By Dr. Peter Kim of Passive Income MD, WCI Network Partner
Those of you who know me personally know that I’m a big fan of real estate investing. In fact, I think it's one of the best ways for physicians to achieve financial freedom.
The passive income provided by such investments can continue flowing for your entire life, and in fact, the best investments can actually be generational–extending well beyond your own lifetime. However, the biggest benefit of real estate investing is that it can start providing cash flow immediately, and you can begin replacing some of your income right away.
Is There a Foolproof Plan?
I’ll go ahead and say this at the outset: there is no perfect, magic formula for how many rental properties you need in order to retire, just like there’s no perfect, magic formula for how large your stock portfolio needs to be in order to retire.
Yes, there's the popular 4% rule, but in no way is that a guarantee either. There are just too many factors to consider. At the end of the day, all you can do is make a well-educated guess, use real current numbers, and look at both history and statistics.
In all of this, I'm making the assumption that you have absolutely no other source of income, including retirement portfolios, Social Security, and rich children to support you.
More information here:
Buy One Property a Year and Retire Early?
So, How Many Rental Properties Do You Need?
Personally, I like to follow the acronym K.I.S.S.—Keep It Simple, Stupid. This helps me come up with a very simple, completely attainable goal.
As far as answering the question of the day—How many rental properties do you need to retire?—here’s how I go about it:
- Figure out how much you need in retirement to cover your monthly expenses and enjoy life a little.
- Figure out how much monthly cash flow you get from a typical rental unit/property.
Using those two numbers, figuring out how many rental properties you need to retire is fairly simple. To do it, you’ll just need a couple of formulas:
- Monthly amount needed for retirement ÷ Cash flow per rental property = Number of rental properties you need
- Cash flow = Income – Expenses
For our purposes, income is mainly from rent paid for by your tenants. Expenses include the mortgage, interest, taxes, maintenance, vacancy, and a whole host of other things.
More information here:
How to Use Real Estate to Pay for College
An Example at Work
With all that in mind, let’s use an example. Imagine there’s a man looking to find out how many rental properties he needs in order to retire. In order to comfortably retire, he needs $8,000 per month to safely retire and have everything covered.
He’s been buying up a few rental properties, and he notices that he averages $200 per month in cash flow per rental unit. How many properties, then, does he need to retire? ($200 per unit is a very doable and conservative amount. I tend to see closer to $300 per unit in my own portfolio.)
$8,000 ÷ $200 (per rental unit) = 40 units
There you have it: a nice, concrete number to shoot for. If you buy a 10-unit building that provides $200 per unit in cash flow, that’s $2,000 for the building. You only need three more similar buildings to reach your $8,000 goal. Passive income now covers all of your expenses.
Now, I know what some of you smart folks are thinking. You’re thinking that this is ridiculously simplistic—and you’re right. I didn’t mention anything about rent increases, leverage, tax benefits, increasing expenses, etc.
But I can assure you that if you follow the rough formula and do end up with something like 40 units under your belt, you’ll have done something right. You’ll be very close to (or, more likely, way past) where you need to be to retire, and like our hypothetical real estate maven, you’ll be well on your way to retiring comfortably with passive income flowing freely into your accounts.
Have you thought about retiring and using passive income to offset the loss of your salary? How many rental properties would you need? Would you feel comfortable using my formula? Comment below!
We have 22 units that provide 100% of our living expenses plus “padding” (at least in good years!). We started in 2009, as a response to the financial crisis, deciding not to leave ALL our assets to the whim of the financial markets. We accumulated several single family homes, duplexes, 4-units, 7&8 units and one 11 unit for total 53 units. We plowed 100% of cash flow into improvements as ALL the buildings were more or less “distressed”. Staring in 2017 we began selling off, using the accumulated equity from debt paydown and appreciation to pay off mortgages on buildings we kept. At the “end” of our story we find we’re “taking home” 15-20% more with 22 units paid off vs. 53 units with 80% LTV mortgages.
I’ve always thought that by paying off your loans you are losing your number 1 deduction for tax purposes – the mortgage. Are you not seeing that?
If your mortgage is your biggest deduction, you’re doing it all wrong. I’ve got more deductions now than I ever had and I haven’t had a mortgage in years.
Besides, it still doesn’t make sense to pay a dollar to get $0.45 off your tax bill.
When investing in real estate, you don’t get a mortgage for the deduction, you get it so you can get the appreciation, amortization and a little income on 4 properties instead of just appreciation and income on one.
I should not have said the #1 deduction, as that is the depreciation on the property. I also believe you using your personal property deduction is an apples to oranges comparison when we are talking about what is essentially a commercial business.
