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Question re: Income stream preferences
Old 12-12-2011, 02:21 PM   #1
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Question re: Income stream preferences

Would you prefer your retirement income stream to come from rental properties or stock market investments? To keep the analysis simple, please make a binary answer: RE or stock market investments. Also, please include why you made your choice.

Assumptions:
1. Real estate is managed by a RE management company. Income is passive income.
2. Income is the same after tax for both the real estate and stock market choices.


Reason for my question: we will be early retiring in 4.5 years and have started analyzing income stream sources. We have three rental properties, that when paid off, would provide about 70% of our income needs (we have more than sufficient market investments now to make up the other 30%). To pay the rentals off we would have to stop investing in the market and put all excess money into paying off the rentals.

(OR)

We can sell the rentals now and put the profits into the stock market.

So, the reason for my question, RE or market investments, is to gleen what analysis I should be doing to determine the right course.
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Old 12-12-2011, 02:26 PM   #2
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I wonder how long it will be before someone mentions Wellesley.......
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Old 12-12-2011, 02:30 PM   #3
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I like to diversify my income sources. So I would prefer to get some income from real estate and some income from the stock market. I don't see why you have to sell ALL the rentals. Maybe you could sell one of the rentals and use the proceeds to pay off the other two units. Yes, I know, my answer is not binary, but neither is life.
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Old 12-12-2011, 02:55 PM   #4
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Yep, know about Wellesley....heh, heh, heh...thanks Uncle Mick We'll be rolling our existing 401k accts into Vanguard IRAs and will be putting them into Wellesley when the time comes.

And I agree FIREd that the right answer is a combination, I just don't know what the exact analysis steps I should be doing to determine what course of action to take (sell one rental, sell all, sell none, etc).

I know that all three rentals exceed a 7% ROI (after all expenses and management fees) and that a SWR is in the 4% range. And it seems that keeping the rentals appears to be the right thing to do since their return exceeds the SWR, but I don't know if I'm looking at the analysis correctly.
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Old 12-12-2011, 03:05 PM   #5
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Lisa99, FIREd is making a different point, which is diversification. You are thinking about return. Are you are only looking at the income stream and not the value of the underlying assets?
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Old 12-12-2011, 03:09 PM   #6
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Michael, I'm not honestly sure what all I should be looking at.

We will definitely be diversified, but I want to make sure we can wring the most income out of the assets that we have.
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Old 12-12-2011, 03:15 PM   #7
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If you are in one of the dominant real estate markets, given your assumptions, I would take real estate. You do not want to get Detroited, though.

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Old 12-12-2011, 03:21 PM   #8
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No opinion, but look at you throwing around things like "ROI" and "SWR" and "income stream"! Not long ago that Ameriprise advisor would have been patting your hand and telling you not to even think about these things.
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Old 12-12-2011, 03:23 PM   #9
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Thanks for the input Ha. All three properties are in the Dallas TX area.

The properties have a history of no vacancies (the mgmt company is very good at releasing to result in no vacancy) and the area has good job growth, so is one of the best in the country economically.
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Old 12-12-2011, 03:23 PM   #10
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Quote:
Originally Posted by Lisa99 View Post
Michael, I'm not honestly sure what all I should be looking at.

We will definitely be diversified, but I want to make sure we can wring the most income out of the assets that we have.
It seems to me the most important question right now is what do you need? Will you be financing your retirement with this income, or is it just a supplement?
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Old 12-12-2011, 03:24 PM   #11
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No opinion, but look at you throwing around things like "ROI" and "SWR" and "income stream"! Not long ago that Ameriprise advisor would have been patting your hand and telling you not to even think about these things.
You're so right...thanks for the reminder!
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Old 12-12-2011, 03:26 PM   #12
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Michael, I'm not honestly sure what all I should be looking at.

We will definitely be diversified, but I want to make sure we can wring the most income out of the assets that we have.
If generating the most "income" is your goal, then real estate seems to have the upper hand on paper (I know nothing about your local market, so who knows). However, do you really want to generate 7% income if you only actually need 4%? You should try and remain as tax efficient as possible...
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Old 12-12-2011, 03:27 PM   #13
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Originally Posted by Lisa99 View Post
Would you prefer your retirement income stream to come from rental properties or stock market investments? To keep the analysis simple, please make a binary answer: RE or stock market investments. Also, please include why you made your choice.
I love/hate binary answers.

