taking out a mortgage) can help you purchase more properties with less upfront capital. However, it's important to remember that this leverage also increases risk; you'll have more debt to service and can be more vulnerable to market fluctuations.
Diversification is one method some investors use to reduce risk. Investing in multiple rental properties across different markets and asset classes can help mitigate risk and provide steady cash flow during retirement versus putting all your capital in one or two rentals. However, this also means you may encounter a broader range of problems as not all asset types can be managed the same.
Of course, there are a lot of variables to consider when purchasing a rental property for retirement. One way to assess the risk / benefit of a property is by using a real estate calculator, which can provide insights into potential ROI depending on down payments, mortgage rates, and more.
How Much Money Do You Need to Retire?
There is no one-size-fits-all when using rental properties for retirement income. That's because the ideal number of rental properties you need to retire comfortably will depend on factors such as your desired lifestyle, income needs, expenses, investment goals, and additional sources of income.
However, once you have this figure in mind, you can work backward to determine how many rental properties it would take to generate that income.
Let's assume you want $5,000 in total monthly income from your rental properties for retirement. You can use the rental property retirement formula to calculate how much capital you would need to invest based on an average cash-on-cash return and the cash-on-cash return required based on the funds you have to invest.
For example, if your retirement income goal is $60,000 per year and you've determined the average cash-on-cash return is 8%, you would need to invest $750,000 in rental properties:
- I = M x C
- I / C = M
- $60,000 / 8% = $750,000
You can also determine how many rentals you would need to purchase to achieve your goal of $60,000 per year in retirement income if you know the average home price and the average cash-on-cash return.
In a simplified scenario, if homes are selling for $250,000 and returning 6% per year, you would need four rental properties:
- $250,000 x 6% = $15,000 cash-on-cash return per property
- $60,000 target retirement income / $15,000 average return = 4 rental properties with an average price of $250K each.
How to Use the 1% Rule and 50% Rule
Some general guidelines can help you determine how many rental properties you need to achieve your retirement goals.
One common rule of thumb is the 1% rule, which suggests that a rental property should generate at least 1% of its purchase price in monthly rent. This guideline can help ensure the property generates enough cash flow to cover expenses and provide income.
For example, a property bought for $200,000 should generate at least $2,000 per month in gross rental income.
The 50% rule is also significant for anyone investing in rental properties, including those using real estate as a retirement vehicle. The 50% rule states that you should assume half of your rental income will go towards expenses such as property taxes, landlord insurance, maintenance, repairs, and vacancies.
By factoring in the 50% rule when analyzing potential rental properties, you can better understand the property's cash flow potential and determine whether it's a good investment for your retirement goals.
If a property doesn't meet the 1% rule or generate enough cash flow after accounting for expenses under the 50% rule, it may not be a worthwhile investment.
Using these metrics, an investor would need five rental properties that meet both the 1% rule and the 50% rule to generate $5,000 per month in retirement income. This assumes the properties were paid for in cash:
- 5 rentals x $2,000/each in gross rent = $10,000/month gross rental income
- $10,000 x 50% rule (operating expenses) = $5,000/month pre-tax cash flow
More properties would be required if the rentals didn't quite meet one or both of these rules or if the investor used financing to purchase the homes.
Note that any potential appreciation hasn't been factored into this forecast. Part of your retirement planning may include gradually selling off individual homes in a rental property portfolio or conducting a cash-out refinance to turn accrued equity into additional money for retirement.
Choosing the Right Rentals for Retirement
As investors approach retirement age, their priorities and investment strategies may shift toward more stable and predictable income streams. Younger investors often have more margin for error and may prioritize high-yield investments over stability and consistent income.
Retirees or those nearing retirement age must be particularly diligent in selecting rentals that align with their financial goals, as they have less time to recoup any losses.
Here are some key considerations for choosing the right rentals for retirement that offer consistent income and peace of mind.
Location
Choosing rental properties in areas with strong economic growth, job opportunities, and population growth is essential. It will help ensure you have consistent tenant demand and the potential for long-term appreciation.
Due Diligence
Before investing in any rental property, conduct thorough due diligence to be sure you understand all aspects of the investment:
- Research local real estate markets and trends.
- Conduct inspections of the property.
- Review leases and tenant histories.
- Assess your purchase options (cash vs. leverage).
- Analyze financial projections.
Tenant Demand
Understanding the local market is crucial when selecting rental properties. Investors should research vacancy rates, average rents, and tenant demographics to identify areas with high demand from reliable tenants.
Cash Flow Stability
When investing in rental properties for retirement income, prioritize cash flow stability over high returns. Choose properties with reliable tenants and steady rent payments rather than those with the potential for higher rents but higher vacancy rates.
Repairs and Maintenance Costs
Retirees often rely on a fixed income, making unexpected repairs or maintenance costs a significant consideration when investing in rental properties. To minimize this risk, investors must have a solid plan for managing these costs, such as setting funds aside in a reserve account to ensure these expenses do not eat into profits.
Property Management
As investors approach retirement age, they may want to consider hiring a property management company to handle the day-to-day operations of their rental properties. It can help reduce their stress and workload while ensuring their properties are well-maintained and generating consistent income.
Diversification
Investors nearing retirement may wish to diversify their portfolios with a mix of rental properties and other investments, such as stocks or bonds, to minimize their risk while maximizing their potential returns over time.
How to Protect a Rental Property Portfolio
Even when you've done your best to choose suitable rental properties, protecting your portfolio is crucial if you plan to rely on rental income during retirement. Without proper landlord insurance coverage, you may find yourself underinsured and unable to cover repairs or other expenses associated with unexpected events.That's where landlord insurance from Obie can help.
Obie is an online insurance broker offering coverage for property damage, liability protection, and loss of income for rental properties in all 50 states. Obie offers a wide range of policies tailored to meet the specific needs of rental property owners. You can l earn more by getting a free quote now.