But being someone that has ~30 SFH rental properties that are locked into mortgages that are currently far below Prime, why would I expedite paying those down?
I can’t go to the bank and borrow money for 4%, so why would rush to pay back money at that rate – which is ALSO tax deductible for my LLC?
Why would you deleverage? Because you don’t need to take that risk to reach your goals? Because you want more cash flow from fewer properties with fewer hassles? Lots of reasons. You don’t borrow money just because you can. Maybe you have the right amount of leverage right now. Maybe you don’t. I have no idea. Only you can know that.
I like this simple formula because the costs and benefits of owning these units might just about wash each other out. Ostensibly throughout retirement equity would be building and with a timely passing the heirs would receive the property with the step-up. I’d be interested in an alternative exit strategy which asked how many units would I need in order to soon pay off a core (smaller) portfolio of properties with cash flow less hampered by debt service.
This might be the least compelling case for owning individual rental properties that I have ever seen. As the author mentioned, he’s ignoring leverage, appreciation, etc. Even so, if an experienced RE investor like PIMD only gets close to flowing $300/month/unit then I know for me the juice will never be worth the squeeze. I don’t want to keep track of 40 mutual funds and ETFs, but that’s probably child’s play compared to staying on top of just 10 rental units.
I’ll bet paid off real estate does a lot better than $300/month/unit. Think about it:
Let’s say the place rents for $2K. 45% of that will go toward non-mortgage expenses. That leaves you $1,100 a month. Just 7-8 of those will give you lots of retirement income. You won’t experience a huge capital gain boon when the leveraged property appreciates, but your cash flow will be a lot better.
There are very few people managing 40 doors themselves. That’s a job, not a retirement income strategy.
I am a huge proponent of owning and operating real estate for the tax advantages, appreciation, cash flow and building generational wealth. However, it’s essential that you are well capitalized when owning rentals. In the past five years I experienced unexpected expenses that may crush an undercapitalized investor. I own six single family homes in Southern California, netting $120K/year in rental income. All properties are in tier one and two neighborhoods where rents are relatively high and only one property still has a loan. I’ve experienced three major plumbing leaks in that past five years that required $20-30K each in deconstruction and reconstruction cost. I did not submit claims to insurance companies as I know fellow investors who were dropped from their carriers due to placing three claims in the past five years. I only reserve insurance claims for catastrophic loss. Owning real estate has many rewards, but having a large reserve is critical to weather unexpected expenses.
Interesting that you had that experience in what most consider to be very good times for real estate investors. There will likely be much worse experiences for those doing so in the next 5 years when appreciation probably won’t be so good, and interest rates will probably be higher.
Excellent points though. When you need cash, nothing else will do.
I bought my first rental property when I was still in residency. I am a late career physician and at this point we own a significant portfolio of rental properties. Our RE equity is low 8-figures and our annual RE income is mid 6-figures, with minimal leverage left in the portfolio. We also maxed all of our tax deferred accounts by investing in low cost index funds, so we have a good balance of assets to carry us to the horizon.
I feel comfortable facing retirement with both stocks and plenty of cash flowing RE. We self manage a few properties, but the rest have professional management. The plan over the next decade is to step by step sell and 1031 exchange into more passive RE, and we have started down that road.
Nice work. You demonstrate what I think is an excellent, well-balanced approach. It mystifies me that more don’t adopt it.
Good luck finding 1031 exchanges. Probably better off hiring management and getting the step up in basis.
The passive RE syndications sometimes offer 1031 exchanges if you bring over 1 million to them. But you need to know the term of the investment to be sure you can avoid taxes when they sell.
Opportunity Zone Funds also an option.
Your article was quite thought provoking for me but not in the usual way. I was thinking do I want to stop working in medicine , what I trained so long for. Would I swap that to manage real estate? Managing just 10 units seems like a job to me. I would rather just work two shifts per month as an ER doc. That would satisfy my desires and my intellectual needs. What I discovered I wanted was not to retire from medicine but to de independent of medicine and not HAVE to work.
Help!!! I have $250k cash sitting in savings accounts. I also have past experience as a realtor and know the importance of owning RE. But I don’t know how to start as an investor. My goal would be enough properties to stop working and manage the RE instead. I’m 50 BTW. Where do I even start?
Generally start with education and figure out what kind of real estate investment you want. But your real estate investment activity needs to be part of your overall investment and really overall financial plan. You might consider taking the WCI online courses. First, Fire Your Financial Advisor and second No Hype Real Estate.