One rental property can provide a nice little boost to your earnings. But once you start seeing that extra income coming in each month, it’s only natural to start thinking bigger.
For many property investors, building a portfolio that generates enough income for them to give up their 9-5 is the ultimate goal. Although property management isn’t as passive as it used to be, the prospect of investing in enough property to become financially independent is certainly appealing.
But before you start drafting your resignation letter, there are some important numbers to crunch. There’s a big difference between earning a bit of extra cash from one or two properties and building a portfolio that can reliably replace your wage and support your living costs.
So, how much rental income do you realistically need, and how many properties would it take to generate this figure?
In this article, we’ll explain the expenses you need to factor into your calculations, how to work out the net income you require, and how many properties you might need to quit your 9-5 safely.
How Much Rental Profit Do You Need to Replace Your Salary?
There is no universal answer to this question, because everyone has different financial needs.
To get a rough idea of how much you might need to earn, look at how much income you’re currently taking home after tax and consider how much you realistically need to live the life you want or are accustomed to. The figure you arrive at will be completely personal to you and your lifestyle.
Once you’ve established your target income, you can start working backwards to calculate how much profit your property portfolio needs to generate, and roughly how many rental properties you might need.
But before you begin, you need to understand how much profit your existing properties are really generating once all expenses have been deducted.
Gross Rental Income vs Net Cash Flow: What’s the Difference?
There are two key figures you need to pay attention to when figuring out how much money you’re making from a rental property.
- Gross rental income; That’s the amount of income your property is generating before expenses.
- Net cash flow; The amount of rental income you have left after you’ve deducted all your property’s ongoing expenses and finance payments.
The difference between these two figures can be surprisingly big. Your gross rental income may look great on paper, but once you’ve deducted mortgage costs, insurance, letting agent fees, and maintenance expenses, it could be a whole different story.
If you’d like your property portfolio to eventually replace your salary, don’t get overexcited and quit your job as soon as your gross rental income meets or exceeds your salary; it’s your net cash flow that matters.
Rental Property Expenses to Include in Your Calculations
The costs of running a growing property portfolio can quickly add up and eat into your rental income. When calculating whether your portfolio could eventually replace your salary, it’s very important to make sure your projections account for both current and future expenses. Some costs will increase as your portfolio grows, and others can fluctuate significantly from year to year.
Your calculations should account for:
| Expense | What to consider |
|---|---|
| Mortgage costs | If your rental property is mortgaged, mortgage payments could take a significant percentage of your rental income. Remember that your mortgage rate is unlikely to stay the same forever. Consider how your mortgage payments may change if a fixed-rate deal ends or interest rates change. |
| Insurance | Allow for premiums across your whole portfolio, including any additional cover you require. |
| Maintenance and repairs | Don’t base your calculations on an inexpensive year. Even if your properties are in great condition, make sure you’ve set aside a budget for routine maintenance jobs and larger unexpected repairs across your portfolio. |
| Void periods | Don’t assume your properties will generate rent 12 months a year. There will invariably be times when one or more are empty or can’t be let. During these void periods, your other costs will continue, so you need to build a void allowance into your calculations. |
| Letting and management fees | Even if you don’t plan to use a letting or management service from the start, you may find you need to outsource some of the work as your portfolio grows. |
| Compliance and licensing costs | Property management is now more heavily regulated than ever before, so make sure you put aside money to help you meet all applicable legal fees and licensing costs. |
| Accountancy and software | Allow for any additional professional support or software you may need as your portfolio grows. |
How Is Rental Income Taxed?
Even after deducting expenses, you still won’t know how much profit you can pocket until you’ve calculated how much tax is due.
If you own your rental properties personally, your rental profit usually forms part of your taxable income. When calculating your taxable profit, make sure you deduct all allowable expenses so that you don’t end up overpaying on tax.
Common allowable expenses include:
- Letting agent and property management fees.
- General maintenance and repairs.
- Certain travel costs.
- Landlord insurance.
- Professional fees.
Mortgage interest is treated differently; you cannot usually deduct it as an allowable expense. However, you may instead be able to claim a basic-rate tax reduction for qualifying finance costs.
