Replacing Your Salary with Rental Property Income

packs-163497_1280-PDRental property income is not as safe as a government pension.  It is not as safe as a government bond.  It is not even as safe as a salary, depending on who you ask, and what your temperament is.  But based on the risks involved, it should have a greater return.  And the risks can be mitigated, if you screen tenants property, know what to look for, and keep your property maintained.

The first thing you need to do is determine what income level you need to replace.  Often, the retirement Gurus recommend you need 85% of your pre-retirement income to be replaced to live in a manner you have been accustomed to; let’s do some analysis on this.  I think it is quite a bit less than that, if you have been living your life like you really want to retire.

Lower Expenses

First of all, once you retire, you do not have certain expenses.  For instance, you no longer will have to pay Social Security and Medicare taxes, which are 7.65% of your current salary.  If you are above the maximum of social security, then your formula might be slightly different.  I am going to assume a $100,000 salary.

You will also not have to save any additional money in your 401K.  If you are making 100K a year, and are over 50, you should be contributing the maximum of $23,000.  That is $17,500 for the under 50 portion, and the additional $5,500 for the over 50 catch up portion.

Mortgage Payoff

By the time you get to be retired, you should have your own home paid off.  If not, you better get started.  Too many expenses are the major obstacles in a retirement plan, and of course having enough income.  So, assuming that you were living fine for a long time on a budget with a house payment while you were working, you should be able to live fine on the same amount of income or budget after you have your house paid off.  You do not need to make that amount of money.

A typical house payment, for principle and interest only, might be $1400 per month.  This will depend on how large your mortgage was, and what your interest rate was.  In this case, $1400 is $16,800 per month.

There are a lot of expenses that you no longer need to spend on after you retire.  Things like expensive lunches in at restaurants, or the company cafeteria.  You can cut commuting costs, bus fare, parking fees, dry cleaning, and maybe even doggie day care.  If you want to go extreme, you can now eliminate any shaving and haircut costs too.  But these are all very subjective costs, so they will not be factored in.

If you are retiring at 65, you may find that Medicare is cheaper than your portion of your employer’s health care expense.  If you can ‘buy’ vacation at your workplace, where a deduction is made from your paycheck to get extra time off over and above the company vacation allocation, you can deduct that cost from what you need too.

Since you are also making less money, you can offset the amount a bit by the reduced federal and state income taxes that you will pay after you stop working.  In some states, pensions and social security are not taxed at all, so that is a major expense that you no longer have to pay.

Rental income is considered passive income, and can be offset by depreciation.  Any income that is offset by depreciation is money in your pocket, tax free.  You may never have to recapture the depreciation if you do not sell.  Your heirs will inherit he property at the new basis, no recapture tax needed.  (check with your accountant…)

Let’s Run the Numbers…

Salary $100,000

FICA ($7,650)

401K ($23,000)

Mortgage P&I ($16,800)

Total Salary Equivalent $52,550.

That is only 52.5% of your working salary.  And that assumes a lot of expenses that you will no longer have to pay now that your salary is less, and you do not have work expenses.  You can live in exactly the same lifestyle as you do now, just because you were able to live in a manner that is reasonable up to retirement.  And this does not even count the lower taxes and lower expenses of not working.

Once again, some investment Gurus recommend to have 25x your salary in savings, but really it is 25x your spending or expenses, not income  $52,550 x 25 is $1,313,750.  That is a lot of money, but it is not $100,000 x 25, which is a crazy large sum of $2,500,000.

If you have investment property bringing in a mere $1,000 a month, it drops that $1,313,750 figure down to $1,013,750.  Factor in some social security of $2,000 a month; that figure drops to only $412,500.  If you work for a company with a pension, and have an additional $1,000 coming in from the pension, you only need $113,750 in the bank to replace your income.

