5 Reasons Real Estate Is the Perfect Early Retirement Tool

by | BiggerPockets.com

“People are always blaming their circumstances for what they are. I don’t believe in circumstances. The people who get on in this world are the people who get up and look for the circumstances they want, and, if they can’t find them, make them.” George Bernard Shaw

Are you interested in retiring early? And by retiring, I don’t necessarily mean sitting around doing nothing or sipping piña coladas on the beach (although that’s cool for a while).

By retiring early, I mean removing the need for a nine-to-five job. I mean working on projects and on schedules you love, whether they pay enough or not. And ultimately, I mean spending only a few hours per month on real estate and the rest on whatever matters most to you.

This idea of early retirement has been my goal for a long time.

And a couple of years ago, at 36 years old, I finally hit it using real estate. To take advantage of that freedom, my wife, my two young kids, and I just spent 17 months living in Cuenca, Ecuador.

For us, language learning, cultural immersion, and lots of quality time together was the big motivation (i.e. the why) for early retirement. For you, it could be something else. As long as your why motivates you, that’s awesome!

But whatever your reason for early retirement, it turns out that real estate is the perfect tool to get you there. I’ll show you five reasons why in the rest of this article.

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1. Beautiful, Dependable, Monthly Income

Income is the core benefit of real estate investing. Even the worst rentals I own produce more income than equivalent amounts of money in other assets like stocks or bonds.

For example, on July 9, 2018, the dividend rate of the S&P 500 (a group of major stocks) was 1.83 percent. And the interest yield of a 10-year Treasury bond on the same date was 2.86 percent.

But in the right markets, I often see unleveraged (no debt) income returns of 5 percent to 10 percent with rental properties — even after paying all expenses (including a property manager). And with safe, long-term leverage (if you choose to do that) you can sometimes see those income returns double to 10 percent, to 20 percent, or more.

For early retirees who want to live off investment income, these differences in income matter A LOT!

For example, here’s a chart comparing actual yearly income (pretax) for an S&P 500 index fund, 10-year US Treasury bonds, and an unleveraged rental property with a 7 percent income yield. It assumes you invest $500,000 in each asset type.

Asset Type Income Yield Income/Year for $500,000
S&P 500 Index Fund 1.83% $9,150
10-Year Treasury Bond 2.86% $14,300
Unleveraged Rental Property 7% $35,000

That’s a huge difference! Which would you prefer to live on: $35,000 or $9,000?

And yes, I understand stock equity investors can sell appreciated shares and live off the principal. But which is safer in a volatile, bubbly investing environment like 2018? Eating into your principal or never touching it?

I’ve made my choice. You’re here reading on BiggerPockets, so I bet you have too.

Related: Retirement Might Be Closer Than You Think—If You Do These Two Things

2. Control — You Make a Difference in Your Success

Now that I’ve beat up on stocks and bonds, let me also say that they can make great investments as well. In particular, owning a low-cost index fund of the entire stock market is likely to do very well over the long run.

But when you’re first building your wealth to retire early, real estate has a clear advantage over more passive investments.

Real Estate Gives You More Control

I have a theory that we real estate investors are all secretly (or not so secretly) control freaks. We need to be involved. We like jumping in, getting our hands dirty, and influencing the success of our investments.

Luckily, getting personally involved is what real estate is all about.

Your best deals will happen when you use your skills and hustle to find deals below value. You’ll increase your wealth dramatically when you improve properties to increase rents. And when you manage properties well on the back-end, you control your income stream for years.

So, it’s not only possible to influence your real estate investments, it’s imperative!

What about an index fund? You only control when you buy, reinvest your dividends, and sell. The managers and employees of the companies you own control your success.

Neither choice is wrong. Some people like 100 percent passive index investments. I actually like them, too, as a diversification tool.

But early retirees get another aspect of control from real estate: timing.

3. Timing — Waiting on Passive Stock Markets Isn’t Necessary

Real estate gives you more control over the timing of your wealth building. As an aspiring early retiree, you probably have a target date for your financial independence (FI). And I’m willing to bet the date is sooner rather than later!

