How To Retire Early by Investing in Real Estate

If given the option, the vast majority of Americans would choose to retire early. Of course, doing so is challenging. Most of us need more financial resources to achieve this dream. Early retirement means having access to regular cash flow, stable income-generating assets, and the ability to manage those assets to allow early retirement.

The good news? With a properly structured portfolio, such retirement is possible. Real estate investing can potentially enable someone to retire early. Indeed, many real estate investors start to purchase real estate and rental properties with this explicit goal in mind. Rental income can be an ideal form of passive income, enabling someone to generate the cash flow they need to support their lifestyle, particularly as they get older, thus allowing them to achieve financial independence and early retirement. 

How Do I Calculate My Retirement Number

You can use a few different formulas to calculate your retirement number depending on your invested assets. All of them are based on your estimated annual expenses.

Determine Your Retirement Expenses

A good starting point for estimating retirement expenses for most people is to use their current annual costs.

Of course, this number will change as you get closer to retirement (hopefully decreasing as you pay off debt and other obligations).

But for now, using your current spending as a guide will give you a general idea of how much you’ll need to spend in the future. Your everyday spending should be easy to calculate, depending on the budget templates. Please look at your entire monthly expenses and multiply them by 12.

Estimate Real Estate Income

Investing in real estate makes your retirement income calculation more straightforward.

After subtracting all your operating expenses, including capital reserves, the income from the real estate should match your expected retirement spending. Since rents in real estate usually keep pace with inflation, rent increases would ideally protect your spending power in retirement.

Of course, evaluating a rental property and managing one is a full-time activity. Although IRS classifies rental property as passive income, any landlord can tell you it is far from passive.

To be clear, achieving financial independence through ownership of rental properties takes work. However, there are ways anyone can get involved in real estate investing.

How Many Rental Units Do You Need To Retire Early With Real Estate

Let us start with some basic assumptions to calculate the units and capital needed roughly.

1. Your living expenses in retirement are $40,000 annually, so you would need at least that much cash flow after accounting for all possible costs, including capital reserves.
2. If you buy a property that meets the 1% rule of rental properties, a $100,000 property will generate $1,000 in rent. Of course, the rent is not the income since one needs to subtract expenses.
3. Per the 50% rule, you can expect a $500 profit on the unit, resulting in a $6,000 annual income.
4. Based on the above calculation, you would need $40,000/$6,000 or approximately seven such units to survive on your rental income.
5. With a 25% down payment typically needed for rental properties, you should have $25,000*7 = $175,000 saved for a down payment.

In reality, obtaining properties meeting the 1% rule is challenging. Also, individuals must have excellent credit scores to qualify for the best mortgage rates. But at a high level, these numbers indicate how fiscally responsible individuals can get started on their early retirement journey.

While it may seem stressful and, in fact, not advisable to buy seven rental properties at one time, investors can start slow and begin to scale up. House hacking by purchasing a duplex or fourplex can provide the training wheels for managing rental properties.

Types of Real Estate Investing

Besides rental properties, individuals can consider a mix of different types of real estate investing, especially when looking to get started investing in real estate with little to no money.

Real estate investing takes multiple potential forms, enabling the development of real estate strategies to provide you with critical retirement income.

Active Real Estate

First, many investors choose to purchase properties, improve them, and sell them. This process – house flipping – requires more work and active investment. However, house flipping has become a popular way of taking, improving, and selling property.

House flipping is a time-tested vehicle, but not one that is without significant risks: If a flip goes wrong, you could potentially lose all of your investment. Like all other real estate investing strategies, you must be cautious when spending your money. If your goal is retiring early with real estate, you must ensure you protect your nest egg above all else.

The type of house flipping you do ultimately depends on your level of expertise and comfort. Some investors are incredibly hands-on, actively selecting properties to buy and doing their work in house improvements.

An advantage of learning to flip houses is that you can leverage the skills for a live-in flip, also known as the BRRRR strategy.

Traditional Rental Properties

Another common strategy for a real estate investor is to buy a home with the express purpose of turning it into a rental property. It can be a great way of generating cash flow and passive real estate income. It also allows you to generate money further to expand your real estate portfolio at a later date. 

