If You Want To Retire Early, Invest In Rental Properties

If you’re pursuing financial independence and early retirement, you’ve probably heard about the 4% Rule: When you’re calculating whether your investment portfolio will cover your cost of living, assume a 4 per cent withdrawal rate.

CampfireFinance has a good summary of why the 4% Rule works, at least in theory:

The 4% Rule is based on two financial averages.

First, the 4 Per cent Rule says that your stock portfolio will grow at an average rate of 7% annually. Second, because the average rate of inflation is 3%, you can safely withdraw 4% of that growth, leaving 3% behind to keep up with inflation.

Because you’re only spending the average incremental growth from your portfolio, in theory you should never run out of money.

However, Paula Pant at Afford Anything has done the maths — and if you invest in rental properties, you’ll be able to withdraw 6% instead of 4. This means you’ll get a bigger monthly payout after retirement, and you might even be able to retire earlier than you expected.

Here’s how she explains it:

If you’re retiring on index funds, you might plan your retirement on the 4 per cent withdrawal rule.

But if you’re retiring on rental properties, you could use the equivalent to a 6 per cent withdrawal rule.

This holds true even if total returns on the two investments are the same.

Why? Two reasons: (1) the returns on a rental property bias towards an income stream rather than capital appreciation, and (2) rental properties don’t hold the same risk of withdrawing the principal.

Her full post covers why rental properties bring in more cash flow than index funds, why rentals are lower-risk investments than equities, and how you can get started with rental properties even if you don’t have a lot of money to invest. (Spoiler alert: look for single-family homes in the Midwest. They’re still affordable!)

If you’ve started investing in rental properties as a way to create passive income and/or retire early, let us know if you think the 6% Rule is accurate—and whether we should all start buying up rentals in addition to putting our money in the stock market.


Comments

    Wow, what amazingly bad advice. It is so, so, bad. Unless you want a great way to lose $230,000 in the first year.

    Whilst the article's advice might make sense in a real economy (i.e. only one found in a text book), in Australia's real estate bubble it is the recipe for penury (good word, look it up ;-) )

    A real estate portfolio of $1M would be one, perhaps two, properties in Australia's epic real estate bubble. That portfolio would yield ~$4k per month, gross. That's $48,000 per year, or a ~5% return. Gross. Before costs like...

    Financing costs. Assuming 20% deposit, 5% pa loan. -4% (per year, reducing)
    Real estate agent costs. -2% (first year)
    Transaction costs. Stamp duty, conveyancing, etc. -4% (first year)
    Maintenance, rate, and insurance. -3% (per year)

    So the first year is a cost of $130,000 (-13%) on the $1M real estate portfolio. Assuming the costs were financed from the loan, after one year you've turned $200,000 cash (the deposit) into $70,000 equity and a $930,000 loan being paid off at $5,000 per month.

    THE COST OF THE INVESTMENT IS MORE THAN THE GROSS RETURN
    ($4k per month rent vs $5k per month expense.)

    INCLUDING THAT REAL ESTATE VALUES ACROSS THE COUNTRY ARE FALLING (down 10% nation-wide, down over 18% in Perth):

    You have turned $200,000 (the deposit) into $930,000 of debt against a portfolio worth $900,000 (the $1M less 10%).

    YOU HAVE LOST $230,000 IN THE FIRST YEAR! Let that sink in, $230,000 gone.

    This advice is so bad

    Inflation is actually ~0 at present, so you're getting a lot more than 4% in either case.

    The entire theory is useless as it’s all based on the 1% rule which is impossible in Australia even in the current property market..

    You buy rental properties that meet the one percent rule, which states that the gross monthly income must be at least one percent of the initial purchase price. This means that your $1 million rental investment brings you $10,000 per month in gross rent, mortgage-free

    Tell me a property you can buy for $500k that generates $5k/month in rent.

    LOL talk about a completely tone-deaf localisation of a US article. Gotta be a new low.

    Plus, the above is not even vaguely an accurate summary of the 4% “rule”. The fundamental point of that study was to show that doing your calculations based on average returns is actually a great way to fail.

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