How many rental properties do I need to retire on?

Planning to retire one day?

Are rental properties part of your retirement plan?

For many Australians they are, yet will their rental properties be enough to provide a reasonable standard of living?

Research by the Australian Bureau of Statistics (ABS) in 1995 reported that 78% of rental property investors only own one property.

Will one property be enough to live on?

Short answer – NO WAY!

So how many rental properties will you need to own to retire on comfortably?

To answer this question, we first need to work out how much money a single rental property generates.

The Perth median rent is currently $395 per week, and the vacancy rate 5.6%.  Combine those two numbers and we get an annual income of $19,400.

Rental expenses that an average Perth property would incur are outlined in this table:

Rental Property Expenses
Item  Amount 
Council Rates  $     1,800
Insurance  $         900
Land Tax  $         500
Management fees  $     2,000
Pest control  $         200
Repairs & maintenance  $     1,500
Sundry expenses  $         300
Water Rates  $         800
Total Expenses  $     8,000

We are talking about cash flow here so I have not included the non-cash costs of depreciation, capital works allowance or borrowing cost amortisation.  Those items are extremely useful in managing taxable income, but less important for assessing cash flow in retirement.

Annual income of $19,400 less annual expenses of $8,000 gives us a cash income of $11,400 per year, or $950 per month.

How much money will you need in retirement?  ASIC has suggested that for a couple who own their own home, retire at 65 and live to 85, an amount of $34,216 will give a modest lifestyle while $59,160 is comfortable.  In rental property equivalent terms, three rental properties will give modesty and five to six properties comfort.

Rental Properties  Cashflow p.a. 
1  $              11,400
2  $              22,800
3  $              34,200
4  $              45,600
5  $              57,000
6  $              68,400
7  $              79,800
8  $              91,200
9  $            102,600
10  $            114,000

From the table above, three rental properties is the minimum that any home-owning couple will need for retirement purposes.  The net cash flow from three fully-owned rental properties of $34,200 is equivalent to:

  • ASIC’s ‘modest’ retirement indicator of $34,216;
  • Full aged pension for a couple of $34,382;
  • Minimum adult wage of $34,980;
  • $1 million earning 3.5% (yes that is higher than current bank rates and may not be easily achievable).

So at a minimum, a couple will need to own their own home and three debt-free rental properties to provide a modest retirement.  Five rental properties gets our couple very close to ASIC’s comfortable retirement.  Six or more houses and we can start to relax a little.

Please note that we have not included any expense here for capital replacement.  Repairs and maintenance cover the small ongoing maintenance costs but do not include major capital expenditure.  Some investors tend to forget that their house is slowly deteriorating and will ultimately be demolished.  Many investors try and play “pass the parcel” with their properties, and hope that some future owner will end up paying the bill for the roof replacement, deteriorating boundary fence or crumbling stumps.  Capital expenditure on residential properties tends to be lumpy, for example termites are discovered and a portion of the roof timbers need replacement.  But if we wanted to provide a long-term estimate of capital expenditure, simply get the replacement cost of the entire house and divide it by the anticipated life of a new house.  A new finished 4×2 home in Perth will cost around $240,000 and last for around 40 years.  A quick calculation gives $6,000 per year average capital cost, which will certainly eat into your free cash flow quickly.

Capital expenditure requirements are not uniform over time.  New houses will have very little money required to be spent on them, with many items in the property covered by warranty.  On the other hand, a house that is twenty plus years old may have suffered years of deferred maintenance, which some future owner will eventually have to pay.

Plan your portfolio to anticipate these capital expenditures.  Simple strategies include having your properties well-maintained during their lives rather than letting repair items build up and compound.  You might also develop a strategy of owning older houses and re-developing them when you are getting close to retirement, so that you have a portfolio of new houses at that time.

Our calculations so far have been about debt-free houses.  You can carry a lot more debt while working than when retired.  While you are working you are earning income from your occupation and paying income tax.  The negative-gearing loss induced by your rental property loans is offset against your employment income and results in a tax refund.

Effective Interest Rate on Housing Loans for Rental Property Investors by Marginal Tax Rate (including Medicare Levy)
Interest Rate Tax Rate for annual incomes over
$0 $18,200 $37,000 $80,000 $180,000
0% 21% 34.5% 39% 47%
4.0% 4.0% 3.2% 2.6% 2.4% 2.1%
5.0% 5.0% 4.0% 3.3% 3.0% 2.6%
6.0% 6.0% 4.7% 3.9% 3.7% 3.2%

For example, if you are working and earning over $80,000 per year, an interest rate of 5% only costs you 3% in after-tax dollars.  This enables you to carry higher levels of debt than you might otherwise choose to.  But once you are retired and the work income ceases, your interest rate is felt at its actual rate of 5.0%.  Suddenly your property portfolio is much more sensitive to interest rate increases and interruptions to income.  You will need to develop a plan for your property debt as you approach retirement.  Some options include converting any interest-only loans to principal and interest ten or more years prior to retirement; selling some properties and using the equity to repay debt, or using lump-sum superannuation payouts to make principal payments.  Each of these options has taxation implications and you should run the scenarios past an accountant experienced in property investment.

Can you go into retirement while still carrying debt on your rental properties?  Yes, as long as you have established both an equity and a cashflow buffer.  You need an equity buffer to allow you freedom of movement with your property decision making.  If you are highly-leveraged, an unexpected fall in house prices could restrict your ability to sell an individual property (as the remaining properties may have insufficient security value for the loans).  You will also need a cashflow buffer so that you are safe from rising interest rates, extended rental vacancies or capital expenditures (such as replacement of a roof or central air-conditioning system).

Note that in all but the most severe economic downturns you will be able to ride out a fall in house prices as long as your cashflow is positive so that you continue to make your loan repayments.  Remember that after retirement you will not have any wage or salary income to plug the gap from vacancies or expenses.  Some of the heaviest casualties in warfare occur during an unplanned retreat or rout.  In the same way, some of the biggest financial losses in property occur when owners are forced to sell during a downturn.  Ensure that you build the twin buffers of equity and cashflow so that you remain in control of your property portfolio and never have to take orders from others.  In the same way, protect your assets from external interference during absence or incapacity by having an enduring power of attorney nominating a trusted person registered at Landgate and a valid and current will.

In conclusion, you will need to own your own home plus at least three debt-free rental properties to have a modest retirement.  Beyond that point, each additional property will add to your comfort and when you have six or more rental properties you can start breathing easily.

Are three or more rental properties achievable?  Yes, but it is not easy.  A large debt-free rental property portfolio takes design, intention and hard work.  Most Australians do not get beyond one rental property.  But if you have made it through to the end of this article, you have the potential to do it.