Again, managing rental properties requires real expertise. Successful real estate investors have developed systems that allow them to screen and select suitable investment properties for future investments properly. They can either learn the basics of being a landlord or outsource to a property manager.

Rental properties can generate monthly cash flow and monthly income, thus becoming a critical component in your effort to obtain financial freedom. You can use the rental income money that you generate to retire early, achieve financial independence, or buy more properties. Furthermore, real estate is an asset that typically appreciates. Capital appreciation means you should be able to sell your real estate for additional income later.

In many cases, individuals can invest in properties themselves or with others. You can turn these properties into profitable rental units. However, managing a rental unit can be problematic in the best circumstances: You must collect rent and utilities, pay bills, manage damages, handle contracts, and more. Real estate investors often turn to a real estate management company for assistance. These management firms have the expertise and experience to manage your real estate portfolio. However, they charge for this service, cutting your profit margins. Don’t let the management of rental properties hold you back from getting started.

Turnkey properties are another option, especially if the numbers are unfavorable in your local markets. For example, I have never found a property meeting the 1% rule in the San Francisco Bay Area. Long-distance investing is gaining popularity since good deals are more challenging to find locally.

Airbnb and other short-term rentals can be a different strategy to obtain higher rents than a long-term rental property. Pay attention to local regulations, which are constantly turning unfavorable towards short-term rentals.

Paper Real Estate Investments

Many investors prefer to lend their capital to investors and contractors using hard money lending with the explicit understanding that they will get a return on investment.

Risks of Real Estate Investing

It is challenging to generate enough passive income from real estate investing to be able to retire early. It can be done, but there are severe risks when investing in real estate. Risk-free investment is impossible. Instead, it would help if you concentrated on understanding the risks, how to mitigate them, and what you can do to minimize your risks wherever possible.

Lack of Liquidity

One of the primary risks of buying property is that you cannot unload it when needed. Real estate is a famously illiquid investment. This means that you may have a very difficult time selling the property. Even in the best-case scenarios, it can take months to prep a property for sale, list it, sell it, and access the money.

Renting a property can offset these risks, as renting a property should mean you get a stable stream of income from the property. Still, there is no guarantee that this will happen: A renter may stop paying rent and force you to proceed with a costly eviction. 

Worsening Neighborhood

This specific risk has a cousin: You may not be able to sell or rent your property. It is always possible that you purchase a property in an undesirable neighborhood or a neighborhood that rapidly becomes less desirable. In these cases, you may have difficulty selling or renting your property.

It can be tough to predict when it will occur. The only proper way to mitigate this risk is by doing your due diligence into a rental property, researching it thoroughly, and ensuring that you are buying property in a neighborhood that is improving.

Loss of Property

There is also the risk of losing the property in general. A fire, natural disaster, or other damage can render the property uninhabitable and potentially cause you to lose all your investments in this property.

Fortunately, affordable insurance is usually available to offset this risk and ensure you are repaid if something catastrophic happens to your property. However, you must make sure that you purchase adequate insurance to cover your loss. You will also need to do your due diligence and ensure that you regularly inspect the property, manage any risks, and adequately care for the property. 

Changing Macro Conditions

Then there are broader, economic-wide concerns. For example, many states made evictions illegal during the height of the pandemic, dramatically and negatively impacting the cash flow of millions of landlords. The commercial real estate market still needs to recover. It may never come back, forcing a significant change in the real estate market and fundamentally altering how people do business and establish cap rates.

It was, of course, completely impossible to predict a pandemic hitting the country and even harder to predict how that pandemic would impact real estate markets. This illuminates a fundamental point: Some risks cannot be predicted. The best way to manage investment risk is to diversify your holdings as much as possible. 

Governmental Overreach

Lately, the government in the U.S. has made evictions harder even if tenants stop paying rent. Also, the increased rent control regulations without limits on expenses, including property taxes, means landlords might lose money.

Tax Considerations of Real Estate

Like most investments, income made from a real estate investment – either through a sale or real estate rentals – does count as taxable income. As such, you must consider the real estate investments you make in the context of how they will impact your taxes. This also means you need to understand how to structure your assets to minimize the taxes you pay.