So, how do you reach your target date on time? By ensuring that your investments grow at the right pace.

With non-real estate investing like stock indexes, the core growth of your portfolio depends on appreciation of prices. This growth of stocks has been steady over the long run, but it tends to be extremely volatile (i.e. goes up and down) over the short run.

A sudden short-term drop in stock prices can delay or destroy your target FI date as an early retiree.

Real estate investing, on the other hand, gives you two very predictable core growth levers:

  1. Positive rental income
  2. Debt amortization (paydown)

While nothing is guaranteed in the investment world, rental income on quality properties is typically stable. As the charts below show, even during the 2008 – 2010 U.S. housing crisis, rents held steady, or only slightly decreased, in most U.S. markets. And this happened while housing prices themselves plummeted.

Related: 3 Feasible Ways to Escape a Soul-Crushing Job, Reclaim Free Time or Retire Early

These past trends do not guarantee the same result with rental rates in the future. And the national trend doesn’t mean rental rates won’t go down in your specific location. Rents are very closely tied to local rates of income and other supply-and-demand factors, so those will ultimately determine your rates.

But the main point is that real estate rental income doesn’t always correlate with the prices of assets. And that’s helpful when you’re quickly building an early retirement portfolio.

The second real estate growth lever, debt amortization, is both built into your mortgage payment and something you can accelerate. The Rental Debt Snowball Plan, which I discuss in detail in the book Retire Early With Real Estate, is a powerful example of this.

With a debt snowball, you can apply extra savings to pay your mortgages off in seven to 10 years instead of 30. And with paid off mortgages, you reduce your risk and increase your income just in time for an early retirement.

4. The Tax Code Loves Real Estate Investors

Politics and changing winds of public opinion can alter tax policy in a heartbeat. For example, the 2017 GOP tax bill changed many tax rules (although many real estate benefits were mostly left in place). So, you can’t ever count on any particular tax benefit to last forever.

But, I see tax benefits as icing on an already good real-estate-investing cake. Here are eight sugary tax-frosting benefits that we get as real estate investors:

Rental Income

Unlike income from your job, rental income is not subject to social security or medicare taxes (a.k.a. FICA taxes). In 2018, for example, this could save you between 7.65 percent (employee salary) to 15.3 percent (self-employed earnings). On $100,000, that’s $7,650 to $15,300 per year!

Depreciation

The U.S. government requires real estate investors to spread out most of the cost of real estate purchases over 27.5 years (for residential buildings). This creates what’s called a depreciation expense, which can shelter or protect your rental income from taxes and reduce your tax bill.

Keep in mind, however, that what the IRS giveth, the IRS taketh away. When you sell a rental property, it’s very likely that you’ll have to recapture the depreciation and pay taxes on it. And the tax rate on this recaptured real estate depreciation is typically 25 percent (as of 2018).

This is why investors often say depreciation comes back to bite you. It’s also why many investors use a 1031 tax-free exchange, which I’ll discuss next.

1031 Tax Free Exchanges

Named after section 1031 of the U.S. tax code, this technique allows you to trade one property for another without paying taxes — if you follow the IRS rules. This tax-free sale allows you to grow and compound gains without the drag of taxes. Properly and strategically using a 1031 exchange can make you millions.

Capital Gains

Gains on long-term investments (held over 12 months) are usually taxed at lower rates than comparable earnings from a job. For example, as of 2018, the long-term capital gains rates are between 0 percent and 20 percent, depending on your overall tax bracket.

So, if you plan well, you can strategically sell long-term properties to capture gains with lower effective tax rates. And for high earners, even the highest capital gains rates can be better than taxes on ordinary income from a job.

Live-In Flips

Living in a fixer-upper house (a live-in flip) can be a huge tax benefit if you move in immediately after the purchase and live in the house for two years or more. In this situation, tax law in the U.S. allows between $250,000 (individuals) to $500,000 (couples filing jointly) of tax-free profit when you resell.