To get $1,000 a month in rental income, after all expenses, including management fees, vacancy fees, maintenance and all other fixed expenses, you should be looking for an 8% cash on cash return.  I do not think anyone should invest in a property that does not have at least an 8% cash on cash return.  You will likely be required to put up 25% for a down payment.

To get $1,000 a month or $12,000 a year from rental income, you need to put up $150,000 at an 8% return.  This can be on one property, or several.

Conclusion:  Real Estate is a great way to get a great investment return.  With higher returns, you have higher risks.  If you are using real estate income for retirement, you should to have other, more secure sources of income to help out and diversify your income streams.  You should also mitigate your risk by only accepting quality tenants.

Real estate income, investments in the stock market, bonds, social security, pensions, etc. all go a long way to a well-rounded retirement portfolio.

What income are you planning on retiring with?

30 Replies to “Replacing Your Salary with Rental Property Income”

  1. I like the idea of owing property and becoming a landlord, but we just bought our first house and I don’t know if we could do it until we get out of debt. Until then I just have to rely on my typical retirement accounts. Maybe someday I can own more real estate (although I am not handy at all) but I really like the blog and the idea.

  2. Eric,
    Great breakdown. I’ve been quietly following your site for some time, and this is one of you best reads. Like you, I work full time and own rentals for retirement investments. I tell younger co-workers all the time to maximize every investment asset in their reach including real estate, as early as possible. Time is their biggest asset, and I wish I’d had someone more clearly explain the advantages of realestate to me in my 20’s. I actually did have a mentor who tried to tell me, but like many 20 something’s, I just didn’t get it as I was pre-occupied with kids, jobs, and buying a house, etc.. While I didn’t seriously start investing in rentals until I was in my forties, I’m so glad I did because a comfortable early retirement is now easily within reach because of those realestate investments, let alone our other retirement vehicles. In my opinion, many investment gurus hurt many young investors by scaring them with higher salary level estimated investing advice ($2M-$4M required in savings) so much so, many just throw up their hands and give up. It’s really not that complex or overwhelming when you break it down. Most 20 to 50 year olds can “slam dunk” a comfortable retirement with a reasonable savings rate and a realestate investment or two and a little time (the more of the latter the easier it becomes!) Most people simply don’t understand the breakdown of what is really needed (as you pointed out very eloquently above it’s not insurmountable). You’ve done your readers (young and old) a great service with this article, keep up the great work!
    -Thom

    1. Thank you for the comment and kind words!

      If I would have started RE investing earlier, and used indexing in the stock market, I would be out of the rat race by now. You do not need to replace 100% of your income with RE, even a small portion is a great way to begin. It should only get larger with inflation as time goes on.

      I am able to replace about 250% to 300% of my spending with my rentals, plus I have my investment portfolio and some social security and a small pension. If more people understand saving for the future, their lives would be better as they get to retirement age.

      1. I hear ya’ Eric about starting sooner!

        Fortunately, the rat race will stop soon for me. My personal rationale for 100% salary replacement in real estate was a personal choice to hopefully provide an early exit (@ 50 yrs old) since other investments were in more restrictive accounts (inaccessible until 59.5 yrs old without penalties). In order to leave my current job early, it a good option for me to accelerate my rental property growth in significant way to leave the hamster wheel early by replacing my entire salary sooner. I just took the approach that all other investments would be icing on the cake at 59.5… in about ten more years. Again, not necessary for everyone, and as you said, most can retire on significantly less, but it was a personal choice on my part to be able to leave ahead of most. That’s the other great thing about real estate, you can stop at one unit or grow it as large as you choose. I’m at 43 units and growing, but then again, I just enjoy the rental business and the freedom it brings. But for most, simply one or two SFH’s will make a huge difference in their retirement.

        BTW, I enjoy your posts on BP too. I’ll visit again soon! Good luck and continued success! -Thom

        1. Thank you for the comment!

          I continually evaluate my retirement plans and make sure I am not only on track to retire, but have multiple option, just in case one fails. I believe you can get the IRA money prior to 59.5, if you have a consistent withdrawal plan.

