Before discussing how to calculate the number of properties needed to replace your current income, understand the following: retirement is not a one-time event. After retirement, you will need rental income to maintain your current standard of living for the rest of your life.
How many properties do I need?
Without inflation, the number of properties you need to replace your current income is easy to calculate. For example, if your current income is $9,000 per month and each rental property has a net income of $300 per month, you would need 30 properties ($9,000/$300 = 30 properties).
However, in reality, inflation does occur. The following example assumes that average inflation is 5% and rent growth is 2%. Under these circumstances, how will your future rental income compare to your current purchasing power of $9,000?
Calculate the present value (adjusted for inflation) purchasing power in years 5, 10, and 15 using the following formula:
- FV = PV x (1 + r)^n / (1 + R)^n
where:
- R: Annual inflation rate %
- r: Annual price increase or rent increase (%)
- N: future years
- PV: Today’s rent or price
- FV: Future value in today’s dollar value
Calculating future purchasing power:
- After five years: $9,000 x (1 + 2%)^5 / (1 + 5%)^5 ? $7,786.
- 10 years later: $9,000 x (1 + 2%)^10 / (1 + 5%)^10 ? $6,735.
- 15 years later: $9,000 x (1 + 2%)^15 / (1 + 5%)^15 ? $5,826.
Over time, their purchasing power declines as rents fail to keep up with inflation, forcing them back into the job market.
But what if you invest in a place where rents are rising faster than inflation? For example, let’s say you buy in a city where rents are rising 7% and inflation is 5%. How will your future rental income compare to your current purchasing power of $9,000?
- After five years: $9,000 x (1 + 7%)^5 / (1 + 5%)^5 ? $9,890
- 10 years later: $9,000 x (1 + 7%)^10 / (1 + 5%)^10 ? $10,869
- 15 years later: $9,000 x (1 + 7%)^15 / (1 + 5%)^15 ? $11,944
Rent increases faster than inflation, providing the additional income needed to cover future cost increases. This will allow you to maintain your current standard of living.
The next question to address is how much cash you will need from your savings. down payment With 30 properties?
it depends on your gratitude
Suppose you want to buy property in a city with lower prices. Prices have been low due to limited demand over the past few years. Assume the price of each property is $200,000 and you have a 25% down payment.
Here’s how much cash I got from my savings for the down payment on 30 properties.
- 30 properties x ($200,000 x 25%)/properties = $1,500,000
For most people, it would be difficult to accumulate $1.5 million in after-tax savings. However, there is a way for him to acquire 30 properties with little capital.
Suppose you want to buy in a city that has experienced significant and sustained population growth and, as a result, rapid price increases. In the following example, assume that the average price appreciation rate is 7% and the increase in demand causes each property to cost $400,000.
Assuming you have a 25% down payment, your cash from savings for your first property will be:
- $400,000 x 25% = $100,000
Because real estate values are rising rapidly, cash out refinance As a down payment for your next property. For example, let’s say the appreciation rate is 7%, you use a 75% cash-out refinance, and your current mortgage payment is $300,000. How many years will it take to earn $100,000 in net income?
The formula used is:
Net Cash = PV x (1 + r)^n – Mortgage Repayment Amount
- After 1st year: $400,000 x (1 + 7%)^1 x 75% – $300,000 ? $21,000
- From 2nd year onwards: $400,000 x (1 + 7%)^2 x 75% – $300,000 ? $43,470
- From 3rd year onwards: $400,000 x (1 + 7%)^3 x 75% – $300,000 ? $67,513
- From 4th year onwards: $400,000 x (1 + 7%)^4 x 75% – $300,000 ? $93,239
- From 5th year onwards: $400,000 x (1 + 7%)^5 x 75% – $300,000 ? $120,766
So, after about five years, your net proceeds will be enough for a down payment on your next property. When you expand your portfolio using cash-out refinancing, you significantly reduce the amount you withdraw from your savings.
final thoughts
If you’re buying in a city where rent growth is slow and prices are rising:
- Real estate prices become cheaper.
- With rents not keeping up with inflation, your inflation-adjusted income will continue to decline, forcing you to find work or continue buying more property.
- All investment funds must come from savings.
If you’re buying in a city where rents are rising rapidly and prices are increasing:
- Property costs more.
- Increasing your rent will help offset the effects of inflation and help you maintain your standard of living.
- Acquiring additional property using a cash-out refinance requires much less money from your savings.
Ready to succeed in real estate investing? Create a free BiggerPockets account and learn about investment strategies. Ask questions and get answers from a community of over 2 million members. Connect with investor-friendly agents. etc.
Note by BiggerPockets: These are the opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.