The rate at which you pay income tax depends on your total taxable income once you’ve factored in your salary, rental profit, and any other sources of taxable income. This means that some people may find that their property income pushes them up into a higher tax band whilst they’re still employed.
However, your tax position could change if you leave employment, don’t forget to consider how this could change things when calculating whether you could live on your rental income alone.
Tax on Rental Properties Owned Through a Limited Company
If you own your rental properties through a limited company, tax rules are different. The company usually pays Corporation Tax on its profits. There may also be personal tax to pay when you take money out of the company, depending on how you do so.
Make sure that you never base your decision on whether to leave your job on pre-tax figures alone. The amount of tax due can have a huge impact on how much rental income is actually available to you.
Understanding exactly what each property costs to run is much easier when your accounts are up to date. PaTMa’s Property Manager helps you record income and expenses and keep track of your portfolio’s financial performance.
Before leaving your job, it can be useful to get personalised advice from an accountant or tax adviser to make sure you understand your portfolio’s tax position and how it could change if you left employment.
How Many Rental Properties Would You Need to Quit Your Job?
So, now it’s time to answer the burning question: “How many rental properties do I need before I can quit my day job?” Unfortunately, the answer is not always simple.
However, once you know how much income you need to live on and have a realistic idea of how much profit your rental properties will generate on average, you’re one step closer to figuring it out.
Bear in mind that there are a couple of important factors that will influence the answer to this question:
-
Your mortgage position: Landlords who own property outright will have lower expenses and could potentially generate significantly more monthly profit; meaning they may require far fewer properties to reach their income goal.
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How profitable each property is: Properties with different purchase prices, achievable rents and running costs can produce very different returns. Therefore, landlords with high-performing properties may need fewer properties to reach their target income.
The best way to calculate how many properties you may need before giving up work becomes a realistic option is to work backwards, starting with your target annual income.
Your calculation would look something like this:
Target annual income ÷ average annual after-tax cash flow per property = approximate number of properties required.
So, if you want to earn £30,000 a year in spendable rental income and you expect each property to generate, on average, £5,000 a year after costs and tax, you would need approximately six properties.
This is, of course, the simplified version. You’ll also need to consider your tax position, how your costs may change as your portfolio grows, and build in a comfortable financial buffer (for both portfolio and personal expenses).
Is Your Rental Income Reliable Enough to Give Up Work?
Quitting your 9-5 is a huge decision, and as exciting as the prospect may be, it’s important not to take the leap until you’ve done your due diligence.
Even if the numbers look good on paper, there are a few things left to do and consider before you hand in your notice. In particular, you need to have peace of mind that your finances are resilient enough to cope when things don’t go quite to plan.
Stress-Test Your Rental Income
Your figures may look great when based on your expected rental income and costs, but the rental market can be unpredictable, and circumstances can change. You need to know that your figures will still hold up if things don’t go to plan before you can rely on it as your main source of income.
Think about whether your portfolio would still provide enough income if:
- Interest rates and mortgage rates increase.
- One or more properties were empty for several months.
- You had to pay for a major unexpected repair.
Before you say goodbye to a reliable salary, you need to have confidence that your portfolio could still cover your living costs under less favourable circumstances.
Build an Emergency Fund Before Leaving Employment
As well as building some wiggle room into your calculations, it’s also wise to have a financial safety net in place before leaving your job.
An emergency fund can help you cover unexpected costs; either portfolio or personal, providing you with greater financial security and peace of mind.
Manage and Grow Your Property Portfolio With PaTMa
PaTMa’s Deal Finder tool helps you research property investments and assess their potential returns.
With Deal Finder, you can research potential investments and create customised financial forecasts to understand how a potential investment could perform financially; all from one central platform.
Deal Finder also provides access to useful property and local market data, including purchase and rental comparisons, planning applications, and licensing information.
And once your portfolio starts to grow, PaTMa’s Property Manager can help you track its ongoing performance and manage day-to-day compliance and accounting tasks.
Sign up for a free trial to find out more about how PaTMa’s Deal Finder can help you grow a profitable property portfolio.
