How to retire with less than 200,000€ in investments

If you have read any financial independence/ early retirement blogs, you’re sure to have come across the 4% rule where they state that once you can invest 25 times your projected annual living expenses, you can safely withdraw 4% per year with a very low likelihood of running out of money after 30 years. Looking at the average national spending of 20,000€/person, this would mean you’d need 500,000€/person invested in order to withdraw the 4% but what if there was a way to achieve the same result with just 197,000€?

In another post, I looked at how owning and renting out a property usually results in negative monthly/annual cashflow as while the rent pays down your mortgage, you have to pay tax on the principal being paid off even though you don’t realise that pay off until you sell the property, and that’s IF you don’t lose property value BUT I have now found a way that gets you positive cashflow which you can use to pay your living expenses OR build up another downpayment for another property. How? By using an interest only mortgage.

Now I normally wouldn’t have considered using one of these, especially not for my primary residence BUT it does makes sense for an investment from which you want regular income and that’s because 100% of the mortgage interest is tax deductible which effectively gives you 30% more of a return than if you were to go with a traditional mortgage. See details below:

Interest only mortgage option

Assumptions:

• Property value: 200,000
• Borrowed amount: 140,000 (70% loan to value)
• Interest only rate: 5.25% (available through this lender)
• Rental Yield: 1,450€/month or 17,400€/year (annual rent is 8.7% of the purchase price)

Initial investment: 65,600€

• Downpayment: 60,000
• Stamp duty: 2,000
• Solicitor: 2,000
• Valuation: 150
• Engineer: 450
• Furniture: 1,000 (assuming second hand purchases, may be a bit ambitious)

Annual Costs: 9,152€ (includes mortgage, tenant board, home insurance, life insurance, repairs, refuse and property tax)

Tax Deductibles: 8,482€ (includes all of the above excluding property tax)

Profit after tax deductions: 8,648€ (17,400 – 8,752)

Income tax (assuming 33% net rate): 2,854€

Annual take-home: 5,394€

If you manage to find and buy three of these type properties while still working your take home comes to 16,182€ but if you quit regular employment and only rely on the income from the properties your income tax band drops to 18.6% and your net take-home comes to 19,918€ which is close to the national average of annual spending.

Risks

Of course no investment comes without its risks but I do think this particular model is quite risky. To name a few:

• Non diverse, if something goes wrong with the property, like some natural disaster not covered by insurance hits and your capital asset is wiped out
• Rental market could fluctuate. If another recession hits as hard as the last one, rents will have to go down if people can’t afford the current rates wiping out your returns and possibly resulting in negative cash flow
• Managing tenants, potential months where property is left vacant or tenants don’t pay rent
• It’s hard to find a rent ready property for 200,000 that would rent for as much as 1,450/month
• One major repair could cause you to lose a full year or more of income
• Managing a property is hard work and so income is not passive, which could be hard to maintain while you are still working and building up your portfolio
• It’s an interest only mortgage which means you are not paying off any equity in addition to your initial 30%. I’m not sure what that means if you go to sell the property, if there is a capital gain, do you split the profit with the bank? Also not sure how this works if you sell at a loss?

It’s for all of these reasons that even though I personally could potentially retire in the next 3 years using this technique, I would rather work a few more years and invest in the stock market where I could truly get passive income which is well diversified but I thought I’d share the idea in case others who have a higher risk tolerance (or aren’t as lazy) would benefit from it.

Traditional mortgage

But how does a traditional mortgage stack up? Using the same assumptions except that you could get a 4.8% 25 year investor mortgage, and your overall profit would be 10.9% compared to 10.12%, your annual take home would be 36% less at 4,248€ once your income tax rate was down to 18.6%. During your accumulation phase your take home would only be 2,912€ compared to the 5,394€ with the interest only mortgage (56% less) BUT the added benefit is that the principal of the mortgage is being paid off so you are delaying your returns, and as the principal is paid down, your interest also decreases which further reduces your take home over time as you will be paying higher taxes on the principal which the rent is covering.

Other options

There is another option we’ve considered and that was to convert our attic into a 1 bedroom apartment for say 60,000€ and rent it out for 1,000€/month including utilities. This would come to 12,000€/year which you can claim tax free under the rent-a-room scheme. This would be a continual annual 20% return on the initial investment which would pay for itself in 5 years and then every year thereafter would be net profit.

The downsides to that approach are that you’d need to live with someone else, even if they had their own living quarters, you would share an entrance and have noise considerations etc which isn’t something we are prepared to contend with even though it could technically mean I would have the vast majority of my living expenses covered as soon as the renovation was complete and the space rented out.

Also, the renovations may be tricky as there are a lot of codes you need to comply with when converting your attic into a habitable space.

But again, I thought I’d share the idea here in case it does suit other readers. Or maybe your property could be extended to create a granny flat (as long as the addition is attached to your residence it is eligible for the rent-a-room relief).

What about less expensive properties?

What if you could find cheaper properties with lower rents? For example you buy a property in Longford for 70,000€ with initial outlays of 24,000€ and rent it out for 680€/month (annual rent = 9.7% of purchase price), you would need to buy 7 properties to achieve the same take home as the initial example for a total investment of 168,000€. While this is 29,000€ less than the first example, it would require maintaining 4 additional properties.

What about more expensive properties?

What if you buy something more expensive which you get you higher rents? For example Dublin City Centre where the average house price is now 400,000€ and average rents are 2,000€, you would need 4 properties instead of 3 to achieve the same take home, and your total investment would need to be 518,400€ – which means you would definitely be better of investing in the stock market and getting well diversified passive income without all the hassle of managing numerous properties.

The happy medium

If you could find a rent ready house/apartment for 225,000€ and rent it out for 1,875/month, you would only need 2 properties for one person to retire or 4 properties for a couple to retire. Maybe the guide is that if buying an investment property your annual rent should be at lease 10% of the purchase price?

Alternatively you could buy 2 properties and have one person stay home while having their expenses covered while the other person continues to work and invest in the stock market as a means to diversify your portfolio OR you both continue to work and invest together until you have a portfolio big enough for you both to retire.

What about cash purchase?

If you had a lump sum of 200,000€ for the first example, your return on investment would be 6.05% instead of 10.12% and it would take 2 properties for you to obtain the same level of income for a total investment of 400,000€, so again if you had that kind of money it would be better off put in the stock market so you don’t have all the risks and hassles of owning and managing properties.

What about house flipping?

If you are in any way a handy man/woman, flipping houses might be an option for you though I haven’t looked into the rules in Ireland around this yet. In Canada for example you need to live in a house for 3 years before you can sell it in order to be exempt from capital gains tax (this was brought in because so many people were flipping houses and the government was losing too much money).

Check out this video for some inspiration on buying expensive properties in high cost areas and turning them around to make a profit.

Anyway, even though these are not options we are currently considering ourselves, I thought I’d share it as I did the number crunching for my own purposes and hopefully it’s some food for thought for some other investors out there.

Would love to hear your thoughts and any other outside the box thinking you have considered for your investments!