          Keep up the great work!

          1. Yes, thanks Eric, I’ve considered 72t rule options (it’s actually mostly in a 401k), but believe I can hit a comfortable FI mark via my REI’s alone by age 50 in order to leave the rat race soon (within the next couple of years now). The 72t option is a good backup option, if necessary due to some unforeseen issue at a future date. I appreciate the suggestion.

            I’m actually leaning more toward a gradual roll over (over approx 10 yrs from age 50 to 59.5) from the 401k (once I leave the hamster wheel) to a qualified new Roth to ultimately avoid RMD, and have some capital available within 5yrs (after it’s started maturing in the new Roth–as you likely already know, input capital becomes accessible after 5 years in a Roth), all the while, trying to stay under the next higher income tax bracket during each annual roll over. This would keep the taxes low on each annual roll over amount to the Roth by spreading it out over up to ten years (as long as I can keep our total income under the next tax bracket) and also avoid any tax penalties since it’s a qualified Roth. Luckily, another great point to RE, a large portion of my RE income will still be very tax efficient (due to depreciation, etc.), so my tax bracket should be lower when I leave the job even though I’d actually be making the same take home income through RE. But best of all, I avoid the longer term RMD at age 70 by not leaving it in a 401k (or traditional IRA). Sorry for the long explanation, but I appreciate the more in depth discussion of efficient retirement options. Would love to hear other ideas!

  3. This is excellent information. I agree with Thom that calculators make it seem nearly impossible to retire with what you need, but the numbers are way off. Expenses should go way down once you aren’t working, including taxes. We are hoping to cover all of our basic necessities with rental income and have the retirement savings to fund anything else we might want to do.

  4. The breakdown that you did about what you really need to retire made me breathe a sigh of relief. We save a lot but I still worry about if we will be able to retire (and I’m only 29 now.) I know time is on my side still, but it’s good to remember that you don’t have to replace your entire salary, especially since your expenses will be so much lower in retirement.

  5. I really like the idea of retiring and living off of real estate income. I like the idea that you are still generating income versus simply withdrawing money out of a retirement account and watching your assets dwindle.

  6. I pulled the plug in my early 50’s in early 2007 with over 20 SFR rentals, two modest pensions and a good-sized IRA. Worst time to retire for most people, especially those entirely dependent on a portfolio of paper assets. My stock portfolio dropped and the properties went down in value even more dramatically in 2008 – 2011. On paper, I was worth a heck of a lot less than when I retired. However, for the most part, my tenants continued to pay their rent and the stock dividend checks continued to be deposited. Well. except for those darn banks, which demonstrates the need for a diversified equity portfolio. My two pension checks appeared every month. It took me awhile (with a lot of tearing of hair and whining), but I finally figured out that the plunge in asset values had very little effect on my income.

    In 2009 to early 2012, I scraped my cash together, and using that money along with capital raised from refinancing my house, I bought four more houses. On top of that, rents started to go up because of all the folks needing a place to live after the short sale or foreclosure.

    The equity market has largely come back, my own house is worth more than it was when I retired, and the rentals have recovered much of their value as well. I am not back to where I was in net worth, but my income is higher than it was before the Great Recession.

    I do not agree with you about carrying a mortgage in retirement. I live in the Bay Area, and earthquakes and wildfires are a part of the landscape. I want the bank on my team when it’s time to deal with the insurance company and/or FEMA. I pulled cash out in 2009 to buy more properties, and refinanced the principal for 30 years at the bottom of the market in December 2012. I consider that money at just over 3 percent to be a prudent way to finance some of the rentals for the long term.

    I also do not entirely agree with your expense calculations. If your retirement is successful, you will have more discretionary spending for travel and hobbies. In my case, I had to pick up most of the cost of health insurance, which goes up dramatically as you approach and get beyond age 60. That’s now an additional $500 a month over what I was contributing when I was working. My expenses are reduced, but not to the extent you show.

