The Money Mustache Community

Learning, Sharing, and Teaching => Investor Alley => Topic started by: GoCubsGo on February 06, 2019, 02:11:39 PM

Title: How to factor rental income into withdrawal %
Post by: GoCubsGo on February 06, 2019, 02:11:39 PM
I'm suffering from a case of not being able to see the forest through the trees and am a little confused on something. 

I currently own rentals that throw off $15K/year in income.  I also receive about $25K/year in dividends and interest from my equity portfolio.   I am shooting for a retirement budget of roughly $100K/year.  That leaves me with having to draw $60k/year from principle (right?).

If I multiply $60K x 25, I'll need $1.5 million.  I've had the number of $2.5 million needed in my head for a 4% SWR (25x$100K).  I haven't really figured out how to factor in the rental portion (and haven't included SS).  I've run fireCalc awhile back but I'm not sure I accounted for the rentals properly.

Once the mortgages are paid off on the rentals, they should bring in over half the yearly retirement spend plus the dividend income should keep growing. 

Trying to figure out a potential exit plan and I feel like I'm missing something or not thinking of my rental income correctly.  Any thoughts would be appreciated.
Title: Re: How to factor rental income into withdrawal %
Post by: neo von retorch on February 06, 2019, 02:21:57 PM
At the simplest level, put aside liquid investments (aka equity portfolio).

All ongoing income (after "retirement") = X
All expenses (household + rental + fun! + taxes on rental/equity income) = Y
Y - X = Z (total annual expenses you must pay for)

25 * Z = nest egg aka equity portfolio (both dividends and interest will come from this nest egg)

If you spend $100k including rental property expenses and taxes but the rental income is $15k/year, then you've got $85k to cover. Multiply by 25 and you're at $2.125m.

You cannot count the dividends/interest from the equity portfolio and then try to apply the 4% rule.
Title: Re: How to factor rental income into withdrawal %
Post by: Travis on February 06, 2019, 03:47:08 PM
And you can't really count the rents alone as satisfying your FIRE needs unless it's profit after all landlord expenses or your rental expenses are part of your FIRE number.
Title: Re: How to factor rental income into withdrawal %
Post by: MustacheAndaHalf on February 06, 2019, 09:50:54 PM
Speaking as someone who doesn't own rental property, I would take a first cut at your situation by doing this:

current rents minus rental expenses = $15k/year
same, but after mortgages paid off = ??/year
when will the mortgages be paid off = ?? number of years

If the mortgages are paid off before retirement, then you're looking at the second number rather than $15k/year.  Or if they are midway between those two, I'd just average the two numbers together to get a rough idea.  You can't predict your equity returns for the next decade, so any estimates down to the penny are going to be wrong anyways.  So I'd just get a rough idea of the situation at retirement.

If your interest income will be significant, keep tax-exempt bonds in mind for your retirement portfolio.
Title: Re: How to factor rental income into withdrawal %
Post by: neo von retorch on February 07, 2019, 07:05:48 AM
Here's how I handle a mortgage that will be going away...

At time of retirement, expenses excluding mortgage payments but including real estate insurance (homeowners, landlord), income and property taxes, rental management/maintenance, etc = X

All mortgage balances at time of retirement = Y

Nest egg must be enough to pay off all mortgages, and be 25x ongoing expenses in retirement

So nest egg Z = 25X + Y

Then, of course, if the mortgage is a low interest rate, I don't actually pay it off, but I know my nest egg is big enough to support it.
Title: Re: How to factor rental income into withdrawal %
Post by: Another Reader on February 07, 2019, 07:54:42 AM
Track your net operating income after all expenses, including capital improvements, for several years.  Track how much the rents increase annually, how much you spend on taxes, insurance, HOA's, repairs and maintenance, and capital improvements and how much these increase.  Figure out how long the properties are vacant, and your collection loss.  Include a management expense, even if you manage the units yourself, as you may not in the future.

Once you have a handle on this, you can project some averages into the future.  You cannot predict when you will have to make capital improvements, when rents will go up or down, and what your vacancy will be.  Estimate income and expense, and grow them at a reasonable rate.

The net income, which is smoothed, is what you use in your calculations of what you need from other sources. 

If you have mortgages, subtract the principal and interest from the net income for those years you will have the mortgages.  You may need more income from other sources in the early years if you retire before the mortgages are paid.  For example, you may have $20,000 a year in debt service for 5 years after you retire, and $10,000 for another five years.  You may need some padding early on to cover that.

How I would handle Social Security would depend on your age and how many years you estimate you will pay in.  A 25 percent haircut in benefits in 2034 is a common assumption if you are under 50.

Remember, everything is an estimate.  Precision to the extent reasonable is useful, but your precision may exceed your accuracy when you predict the future.
Title: Re: How to factor rental income into withdrawal %
Post by: GoCubsGo on February 07, 2019, 01:31:51 PM
Thanks all for commenting.  I've been a landlord for 15 years so the current $15K in net income is a smoothed out number which includes all expenses including taxes and insurance and an estimated yearly capital projects budget (the homes have had major renovations in the past 4 years but I still include a number as an expense). Obviously that number grows the minute the mortgages are retired.  I'll do a spreadsheet to work that out.

I guess my error was counting the $25K a year in interest and dividends as income and thus reducing the amount of liquid equity position I need to have. 

I'm potentially within 5 years of FIRE and I need to tighten up my projections  so that I don't work 10 years because I wasn't valuing all my investments properly.   I also have $400K in home equity that currently isn't included in any calculations .  It may make sense to use that equity for another cash flowing rental property.