I need to repeat that for emphasis. TAX-FREE PROFIT.

This rule is probably the best deal in the entire tax code. And BiggerPockets’ own Mindy Jensen and her husband have used live-in flips better than anyone I know. You can learn all about it in this podcast episode.

Borrowing is Tax-Free

You only pay a capital gains tax when you sell a property. So, if you decide to refinance and pull out some of your equity, you can use all of the money tax-free.

Of course, this increases your property expenses and you have to pay the money back. But this can be a helpful strategy to use the wealth in your properties as you need. I actually plan to do this with two rentals to help pay for my two kids’ college expenses.

Self-Directed Retirement Accounts

You probably know about the tax benefits of 401K and IRA plans, but you might not know that you can invest these in real estate and other alternative assets like private mortgage loans. This means any income or gains you make from the real estate are tax-deferred or tax free (depending on the retirement account type).

Of course, there are many very strict rules you must abide by. But learning how to invest in a self-directed retirement account is worth your time.

Die With Real Estate (Seriously!)

Death itself is not exactly a good strategy. But dying with real estate can be a big tax advantage for your heirs.

Instead of facing capital gains and recaptured depreciation taxes like you would, your heirs will get what’s called a “stepped-up basis.” This means their basis for taxes is reset when you die. So, if they immediately resell, they’ll pay no tax.

Keep in mind, however, that inherited assets are still subject to estate taxes. But there tends to be a large estate tax exemption (in 2018 there is an exemption for anything below a base of $10 million). The actual amount and limit of estate taxes seems to change with every new political administration. So certainly keep an eye on it.

5. Real Estate Is Simple and Understandable

I’m a big fan of Warren Buffett, and I like to study his lessons. And one of his primary investment tenets is to only buy assets that are simple and understandable.

For this reason, I choose to invest primarily in residential real estate. Compared to most other investments, residential properties are very intuitive and easy to understand.

Why?

Because ordinary people live in residential units. They want things like safety, convenience, comfort, affordability, style, and good school districts. When you shop for a residence, you probably look for the same things.

Real estate is also a “real” asset. It’s tangible. In the right locations, ever-rising construction costs and salaries buoy real estate values.

Housing also doesn’t easily go out of style or get replaced by the latest technology. People just remodel instead of abandoning the property.

People will still be living in homes long after you and I are gone. And that makes me very comfortable depending on real estate as a safe early retirement investment.

Is Real Estate Your Early Retirement Tool?

The great French Marshall Lyautey once asked his gardener to plant a tree. The gardener objected that the tree was slow growing and would not reach maturity for 100 years. The Marshall replied, ‘In that case, there is no time to lose; plant it this afternoon!’ John F. Kennedy, 35th president of U.S. (1917 – 1963)

Have I convinced you that real estate is the perfect early retirement tool? Obviously, I’m biased! It’s worked for me and the 25 early retirees I profiled in my upcoming book Retire Early With Real Estate.

For those of you already investing, I hope you’ll be encouraged and keep climbing toward your early retirement goals.

And if you’re just starting, it’s always a good time to begin climbing toward early retirement. Build your knowledge and your network here on BiggerPockets, and start looking to plant that first real estate seed!

Do you have a goal to retire early? What does that mean for you?

And why do you choose real estate to help you get there? Share below!

About Author

Chad Carson

Chad Carson invests in Clemson, South Carolina. He also writes at coachcarson.com about using real estate investing to retire early & do what matters. For practical advice each week — join his free newsletter at coachcarson.com/newsletter.

21 Comments

  1. Christopher Smith

    Good Points:

    I’m in the process of what you describe right now.

    Bought into the housing crises in the 2010 – 2013 time frame with about 1.2 in capital East Bay CA. Timing was very fortuitous and properties are now at 3.1 and kick off about 110k cash annually, and at least twice that in appreciation. Plus they are all professionally managed, so its truly a passive revenue stream.

