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pull cord sooner rather than later?
Old 07-26-2006, 03:06 AM   #1
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pull cord sooner rather than later?

I've taken a closer look at the balance sheet and budget needs for ER and wanted to run it by the group.* I've received a lot of good info and advice since first posting in Dec 05 and wanted to get feedback on most recent financial situation.* This is sort of an updated "Hello I am..." post.*

I've determined that the lowest I'd like to go in terms of after-tax cash flow is $4500/mo.* Assuming a tax rate of 18%, that would require just under 66k annually pre-tax.* I'm erring on the high side on the tax rate because the bulk of my cash flow would be from rental income.* Even with depreciation write-offs, tax rate would be higher than living off of dividends and cap gains.

Repositioned rental propty equity (after >200k in commissions/selling costs* :P)would be 900k.
Cash 275k
Home equity (after commisions/selling costs) 375k
401k/ESOP* 355k

Here's what I would execute in a year or less:
1.* Sell rental properties and 1031 into "cash cows" yielding 6.5%
* * *900k * 0.065 = 58,500/yr
2.* Sell personal residence, relocate to cheaper area, buy house for 250k cash.* *
* * *375k - 250k = 125k
3.* Invest extra 125k in diversified portfolio (this is new thinking for me, ie not putting it back into real estate, see what you've done!)
* * *125k * 0.04 = 5k/yr
4.* Keep 100k in cash as a buffer.* Put remaining 175k to work.
* * *175k * 0.04 = 6800/yr or put it in RE investmt 175k * 0.065 = 11,050/yr

Depending on how the 175k was invested annual cash flow would be 70,300/yr or 74,550/yr.* Even though the real estate might have a higher yield I do see the value in diversifying away from RE and into a portfolio with a 4% SWR.

I would prefer to roll the 401k/ESOP money into and IRA and keep hands off.* My estimate of annual withdrawals from a 72(t) is 9600/yr.

Using 18% tax rate, cash flow (w/o 72t) would be in the neighborhood of 5k/mo, slightly higher than my minimum requirement.*

Wild cards:* finding reasonable health insurance, keeping rental income ahead of inflation, relocating from San Diego to less expensive area, having a big enough buffer.

Is it time to pull the cord?

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Re: pull cord sooner rather than later?
Old 07-26-2006, 04:28 AM   #2
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Re: pull cord sooner rather than later?

How/where do you propose to find relatively risk-free rental properties that will net you 6.5%?

Is 900k after you've discounted the price of your rentals so that they would sell in this market (i.e. 5%-10% under the comps)?

The two kinds of rentals I know of that can touch 6.5% returns are commercial properties and low-income houses. Commercial properties I don't consider to be risk-free. Low-income houses at less than 80k a pop means you would end up with a whole bunch (900k/80k) of them, each filled with less than desirable tenants. Under this plan it sounds like you would be a "professional land lord" but not 100% retired. What happens if you have a few months vacancy on one or more of the rentals? Tenants who cause a few thousand in damages and then skip town?

You may be able to use a 1031 from the rentals to purchase your new primary residence (as a "rental"), which would reduce your tax burden. You could 1031 some other portion of the profit into one or two easy to maintain rentals (which would probably net you 4.5%, not 6.5%). Then you could take the entire amount from the sale of the home you currently live in, tax-free, and invest it outside of RE, for diversification.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 07:01 AM   #3
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by califdreamer

I've determined that the lowest I'd like to go in terms of after-tax cash flow is $4500/mo. Assuming a tax rate of 18%, that would require just under 66k annually pre-tax.

Here's what I would execute in a year or less:
1. Sell rental properties and 1031 into "cash cows" yielding 6.5%
900k * 0.065 = 58,500/yr
What do you mean by "cash cows" some sort of bond fund? 6.5% may give you $58,500 in today's dollars but you will be in trouble 10-15 years down the road due to inflation. You need a balanced portfolio and ~4% at start to be historically safe.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 07:02 AM   #4
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by macdaddy
How/where do you propose to find relatively risk-free rental properties that will net you 6.5%?
I'd imagine you could relatively easily fine triple net leases that would yield that much.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 08:16 AM   #5
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by brewer12345
I'd imagine you could relatively easily fine triple net leases that would yield that much.
I agree commercial rentals can be lucrative, however the risk is that they take longer and are harder to rent, and tenants have been known to declare bankruptcy. I'm not sure I would be comfortable depending on one or two commercial properties for the vast majority (900k * 0.065 = 58,500/yr) of my retirement income.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 01:51 PM   #6
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Re: pull cord sooner rather than later?

