G. Brian Davis is a landlord, real estate and personal finance writer, and the co-founder of SparkRental.com. Swing by SparkRental for free rental investing tools such as a free rental property calculator, free video courses on building passive income from rentals, a free online rent collection service, and a lengthy library of other free landlord tools.

Don’t want to work forever?

Me neither. I want to retire while I’m young and fit. Write novels. Work at a winery for fun. Be there for my (yet unborn) kids.

And travel. My wife and I visit around ten countries each year and spend nine months of the year overseas.

So I’m a bit obsessed with FIRE, or “financial independence/retire early.” And you can retire early with real estate roughly four times faster than you can with traditional stocks and bonds.

Here’s how real estate – and rental properties, in particular – can help you reach financial independence within the next five to ten years, by throwing out traditional retirement concepts like safe withdrawal rates and the 4% Rule.

The Classic Model for Retirement

In the 20th Century, people either worked until they died (which happened often; the life expectancy in 1936 was a meager 58.5 years), or they relied on pensions and Social Security.

And why not? With such short life expectancies, it was affordable for employers and Uncle Sam to pay for a few years of retirement.

But when retirees start living for another 15, 20, 30 years after retiring, the math changes. Employers just can’t afford to keep paying ex-workers for decades on end, while receiving no value back.

The answer for employers was to transition from defined benefit plans (e.g. pensions) to defined contribution plans (e.g. 401Ks). Instead of saying “We’ll pay you $1,500/month until you die,” they say: “We’ll match up to 3% of your paycheck in contributions toward your retirement account.”

Notice how employees are suddenly responsible for their own retirement planning? They have to manage their own retirement plans and choose what to invest in – which spells trouble when most Americans can’t pass a basic financial literacy test.

To this day no one teaches Americans how to plan for retirement. Among other questions, they had to start asking themselves “How much do I need to retire?”

Which brings us to safe withdrawal rates, the 4% Rule, and its corollary, the 25X Rule.

The 4% Rule

In 1994, financial planner William P. Bengen reviewed 50 years of market data and found that retirees could safely withdraw up to 4% of their portfolio every year to live on, without running out of money for at least 30 years. Thus the 4% Rule was born.

For example, if you have $1,000,000 saved as a nest egg, the 4% Rule states you can withdraw $40,000 in the first year of retirement. Over the rest of your life you can adjust for inflation, but otherwise keep withdrawing the same amount ever year, and your portfolio should mathematically last at least 30 years.

Which means you can flip the rule around to determine how much you need to retire. If you want $40,000/year annual income in retirement, you can multiply your income figure by 25, to reach your target nest egg ($1,000,000 in this case).

Since then, economists and personal finance experts have hemmed and hawed and disagreed over whether the 4% Rule still holds true in today’s economy. But the question of whether 4% or 3% or 4.5% is the magic number for safe withdrawal rates doesn’t bother me.

What bothers me is the very premise: you gradually sell off your assets, hoping that you don’t run out of money before you die.

The FIRE Model for Retirement

In the old model, you save up a nest egg over a 40-year career, then you gradually spend it down in retirement.

In the FIRE model, you build a portfolio of income-producing assets, designed to keep generating income indefinitely. What I like to call “forever income.”

Because when you retire in your 30s or 40s, you may well live for another 50, 60, 70 years.

Examples of forever income include dividends from equities, rents from real estate, interest from private notes. For that matter, you can even sell off equities for income, if your withdrawal rate stays significantly lower than your portfolio’s growth rate. (But that means you still need other sources of income, so you don’t need to sell anything during corrections and crashes.)

The goal with FIRE is to be able to live off of the income from your investments, from here to eternity. A nest egg that keeps on growing, the gift that keeps on giving.

Don’t get me wrong, I love equities. They offer easy diversification and historically high growth. But it’s rare for dividends to pay more than 2-3%, which is why I love rental properties for ongoing income.

Rental Income: Cash Purchase

Here’s how the math breaks down for rental income, compared to the 4% Rule.

But to run the numbers, we need to make some assumptions. First, we’re going to assume that you buy properties that rent for 1.5% of the purchase price (e.g. you buy a property for $100,000, that rents for $1,500/month). Some investors only buy properties that rent for 2% of the purchase price, others prefer properties that rent around 1% of the purchase price; for our purposes, we’re assuming 1.5%. (Yes, these deals exist, even if not in your expensive coastal market!)

Our next assumption is that your non-mortgage expenses will total around half of the rent. But in reality, landlords can lower their expenses through better property management.

So, your $100,000 property that rents for $1,500/month will net you $750/month, after insurance, property taxes, vacancies, repairs, maintenance, property management fees, etc. Which in turn comes out to $9,000/year in income: a 9% return. (You can play with the numbers using our free rental property calculator.)

Fair disclosure: it takes work to find good deals on rental properties. It’s not like buying an index fund with the click of a button.

At these numbers, it takes about $450,000 worth of rental properties to generate $40,000 in annual passive income. If that sounds like a lot of money, consider that it would have taken $1,000,000 to generate $40,000 using the 4% Rule.

And you would have had to gradually sell off your assets to achieve it. Not so with rental income.

Rental Income: Financed Purchase

What if you use leverage to buy rental properties? Borrow other people’s money to build your portfolio?

The math changes once again.

We’ll need to add a few other assumptions here. Let’s assume a 20% down payment on the loans, and a 6% interest rate.

A $100,000 rental property would thus require a $20,000 down payment, and a quick crunch with the rental property calculator reveals you’d lose $479.64 to the mortgage payment each month. So instead of netting $750/month on it, you’d net around $270/month, or $3,240/year.

Working backward here, if every $20,000 you invest nets you $3,240/year, you’re now looking at an impressive 16.2% cash-on-cash return.

Does the risk also rise along with the returns? Sure. You’ve taken on a debt obligation, in order to accelerate your investments. But there are ways to mitigate that risk, such as setting aside half the rent in a savings account to cover those expenses that we budgeted for above.

The bottom line is that the retirement math changed again. To generate $40,000 in annual rental income, you’d need to put down around $246,900 in down payments. 

That’s less than a quarter of the $1,000,000 nest egg you would have had to save up with the 4% Rule. In other words, four times easier to retire with real estate investments than stocks and bonds alone.

Pros, Cons, & Caveats

There are a million ways to complicate the conversation above.

“What about interest compounding Brian?” or “I can’t buy rental properties in my area that rent for 1.5% of the purchase price!” or “But I can invest in equities in a tax-deferred account!”

To which I would reply “Returns are returns – you can compound rental income returns by reinvesting them,” and “Then invest outside your home market,” and “You can buy real estate in tax-deferred accounts, and even if you don’t, it comes with plenty of juicy tax benefits.”

And so on, and so forth.

Which is not to say rental investing is without its downsides. It requires some education and skill to do profitably. Each investment requires a significant amount of cash (unlike equities, which you can buy with $100 if you like).

It also takes work to find good deals, and it takes work to manage the properties (if you don’t hire a property manager).

But real estate boasts some unique advantages, too. Rents adjust for inflation automatically, unlike returns on bonds or equities. (In fact, rents are one of the largest drivers of inflation.)

Real estate almost always appreciates in the long term. Even while it generates rental income, month in and month out.

Perhaps best of all, the returns are predictable with a simple rental property calculator. You know the purchase price. You know the rent you can charge. And while you may not know when the next repair bill will come, you know how much repair costs will average in the long term.

Join me on the journey to reach FIRE. And consider using real estate as the vehicle for your journey.

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