Retirement is an exciting topic. Depending on who you talk to, it can be seen as a time when you can finally reap the benefits of years of work and effort, or it could be seen as a troubling time when one must grapple with difficult decisions that must be made to succeed.
Whatever view you take, there’s no denying retirement is expensive, and doing the math can make people balk. But many of those concerns can go away if you use the resources available to build your retirement income portfolio with rental properties.
How to Build a Retirement Income Portfolio with Rental Properties
1. Identify the Problems
Retirement is expensive!
The government has stepped in to try and address this problem by offering incentives for those saving for retirement. However, even with these incentives, the amount required for comfortable retirement living will still be considerable. You can ignore it, or you can address it head-on.
2. Calculate the Costs
In the following examples, we will look at how much it costs to own rental property separately from how much it costs to run a rental property. We will also look at some of the benefits of owning rental properties.
Rental homes require maintenance and upkeep, costing hundreds of dollars per month per unit. (For example, a standard 2-bedroom condo requires $200 per month in basic maintenance fees and $150 monthly housing association fees.)
3. Add up the Costs
If you own a rental property and pay housing association fees, you will spend approximately $1,200 monthly on maintenance alone. Add in the cost of utilities (if you use these services), insurance, and property taxes, and you can see that owning rental properties is an expensive business.
However, you can offset these costs if you have a substantial amount of free cash flow going into your portfolio regularly. Let’s look at an example of a property that costs $1,200 per month to run but generates a rental income of $3,000 per month.
4. Determine Tax Savings
Let’s assume the property generates $60,000 per year in rental income and costs you $48,000 per year to maintain the property. It means you will be left with $12,000 in cash flow after you pay your expenses. However, if your effective tax rate is 25%, you will take home only $9,600 ($60,000 x 0.25 = $15,000; -$15,000 + $4800 = $9,600). It means you will have the following income in your retirement portfolio:
Annual Income = $60,000 Total Operating Expenses + $48,000 Net Monthly Cash Flow = $108,000
5. Determine Your Expected Return
Your Return on investment will depend on the price you pay for a property and your rental rate. The affordability of a property is one of the first things to consider when looking at something as an investment. You may be able to find a home that generates substantial cash flow but is priced over $1 million – not very practical for most investors.
In this example, we will assume that you found a lovely home in an affluent neighborhood that costs $100,000 and generates a $3,000 monthly cash flow. It means your Return is:
Total Monthly Cash Flow = $3,000 Total Operating Expenses + Net Monthly Cash Flow = $4,200 Annual Income (Cash Flow) x 12 Months of the Year = $48,000 Annual Income x Rental Rate (20%) x 100% = 72% Return on Investment
Generally, you should shoot for at least a 20% return on investment if you’re considering a rental property. It will ensure that your annual cash flow will remain high even if you aren’t taking in a lot of money from the property.
6. Make the Return Last
To make the Return last, you must think carefully about how much cash flow is required each month to make monthly maintenance checks and property rentals possible. You’ll also have to consider whether you can afford to increase this amount as your cash flow increases or if it’s simply too expensive for your portfolio.
In our example, we’ve assumed a rental rate of 20%. It means we’re only collecting $480 per month in rental income. To earn at least a 20% return on investment, we need to bring in a minimum of $480 per month or $5,760 per year. It is less than the $6,000 collected by owners of other rental properties with higher rental rates.
7. Plan for Change
The Return on investment and monthly cash flow you receive from your rental properties may change over time. Remember this when planning for your retirement income portfolio. If your rental properties currently provide a 20% return on investment and $4,000 per month in cash flow, but you’re only collecting $2,400 per month ten years later (a drop of 50%), you should consider selling the property and buying another one. It is because it will be hard to maintain a healthy retirement income if your cash flow is too low.
If you ignore the problem, you might be OK initially, but as you age, your health might decline, and your ability to work might decrease. Your income will already be low if you save little or no money. If you depend on social security to sustain you, you’ll die broke.
The solution is to identify the problems and make a plan. If you are already paying off your house, one of your biggest problems has been resolved. You can use the money that you would have spent repaying your mortgage to build a retirement income portfolio with rental properties instead. You will have to take out a mortgage for the property, but if you can leverage your existing equity and find some rentals that pay for themselves very quickly, this might be an excellent way to go.
8. Build a Portfolio
The reality is that you will have to use retirement income for at least 20 or 30 years. It is a long time, and one lousy investment could jeopardize your future. The solution is to build a portfolio with rental properties that can support you comfortably while growing your wealth.
When building a retirement income portfolio with rental properties, you should always buy two properties in case one property stops paying for itself or you need to sell it quickly because circumstances change. It would help if you also tried to build your portfolio over time so that the bulk of it won’t be realized on your tax return all at once, which could make your tax situation more complicated.
9. Calculate the Return on Investment
The final step is to calculate the Return on investment of your rental properties. To do this, you must find out how much you’ve spent on your rental property and how much cash you are receiving from it.
10. Take Advantage of the Tax Write-Offs
When investing in rental properties, one thing that many people need to take into account is the tax write-offs that they can use to save money and make more income. For example, if you invest in a fixer-upper, your expenses could be increased by 30%.
Investing in rental properties is an excellent way to increase your retirement income and make more money, but it comes with many responsibilities. You have to be careful about your selection of properties and do your research to ensure that you are making good decisions for yourself and your family. Don’t be afraid of hard work and long hours when investing in rental properties because this can all be reduced when it comes time to collect the income from those rentals if you know what you’re doing.