Thanks for feedback.

Quote:
Originally Posted by macdaddy
How/where do you propose to find relatively risk-free rental properties that will net you 6.5%?
I usually invest in Class B apartment buildings with a partner or two so we can buy a large enough propty to warrant using a professional propty mgr.* We do a little research and look for what we think are the best mkts to invest in.* For instance, there's no way we could get a 6.5% yield by buying in CA now.* Better to go elsewhere.* There are many apartment building markets that did not experience increase in values during the boom and are good investments now IMHO.*

Quote:
Originally Posted by macdaddy
Is 900k after you've discounted the price of your rentals so that they would sell in this market (i.e. 5%-10% under the comps)?
I keep abreast of propty values and believe I have appraised them fairly.* None of the properites are single family houses BTW.

Quote:
Originally Posted by macdaddy
The two kinds of rentals I know of that can touch 6.5% returns are commercial properties and low-income houses.
I do have a commercial propty in the mix.* It did fine but I would exchange it into an apt bldg rather than another propty of its type.* I have no interest in single family dwellings as investments.*

Quote:
Originally Posted by macdaddy
You may be able to use a 1031 from the rentals to purchase your new primary residence (as a "rental"), which would reduce your tax burden.
This is an interesting idea.* It seems in the past I've looked at ways to incorporate the use of a 1031 exchange using the residence and their was a problem with it.* I'll look into it again.

Quote:
Originally Posted by donheff
What do you mean by "cash cows" some sort of bond fund?
Bad choice of words on my part.* By "cash cow" I meant a real estate investment that would throw enough cash to give me a 6.5% yield.* One of the challenges of depending on RE rental income is making sure you keep pace w/ inflation.

Quote:
Originally Posted by brewer12345
I'd imagine you could relatively easily fine triple net leases that would yield that much.
I've seen some NNN real estate deals that purport to yield 7.5%, etc.* As macdaddy pointed out, there are risks involved.* I would probably keep my focus on crummy old apt bldgs.* My favorite.

Quote:
Originally Posted by macdaddy
How/where do you propose to find relatively risk-free rental properties that will net you 6.5%?
Back to the first question, here were my assumptions:
1.* Buy apt bldg with 50% down payment
2.* Finance 50% with 30 year loan at a rate of 7%.
3.* Buy a bldg with a 7.25 CAP rate
4.* Working thru the #s, that would yield a cash-on-cash return of 6.52%.





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Re: pull cord sooner rather than later?
Old 07-26-2006, 02:05 PM   #7
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Re: pull cord sooner rather than later?

dreamer, could you talk a bit about the kind of property you usually buy and where you find them? How many units? How do you make sure you don't get killed in the deal? What does a property manager cost?
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Re: pull cord sooner rather than later?
Old 07-26-2006, 04:34 PM   #8
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Re: pull cord sooner rather than later?

It looks to me like you have a lot of exposure for a crappy return.* You're talking about a business, not an investment, and 6 percent and change for a business is just not worth it.* You have the worst of both worlds: huge downside risk, and very modest return.* Just stay in cash if this is the best you can come up with.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 04:43 PM   #9
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by Cransten
It looks to me like you have a lot of exposure for a crappy return.* You're talking about a business, not an investment, and 6 percent and change for a business is just not worth it.* You have the worst of both worlds: huge downside risk, and very modest return.* Just stay in cash if this is the best you can come up with.
He might have to roll it to RE or else pay some pretty crippling cap gains and depreciation recapture taxes.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 04:49 PM   #10
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Re: pull cord sooner rather than later?

The apartment idea sounds pretty good to me as long as you find good management and have a good handle on expenses.