    Probably won’t consider retiring for another 10 to 15 years, but I could do it now if I had to do so. I’m kind of locked in to the properties now because of the massive tax burden if I sold them (probably wouldn’t 1031 unless the opportunities were really compelling).

    However, not really a problem because I’m good holding what I have until I die collecting close to 10k a month cash flow, and having the entire gain disappear at death. I do have various other sources of income, but it’s very reassuring that I have a healthy and growing rental income stream waiting for me when I do decide to hang it up.

    • Chad Carson

      Wow, sounds like you’re in good shape. Congrats! And thank you for sharing your story. Solid income + solid appreciation … not sure you need to change much as long as that meets your needs. You check a lot of needs off with your portfolio.

  2. Joseph Walsh

    Good Article, however I wish the Author wouldn’t of went the “worst case” scenario for dividend stocks in the comparison, it wasn’t needed IF one is investing specifically to live off of dividends, the money will be in high-yield options with significantly stable history. That said, the amounts are still in the 4-5% dividend range. However, one would think that if you planned to live off of investments, part of the plan would be to sell and recapture some of the appreciation gains. S&P 500 historically returns over 10% over any 20 year period. The example could of used that number, and frankly, real estate is still the superior choice, for all of the same arguments.

    • Chad Carson

      Joseph, I used the current S&P 500 dividend yield. Hardly a worst case choice since that’s the average of the 500 biggest companies in the market. And plenty of big companies (Berkshire, etc) don’t pay dividends. But I agree you could do better with a dividend growth strategy. I actually like that approach a lot.

      As to selling off equities, the sequence of returns risk is a big concern. Historical returns of 10% don’t necessarily mean you or I would get 10% at the time we need to sell. And if we experience a prolonged downturn right after we start drawing down (i.e. selling some of our equities) we could run out of money. That’s why dividend income or real estate income is very relevant.

      This blog author (also an economist) has done a good job researching and explaining the challenges of the sequence of return risk: https://earlyretirementnow.com/2017/12/13/the-ultimate-guide-to-safe-withdrawal-rates-part-22-endogenous-retirement-timing/

  3. Cindy Larsen

    Fantastic article Chad!

    I have learned a lot from your articles over the years. You present ideas and strategies very clearly, and this article is a great summary of a lot of important concepts. Since I’ve been studying real estate investing for 5 years now, and been a landlord for 4 years, I was already aware of the ideas and strategies you discussed above. Even so, I am definitely going to buy your book. If there is even one additional thing I learn from it about how to maximize my retirement wealth, your book will be worth the price.

    I am already on my way to early retirement, having purchased 6 tax parcels with 16 units on them this year. I also own one additional parcel with two units on it. Taking into account purchase prices, all mortgages, and that I own two of the parcels outright, my Amount Owed/Purchase Price ratio is currently 55%. I have a Debt Snowball plan in place, paying off the highest interest loan first.

    I also round up the mortgage payment on each property to the nearest $100 from day one. Paying extra at the start of a mortgage can save you tens of thousands over a 30 year mortgage, so even my lowest interest rate mortgage @ 3.75%, the last one I will pay off, will be paid down significantly in the next ten years. If it ever happens that interest rates go down, (I’m not holding my breath) I can consider refinancing one or more of my outstanding mortgages so I can lower my payment(s) and accelerate my debt snowball even more.

    Leverage has great tax benefits, but what people don’t talk about is, even if you are in the 35% tax bracket (so you can deduct 35% of the mortgage interest you are paying), you are still paying the whole mortgage payment, which is mostly interest, and you never get the interest you pay back. if you don’t pay off the mortgage early, the total of the interest payments over the life of the loan is almost as much as you originally borrowed. Those interest payments are cash invested with zero return.