    I do think you are going to be in great shape when you pull the plug. There’s a lot to be said for that multi-legged income stool. After a couple of years, you will be wondering why you didn’t retire earlier.

    1. Thank you for the comment!

      By paying off a rental property mortgage, my cash flow is quite a bit better. I agree, there are also additional risks when you pay it off. Now, you are on your own fighting litigation or insurance companies.

      But I do feel safer with a mortgage paid off.

      1. I agree with paying off the rentals. I’m working on that now. Some were purchased with cash and others have been paid off or are on the payoff schedule.

        I’m under 40 percent leverage on my house, because I bought in Silicon Valley many years ago. I have a ton of trapped equity and a tax disincentive to sell. I expect to rent this house as I get older rather than pay capital gains tax on the gain on this property and the rolled over gain on the previous property.

        1. Congrats on the payoff schedule!

          There are two schools of thought. If you want cash flow, pay off the rentals. This is a great strategy for retirement. If you want to build wealth, take on as much debt as you can, and hope for the best.

  7. I love your positive attitude. All the mainstream media ever throws at us is crap like ,”Why you’ll have to work until you’re 92″ or “Why you need 1400% of your income in retirement.” It’s very refreshing to see someone approach it with logic and good sense.

    I do have a question about this though:

    “I am able to replace about 250% to 300% of my spending with my rentals, plus I have my investment portfolio and some social security and a small pension. If more people understand saving for the future, their lives would be better as they get to retirement age.”

    I’m wondering why you’re still slaving away in that cube farm. Abandon it!

    1. Good question… I often wonder that myself. Since my RE income really ballooned in 2013, it is a relatively new discovery on how much they really generate. I am able to use my real job as my tax paying job by increasing the tax withholding to quite a bit. I am going to evaluate at the end of 2014 how much money I have saved over the past two years, over and above my salary.

      So I may leave earlier…

  8. I am following in your footsteps in this category. We are currently focused on paying off the rental properties and personal debt, these are our biggest expenses, once these are paid off, the cash flow would more than cover expenses.

    So assuming you retire tomorrow, do you have a plan on the break down of what money you will be using to fund your expenses, ie 50% real estate, 40% 401K/Stock and 10% Betting on Black at the Casino.

    1. I am actually planning on funding my retirement 100% with rental income until I turn 62 or so. If I can spend what I spend now, plus save just a bit, I should have a sizable portfolio with which to begin withdrawing at ~62. It is already ~$1M, so I hope it can get to close to $2M in seven years when I turn 62, with some regular savings.

      I still have 21 months to work, and since 2013 I have saved all my salary from my real job, plus some. So I think it is realistic. With that in mind, I have lived on my rental income for the past few years already. If I save ~200K between now and retirement, plus add another $200K during retirement, I can start selling my rentals or whatever I want at 62. I will probably take a less active, more vacation, approach at that time.

      My investment portfolio would have been ~$150K higher, but I paid off a mortgage. I also have higher rents now, and paid off another mortgage on my own home this Spring. That’s an additional $2,550 in cash flow from paying off the two mortgages.

  9. This is a great article NNL. As my rental income grows, I think about this more and more. How much is really enough? I’ve been told by many people that you actually need less than you think in retirement because of the reasons you had mentioned.

    I still think I’d be a little nervous to pull the plug when the time comes, though.

      1. Would you ever allow anyone to put something on one of your rental properties ie a walkway, driveway or say a fence.

        1. Thank you for the comment!

          If it would add permanent value to the property, then probably yes. If it was for the convenience of the tenant, and needed to be removed after they left, I would need a large enough deposit to remove it.

      2. Just found your website a few days ago and started from the beginning but I love the “Parable of the Mexican Fisherman” you are referring to, and often my 12 year old daughter will say then why are we still buying more properties when I mention it. I often answer “I don’t really know”!

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