Author Topic: Factoring Rental Income and Real Estate into Asset calculations?  (Read 2692 times)

NewEnglandAl

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Hi all,

I'm new here and have been trying to find an answer to a question I had about what I'm calling the 25x rule (Yearly Expenses x 25 = Total you need to retire). I own a rental property that is making me some decent money and the property itself is appreciating nicely. In terms of the 25x rule, I was wondering how to factor these in. I was thinking I could subtract the yearly rental income from my yearly expenses and multiple that by 25 but I was unsure if I should then count the value of the property itself towards the total assets I need to retire.

In other words, I own a property worth $X, it earns (after taxes, expenses, etc) $Y per year, and my expenses are $Z per year. So the calculation I was doing was (Z-Y)x25 to get the total I need to retire (T) and then T-(X+rest of my assets) to figure out how much MORE I need to save. It occurs to me though that I might essentially be counting my rental property twice (the rental income to reduce expenses and the equity factored into my assets).

How do you suggest I apply the 25x rule factoring in the rental income and equity in the property? Thanks for the insight.

tct

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Re: Factoring Rental Income and Real Estate into Asset calculations?
« Reply #1 on: January 15, 2015, 09:40:45 AM »
If you understand where the "25x" rule comes from you easily answer this yourself. The "25x" rule, also know as the "4%" rule basically comes from the following: If you spend $25000 per year, you need to save 25000 x (25) = 625,000. The assumption is that your 625000 will grow at a 7% rate allowing you to draw 4% each year(forever) to pay your living expenses (625000 x (.04%)) = 25000. The other 3% accounts for inflation so that your stache will continue to grow and your 4% draw down will keep up with inflation.  Your rental property may return more or less than the assumed 7% in the scenario above. If the rent returns more than the 7% (compared to the current value of the house) then you may need less than 25x your spending. If the rental returns less than 7% you may need to save more than 25x your spending.

NewEnglandAl

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Re: Factoring Rental Income and Real Estate into Asset calculations?
« Reply #2 on: January 15, 2015, 10:23:49 AM »
Thanks for the insight, tct.

My understanding of the "25x"/"4%" is that you need to earn 7% while pulling out 4% in order to maintain the amount of principle after accounting for inflation. With a rental property, however, after the expenses involved in maintaining the property, rent does not reduce the "principle" and thus you wouldn't need to make 7% to adjust for inflation. That would then mean that a rental property would break even with the "25x"/"4%" if the rent earns 4% of its value. Is that right?

Assuming that's right, I thought I could subtract the rental income from my annual expenses for the "25x"/"4%" rule and then multiple my remaining expenses by 25. Does that make sense? Am I missing something? If that makes sense then I assume I should NOT factor the equity of the property into my asset calculation...right?

On top of the rental income, the property is also appreciating. How should I factor that in?

Thanks again.

arebelspy

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Re: Factoring Rental Income and Real Estate into Asset calculations?
« Reply #3 on: January 15, 2015, 11:30:37 AM »
Assuming that's right, I thought I could subtract the rental income from my annual expenses for the "25x"/"4%" rule and then multiple my remaining expenses by 25. Does that make sense? Am I missing something? If that makes sense then I assume I should NOT factor the equity of the property into my asset calculation...right?

That's all correct.

On top of the rental income, the property is also appreciating. How should I factor that in?

I wouldn't.  The property will appreciate, the rents will go up, and so with your expenses (both on the property and personal expenses).  They should all (roughly, over a long enough time period) track inflation.  So the real return will be 0, but you'll have an inflation adjusted income stream taking care of that portion of your expenses.

At any given time if it's appreciated more than expected you can reevaluate the available equity and see if it ought to be redeployed elsewhere.
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NewEnglandAl

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Re: Factoring Rental Income and Real Estate into Asset calculations?
« Reply #4 on: January 15, 2015, 11:59:03 AM »
Awesome. Thanks for answering my question so quickly. Much appreciated.