7 Ways Rental Properties Can Help You Retire Earlier
By G. Brian Davis, SparkRental.com
Once upon a time, workers saved a nest egg over a 40- to 50-year career and then spent it in retirement. And hope they haven’t run out of cash before they kick the bucket.
This withdrawal model raises all kinds of questions about safe withdrawal rates and how much you need to save for retirement. As retirement approaches, it also forces you to shift money into low-risk, low-return investments to mitigate the risk of return streak (the risk of a stock market crash early in your retirement). .
You also shouldn’t expect a lot of help from Social Security. A 2020 senior league study found that the purchasing power of benefits had fallen by 30% since 2000.
Enter: rental properties.
How Rental Properties Can Help You Retire Earlier
Although I don’t plan to retire someday, I plan to achieve financial independence at age 43. I am currently 40 years old.
Financial independence is the ability to retire, to live solely on investment income. You achieve it by creating passive income from your investments.
As you build passive income and work toward your own financial independence and retirement, don’t cancel rental properties. They come with awesome after-work income benefits.
1. Current income
When you buy a rental property, it immediately begins to generate income for you. And never stop.
Best of all, it doesn’t require you to sell any assets.
Because in the traditional nest egg model, you build a portfolio of paper assets like stocks and bonds, and then gradually sell them to generate money that you will live on each month. Which means your net worth decreases over time and you may run out of money.
With their current passive income, rental properties do not carry this risk. Rather the opposite: real estate generally appreciates over time, increasing your net worth rather than decreasing.
And real estate values aren’t the only ones to rise over time, either.
2. Higher rents, fight against inflation
Not only are rents rising to keep pace with inflation, but rents are a major driver. This means you don’t have to worry about inflation sapping your returns over time like you do with obligations.
Imagine buying a bond paying 5% annual interest. If inflation is 2%, your “real” return is only 3%. Which doesn’t really inspire champagne corks to pop.
In most cases, your rental cash flow and cash returns increase over time, especially if you use leverage.
3. Leverage: the power of other people’s money
You can use other people’s money to finance the majority of your cost of buying real estate. Their money is your asset.
When you take out a rental mortgage, your principal and interest payment is permanently blocked. So over time your rental income increases, but the cost of your loan remains the same.
Let’s take a quick example. You buy a turnkey rental for $ 100,000 and borrow $ 80,000 at 5% interest for 30 years. This puts your principal and interest payment at $ 429.46.
The property rents for $ 1,500, and your total average monthly expenses are $ 1,100, leaving you with a monthly cash flow of $ 400. This works out to a 24% cash return: $ 4,800 in net annual rental income on your $ 20,000 down payment = 24%.
Five years later, the rent went down to $ 1,950. But your monthly mortgage payment remains at $ 429.46. Instead of earning $ 400 in monthly cash, you are now earning $ 700 or $ 800 (your other expenses increase with rents, unfortunately).
In turn, your cash yield has also increased. If you’re now earning $ 700 per month in free cash flow, or $ 8,400 per year), that’s a whopping 42% return on your $ 20,000 down payment.
Which says nothing about the appreciation of the property over these five years.
It is the power of take advantage of other people’s money to buy your own valuable and cash-generating assets.
4. Predictability of returns
When you buy a index fund, you hope for the best based on historical average returns.
But you don’t just hope for the best when buying a rental property. If you calculate cash on the right, you know exactly what return it will bring you.
You know the purchase price, you know the market rent and you know or can accurately forecast all your expenses. For example, you know the property taxes, the cost of rental insurance, property management fees. You know the vacancy rate in the neighborhood. You can accurately forecast the average annual maintenance and repair costs.
This means that you will never have to make a bad investment if you execute the cash flow figures accurately.
5. Control of returns and risks
Not only can you predict rental property returns, but you also have some control over them. A control that you don’t have at all when you invest in stocks.
You can improve the management of the property to reduce the vacancy rate and the turnover rate. You can improve the quality of your tenants by renovating the property to attract better tenants. Besides, you can avoid bad tenants through a thorough selection of tenants. Just make sure you know how to read a credit report, and look beyond the score to actual payment history.
6. Diversification of asset classes
If all of your money is tied up in stocks, what happens when the stock market crashes?
Real estate values and rents have a low correlation with the stock market. They are also much more stable.
With a significant portion of your investment income generated from rentals, you don’t have to bite your nails every time the stock market dips. This diversification into another asset class reduces your risk and your exposure to an asset.
And of course you can buy REIT. But as assets traded in the stock markets, they are more closely correlated with stock prices than traditional real estate.
Let the stock market go through its gyrations. As a real estate investor, you can sleep at night knowing you have predictable passive income elsewhere.
7. Tax benefits
Among the many others reasons to invest in real estate, it also comes with tax advantages.
All conceivable expenses related to the property are either deductible or depreciable. This includes expenses such as meals, travel and the home office, which W2 employees can no longer deduct.
Better yet, these deductions are “above the line” which means you can still take the standard deduction on your personal return even if you are deducting these rental expenses.
Depreciation even allows you to deduct the cost of the building itself over time. You can deduct the cost of the building and the cost of any capital improvements in the first 27.5 years you own the property.
When planning your tax strategy, make sure you understand all of the tax benefits of rental properties.
Disadvantages of rental properties
Rental properties come with their fair share of risks and inconveniences, like any investment.
For starters, they come with an extremely high cost of entry. Even if you take out a rental mortgage, you must still provide a down payment. That alone usually costs you tens of thousands of dollars, which doesn’t say anything about closing costs. You can accept a gift to cover the deposit, and with rental home loans, you can even borrow the down payment. But if you borrow it, that extra debt eats up your returns.
Locking in thousands of dollars in each individual investment comes with diversification challenges. When you buy an index fund, you can spread $ 100 across hundreds or even thousands of companies. When you buy a rental property, you can put $ 50,000 in a single asset.
Rental investment also requires a certain degree of knowledge and skills. Investing without learning the ropes invites taking additional risks, to put it mildly. In contrast, anyone can invest money in an index fund and just mimic a stock index.
Once you buy a rental property, it requires continuous labor. Rental income isn’t completely passive – even if you hire a property manager, you still have to manage them.
Finally, real estate is an inherently illiquid asset. It takes time and money to buy or sell, unlike stocks. You can buy or sell shares of an index fund instantly, with no commission. Real estate can take months to sell and requires you to pay thousands of dollars in realtor commissions.
Before investing a dime in real estate, make sure you understand all the risks. And expect to dedicate many hours of training, learning skills such as how to accurately forecast cash flow, close good deals, how to identify profitable markets to invest, and even how to invest remotely if you don’t live near one of these markets.
While you are thinking invest in rental property To generate continued income, consider hacking the home first.
This involves buying a small multi-family property to live in and renting the other unit (s). You can use the rents from other units to qualify for the mortgage and take out a conventional homeowner mortgage. Ideally, the rents on your neighboring units fully cover your monthly mortgage payment and you can live for free.
Which is also very useful in retirement.
Contributor profile: G. Brian Davis is a real estate investor and founder of SparkRental.com, which helps middle class people replace their daily jobs with rental income. He and his family spend 10 months a year abroad, practicing the travel and FIRE lifestyle that he preaches.
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