    Example: Buy a $300,000 property with 25% down. You borrow $225,000 at 5% for 30 years.
    Monthly payments: $1,207.85
    principal paid off over 30 years = $225,000
    Money invested in paying interest over 30 years = $209,825.51
    Tax deduction @ 35% bracket over 30 years = $73, 438.93
    Cost of borrowing $225,000 after tax deduction taken = $136,386.58
    Money lost to interest = 60% of amount borrowed

    On the other hand, investing extra $ to pay down a 5% mortgage, is equivalent to investing those extra $ at a 5% guaranteed return for the next 30 years, and there is no tax on that 5% return. So, paying the 5% mortgage down by $1000 means that your tax deduction goes down by $17.50 per year. But the interest you are NOT paying on that $1000 is $50/year.
    So paying down the mortgage is definitely a win.

    The main benefit of leverage is not that you can deduct the interest from your rental income. It is that it allows you to buy more properties, or buy better properties that you could not otherwise afford to buy.

    Financial advisors recommend, as you approach retirement, to allocate your funds to a mix of stocks and bonds, because, even though bond interest rates are incrediy low, they are not volitile like stocks. Instead, I think it makes a lot more sense to invest in real estate. You can define your returns when you buy because you can determine your income and expenses. If the property cash flows when you buy it with a mortgage, it is very likely to cash flow better later. Even at a 2% inflation rate, and a conservative assumption that your expenses and rents go up 2%, one of the advantages to having a mortgage is that your mortgage expense does NOT increase. So, as rents increase the mortgage payment is a slghtly smaller percentage of the rental income each year. Which means you have more $ to spend paying down the highest interest rate mortgage.

    And when you pay off a mortgage, the cash flow increases by the total amount of the mortgage payment. And then you can use that extra cash flow to pay down the next mortgage. I love the Debt Snowball.

    Another way of thinking about buying properties with a mortgage is, for each property whose mortgage you pay off, the income you will receive in retirement is:

    retirement income =
    Initial cash flow + initial mortgage payment + increase in rental income – increase in espenses

    So the minumum retirement income a property will bring in is already determined when you buy it.
    If the intial cash flow is $100/month and the mortgage is $1000/ month then, when the property is paid off, the cash flow should be at least $1100/month.

    Of course you can increase this retirement income by increasing rental income and/or decreasing expenses. Forcing appreciation by remodeling the property to improve its rents results in additional expenses up front. But if you invest in upgrades that are durable (ie. they stand up to renters kids and pets) then, long term, your expenses will be less and your rents higher.

    Another consideration about paying off mortgages is depreciation. After you pay off the mortgage, you can still depreciate the property (up until you have owned it 27.5 years). This is a tax deduction worth about 4% of the purchase price of each property, every year. Which increases your effective retirement income, since you are paying less taxes. If you pay a property off before you retire, that additional cash flow from depreciation can be used to increase payments on the mortgage of the next highest interest rate mortgage.

    For my money, real estate is the best retirement investment.

    • Chad Carson

      Wow, what a thorough explanation Cindy! Thank you. I particularly like this point:

      “So the minumum retirement income a property will bring in is already determined when you buy it.”

      That predictability is a big deal when you’re depending upon your portfolio. And I’m with you on your point about debt pay down. In a way, paying off mortgages is the equivalent of traditional investors owning bonds alongside equities. It’s a more conservative choice that reduces volatility and risk.

      Thanks for buying the book! Hopefully you’re find a few nuggets in there even with your current progress. I provided several chapters specifically about post-retirement strategies for maximizing life-time income.

  4. Jeremy G.

    I just purchased my first 3 unit multi family property for $171000 i occupy one of the units i rent one of the units for $866/month and the other for $996/month. My mortgage is 1503/month 30 year FHA mortgage. I purchased this property with the hopes that that i can rid myself of student loan debt, buy more multi family properties to replace my full time employment income and retire early… I am forced to live in the property for 4 years due to the NHHFA grant i received to cover the down payment if i move within 4 years i have to pay back the 5 grand they gave me. How can i accelerate my ability to buy another property quickly? I also need to try to refinance at some point to get rid of the PMI but that will prohibit me from buying another property im assuming

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