First, you must understand that owning a real estate property means paying more taxes. There may be taxes on rental income and property taxes you have to will have to pay. Often, these property tax considerations can alter an investment or rental decision, as individuals interested in investing in real estate or renting a property will try to invest in areas where taxes are low. Rental property taxes are criteria for determining the best states for real estate investors.

Selling a property can also result in a tax hit. There will likely be a local real estate transfer tax of some type. There may also be a capital gains tax if you sell the property for more than a cost basis. The good news is that most real estate investors can utilize strategies such as 1031 exchanges to defer tax payments.

You can also use real estate for tax advantages, and in many cases, a real estate investment can be more tax efficient. Real estate property always depreciates, and this depreciation can allow you to reduce your tax bill over time.

Real Estate Investing Alternatives

Even the most experienced real estate investors know that real estate investing is a complicated business. It pays to consider alternative strategies that can allow you to diversify your portfolio while also still gaining the benefits of real estate investing without actually owning property. 

Real Estate Investment Trust

The most effective way to invest in real estate without managing your investments is to invest with real estate investment trusts or REITs. A REIT is a specific type of business that acts as a real estate holding and management company. A REIT will handle all aspects of real estate investments: They manage properties, handle rentals, scout for properties, and more. REITs are professionally staffed organizations that experienced real estate managers run. If you want to learn about real estate when getting paid, consider a career in real estate investment trusts.

As an investor, you can buy a REIT ETF or mutual funds. REIT stock can be purchased or sold on any stock exchange medium, enabling you to invest in REITs. You can then buy and sell REIT stock as you wish. However, the most significant advantage of REITs is their dividends.

REITs are structured in a way that gives them certain tax advantages. In exchange, REITs have to give out the vast majority of their profits in the form of dividends. These extremely high dividends represent a fantastic opportunity to generate cash, particularly for retirees, and are often the best dividend aristocrats.

You can also find REITs that are structured in a way that best suits your needs. For example, some REITs are geared around specific locations or industry types, like residential or commercial real estate. If you want to get granular, you can find REITs that invest in particular properties, like malls, timber, cellphone towers, data centers, etc.

REITs allow you to invest in real estate without ever doing any “hard” work for the investment. You can generate regular cash flow and potentially have stock that appreciates. However, like any other investment, there is always a risk: The health of a REIT and the dividend a REIT generates is never guaranteed. Like any other real estate investment, you must do your due diligence and ensure that the REIT meets your needs.

Real Estate Crowdfunding

Real estate crowdfunding provides opportunities for investors to get involved with commercial properties. Crowdfunding allows several investors to pool their money and buy a real estate investment property with the contributed pool.

Crowdfunding for real estate investors is a way to diversify their investments and own multiple properties with less risk than if they were doing it alone. The process gives individual investors access to the real estate market without owning, financing, or managing properties.

Is Retiring Early With Real Estate Investments Possible

There are several paths to early retirement. Starting a business is the best way to become a billionaire. Investing in alternative assets is another route for savvy investors with a high average net worth. Several individuals got rich based on perfectly timing their cryptocurrency investments.

But real estate and investing in stocks are the popular methods with a shorter learning curve and are easily accessible to all individuals. We have compared 401(k) v/s real estate investing with actual numbers so you can decide based on your circumstances.

So, where does this leave you? Are you ready to make the leap and attempt to become an experienced real estate investor? As you can see, there are many positives to doing so: Real estate investors can generate a steady cash flow, buy a property that appreciates, and ultimately consider retiring early with real estate holdings to support their income. Of course, this investment area has significant risks and many questions for the potential early retiree. 

How many properties do you want to invest in? 

How much money do you have to make this investment? 

Have you developed a step-by-step strategy to make this dream a reality?

These are all fundamental questions that you have to consider for your financial future. Like anything else, a potential investment in real estate requires time, due diligence, and an examination of alternatives, like REITs or real estate syndication. There is not necessarily a wrong answer on how to invest – make sure you conduct the necessary research to protect your financial goals as much as possible.