I looked at a REIT that specializes in class B apartment buildings (UDR), and they yield 4.6%, so you're basically getting 2% for taking on more risk.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 05:56 PM   #11
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by Cransten
It looks to me like you have a lot of exposure for a crappy return. You're talking about a business, not an investment, and 6 percent and change for a business is just not worth it. You have the worst of both worlds: huge downside risk, and very modest return. Just stay in cash if this is the best you can come up with.
Dreamer, you may have more experience in these kinds of investments than I do, but let me play devil's advocate. Let's say you sink the money into a 100-200 unit complex in the midwest, which is the kind I am familiar with. You could probably see a cash on cash return of around 7%. But what happens if vacancies increase? What happens if a tenant is injured and sues? What happens if major capital repairs are necessary and not covered by insurance? What happens if the manager quits? Or worse, steals money from the business?

I don't think the extra couple % is worth this risk. Even so, if this represented 10% of your income stream, it may be tolerable. But you want it to represent nearly 80% of your income stream. Can you sleep at night under those conditions? I know I would have trouble.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 06:37 PM   #12
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by macdaddy
Let's say you sink the money into a 100-200 unit complex in the midwest, which is the kind I am familiar with. You could probably see a cash on cash return of around 7%. But what happens if vacancies increase? What happens if a tenant is injured and sues? What happens if major capital repairs are necessary and not covered by insurance? What happens if the manager quits? Or worse, steals money from the business?

When you buy you need to assume a certain vacancy rate. You get good insurance to cover injuries. You do your due diligence and inspections to figure out a capital budget for capital improvements needed in the next few years. You hire a professional management company that is bonded. You read the financial statements they provide you.

The worst rental property we ever invested in did not cash flow enough to do distributions to owner investors. There was a fire (covered by insurance), a number of units were out of commission for a period of time and new tenants were nervous about moving in. After repairs and getting the occupancy rate back up, our managing partner sold the property. We held the property for about three years and made about 30%. So even bad wasn't that bad. In retrospect, our managing partner probably should have held on to the property.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 06:46 PM   #13
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Re: pull cord sooner rather than later?

Martha:

Would you mind discussing the apartment deal ? Was it a tennants in common (TIC) arrangement ?

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Re: pull cord sooner rather than later?
Old 07-26-2006, 06:53 PM   #14
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Re: pull cord sooner rather than later?

No. I don't do TICs.

We are investors in several limited liability companies where there is a managing member (another LLC) and investor members. Although we have invested in several different LLCs, basically the same people are all involved. A former lawyer in our firm decided he wanted to make a lot of money and would do so by purchasing apartment buildings for the best price possible, improving management, and then selling the properties. He is the best negotiator I have ever know. He makes CFB look like a CFB. A bunch of his lawyer friends and former clients became investors in his deals.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 06:59 PM   #15
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Re: pull cord sooner rather than later?

Martha:

From your point of view what is the upside of a LLC over a TIC deal ?

Is it knowing the management and the other players ? Or is the structure of the LLC itself ?
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Re: pull cord sooner rather than later?
Old 07-26-2006, 07:13 PM   #16
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Re: pull cord sooner rather than later?

Keep in mind it's been hard to go wrong in real estate in the last 10 years. It will be much harder the next 10 years. I have done really well but wouldn't project results from the past 10 years out to the next 10. Now, I assume that appreciation will follow inflation and buy only for the cash flow.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 07:34 PM   #17
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Re: pull cord sooner rather than later?

"You may be able to use a 1031 from the rentals to purchase your new primary residence (as a "rental"), which would reduce your tax burden." macdaddy

You cannot purchase any kind of primary residence with any of your 1031 exchange money. If you try it you will not only pay all the taxes but penalties besides.

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Re: pull cord sooner rather than later?
Old 07-26-2006, 08:16 PM   #18
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Re: pull cord sooner rather than later?

I should have been more specific. Can't he purchase a home w/ 1031 wherever he intends to move, rent it out for a year, and then turn it into his primary residence and move into it? This is legal as far as I know.
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Re: pull cord sooner rather than later?
Old 07-26-2006, 09:40 PM   #19
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Re: pull cord sooner rather than later?