You're going to keep a diversified portfolio and rebalance it occasionally, right? Same for real estate. You'll do the best you can (or the property manager will promise to) but eventually you're going to get told that you're going to need to make a significant capital investment in your properties to keep up their cash-on-cash return.

At that point you'll either:
- Pony up the cash from your savings or other assets
- Sell one of the properties to free up cash to spruce up the others.

Financial analysis aside, maybe someday you'll get tired of dealing with the property manager and you'll sell everything to buy a REIT.

"Wringing the most income out of the assets you have" is not diversification. That's chasing yield, and that's not such a hot idea. Rental property is a great diversifier as opposed to bonds or CDs.

OTOH if you want to keep your properties producing in an efficient manner then it might make sense to compare their cash-on-cash return to CDs or REITs. The issue with this is that we felt pretty stupid being landlords five years ago when long-term CDs were yielding over 6% and our property was producing 4%. Today we're still landlords but we've apparently grown considerably smarter.

A final consideration: if you pay off a bunch of rental mortgages you may never have access to that type of cash again. You'll also considerably reduce your flexibility. Maybe it makes sense to keep using the rental income to pay down the mortgages while you continue to invest your other income into your other asset classes.
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Old 12-12-2011, 03:30 PM   #14
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It seems to me the most important question right now is what do you need? Will you be financing your retirement with this income, or is it just a supplement?
The income streams will be virtually 100% of our income until I draw SS at age 67, 12 years after I retire.

I have a very small pension ($1300/month), but our income projected need is $80k/year, so you can see the pension is a drop in the bucket.
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Old 12-12-2011, 03:34 PM   #15
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Things to consider about rental properties - Major maintenance issues and vacancies. At some point, major repairs and upgrades will be needed on the properties. There is also the risk of an economic downturn in area where your properties are located that could leave your properties vacant or at reduced rents. Either of these factors could take your ROI down to zero or even negative for a period. In addition, a downturn could make it difficult to sell the properties.

For these factors, I wouldn't look for rental properties to provide 70% of your income needs. I would adjust it to down to 30-35% with the remainder set aside for the above risks.
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Old 12-12-2011, 03:45 PM   #16
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Thanks Nords and others for your points on maintenance. One rental that I'm considering selling will need new retaining walls installed in the next 3-4 years to the tune of about $20k. It also has the most equity in it so it makes sense to sell it and put the proceeds into paying down the rental that we were considering keeping long-term.

Lots of food for thought in these great responses.
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Old 12-12-2011, 04:43 PM   #17
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Rentals can be tough. We had 3 residential rental homes for about 15 years. When they started going down a little, the tenants became worse and the maintenance became worse. So you get a worse class of tenant trying to stiff you on rent with higher maintenance.

So we got rid of them. Then my wife inherited a commercial property with a stable tenant that had been there for more than 20 years, with no rent increases. The stable tenant took off last month. So now we have an out of area commercial property to carry until we re-rent or sell it; our preference is to sell it. Fortunately, we can afford to carry it for a couple of years if need be without it being a major drain, but if we were counting on the income, we'd be up the creek without a paddle.

I don't want any more rental property.
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Old 12-12-2011, 05:02 PM   #18
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I don't want any more rental property.
Same here. Been there, done that. Give me portfolio income any day.
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Old 12-12-2011, 07:09 PM   #19
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Stock mkt investments.

Mainly because I have a lower tolerance for the risks that come with RE - many of which have been mentioned by others. Plus the last thing I want is an income stream turning into an outgo stream.

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Old 12-12-2011, 08:13 PM   #20
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Lisa have you considered the tax implications of your income streams from rental properties against tax free stock market investments and/or dividend returns from equity investments or even from a SPIA funded with after tax dollars?

I ask because I am assuming right now you have enough expense deductions that the income from your three rentals may not be generating enough of a positive cash flow to be a tax issue. Once those rentals are paid off, it may. I say this because it sounds like you want to live off that income. Any income from the rentals that cannot be deducted will be taxed. Just be sure to take that into consideration.
Back to your question. My answer is Stock market. Why? More tax efficient possibilities.

Buying rental property is a good move when young as your tenants help pay the mortgage and help you build equity. Time is needed for that. At least 20 years. Not sure it is the best for those of us in our 50s and beyond as time to build that equity is not as much on our side. But that also depends on what other resources one has.
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