Quote:
Originally Posted by califdreamer
relocating from San Diego to less expensive area

Califdreamer* *From your posts I think this is what you need to figure out first.* It looks like your plan would work but it would be hard to "undo".* I'm in N. CA. and faced with similar situation except I know where I'll retire (Honolulu!!!) but I'm also unsure if I want to LEAVE CA because it's HARD to come back.* I don't want to rent my single family home from long distance for a long time but recently found out that if I rent for two years to three years I can pocket my $250K capital gains (single like you) exemption and then 1031 $250-300K excess to another rental in Honolulu.* Even tho I lived in Hawaii for 5 years and plan for it to only be a base in retirement I'm not positive that I would not want to come back to the Bay area.* So this way I have up to three years of keeping my 5.25% mortgage and my LOW prop 13 tax base ( worth over $4,000 a year) and avoid paying taxes on my excess capital gains.* Have you considered what your property taxes and utilities will be in your $250K downsized home?* Could actually be more than staying in your present more expensive home.* Since I'm close to 55 I could also take my low tax base if I choose to a downsized property here in Alameda County (prop 60) or to one of the six counties that still take tax base transfers(prop 90).* If I downsized to a condo I would be more inclined to rent from a distance to keep my finger in the future crazy CA home appreciation.

I have 5 properties in 3 states and my plan now is to sell 3 over the next 10+ years investing the equity in the stock market if I can figure it out or possibly 1031 to a commercial property.* I'll always have my retirement condo and 1 rental that will supplement my small pension.

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Re: pull cord sooner rather than later?
Old 07-26-2006, 09:55 PM   #20
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Re: pull cord sooner rather than later?

Thanks again for feed back. *

Quote:
Originally Posted by brewer12345
dreamer, could you talk a bit about the kind of property you usually buy and where you find them? How many units? How do you make sure you don't get killed in the deal? What does a property manager cost?
I usually invest in apt bldgs that are 25+ yrs old with a blue collar tenant base. *I don't necessarily look for bldgs that are that old, it usually turns out the Class B propties that make financial sense are that age or older. *I've been involved in everything from fourlplexes (when I started) to 150 units (w/ ptrs). *Doing your due diligence, hiring good and experienced management, researching the city and neighborhood you're investing in and being properly insured are all critical elements in making it work. *I stay away from new Class A buildings. *The rents are so high they compete with home mortgages and they compete directly w/ new construction whereas a homely Class B is essentially an irreplacable asset. *I've had different deals w/ mgrs but generally you're looking at 6% of gross rental income plus a free unit and some extra dollars for an on-site manager.

Quote:
Originally Posted by Cransten
It looks to me like you have a lot of exposure for a crappy return. *You're talking about a business, not an investment, and 6 percent and change for a business is just not worth it. *You have the worst of both worlds: huge downside risk, and very modest return. *Just stay in cash if this is the best you can come up with.
Had I stayed in cash the last ten years instead of invsting in RE I'd be a pauper today. *Instead I am a multimillionaire after having an empty wallet in the early 90s. *To be less flippant, I understand this is not for everybody. *I happen to enjoy it. *I'd absolutely love to retire from my 9-to-5 job and be able to research deals all day... well part of the day anyway *

Macdaddy, your devil's advocate points are all valid concerns and must be dealt with. *Martha did a good job of summarizing what needs to be done (eg adequate reserves for capital improvements, vacancy factor built into pro forma P&L, etc.). *I've been sued for slip and fall, insurance took care of it. *I've had a meth lab in a unit that exploded and was out of commission for a while (one unit of fifty in that propty) and fire insurance took care of it.

Quote:
Originally Posted by macdaddy
Keep in mind it's been hard to go wrong in real estate in the last 10 years. It will be much harder the next 10 years. I have done really well but wouldn't project results from the past 10 years out to the next 10. Now, I assume that appreciation will follow inflation and buy only for the cash flow.
This is a good point. *Some are of the opinion that cash yields will become more important as rising interest rates put downward pressure on CAP rates. *Appreciation will be tougher to come by. *Keep in mind, though, even in CA our apt bldgs appreciated extremely well but were somewhat anchored by rental income (unlike SFRs). *And in some regions, apt bldgs did terribly due tenants being able to go buy a cheap home with low interest rates (think Texas). *Rising home prices and interest rates are resulting in increasing rents in these areas. *That's one reason the CPI is increasing.

Brewer, feel free to PM if I can provide more details on some criteria for apt investing.





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