Real estate investors who have gone before: some thoughts please?

[calmloki]

We've been doing rental property for the last 25 years or so, not much in the way of gainfull employment otherwise, so we can't contribute much to any IRAs (have about $50k in IRAs now). Since most of our income has been classed as "unearned income" by the IRS we will have maybe $1000/mo or so in SSI. Have about $450k in money markets,bank certificates, and $187k in property loans we've made. About $35k in stocks and around 1.5M in various rental properties (after discounting for cost of sale,depreciation recapture,and LTCG). This assumes that we sell all the properties in the next couple years to take advantage of the reduced LTGC tax and does not account for any alternative minimum tax that might be imposed. Just looking at it, i'd say we've got about all our eggs in one basket! - Kinda intentional - they've been under our direct supervision and control that way. I keep running the numbers and it looks to me like we've got about enough piled up to get us all the way to 93 or so. No kids to worry about. I guess the questions are: is there any reason to invest in the stock market if one can sew up rates like PenFed's 6.25% and be pretty much 100% safe? Anybody making any money putting their property under the control of a management company? We have a 16 unit apartment that might be a likely candidate, but we bought it from some folks that had it under management and were showing no profit - by doing our own management and much of the repairs it returns a pretty decent income. I'm just getting real tired of dealing with petty tenant issues. Any good suggestions for an exit strategy from the properties? don't really want to do a 1031 exchange - doesn't feel like a good time to be buying yet and am tired of being a landlord.

 

[Nords]

I guess the questions are: is there any reason to invest in the stock market if one can sew up rates like PenFed's 6.25% and be pretty much 100% safe?

The short answer is no. PenFed doesn't go out past seven years with their CDs and you'll have to raise your spending with inflation. 6.25% won't get you through three decades of inflation and a 4% SWR.

The long answer to your question is to read up on asset allocation like Bernstein's "Four Pillars of Investing" and making sure that your returns beat inflation. Some stocks in a portfolio are historically the only way to stay ahead of inflation, although inflation-indexed bonds might have made up a lot of the difference. You can find your volatility comfort level and stay ahead of inflation without having to sacrifice all safety.

Anybody making any money putting their property under the control of a management company?

Yes-- the management company makes most of it, but they give some of it to you so that they can ask for it back later to fund "capital improvements".

You're paying them your profits to do the job that you no longer care to do. They're hoping to make more money from economies of scale, but that might also have an adverse impact on the quality of your tenants. The management company is laying a lot of risk on you and not compensating you for it-- especially when the property's cap gains aren't beating inflation.

Any good suggestions for an exit strategy from the properties? don't really want to do a 1031 exchange - doesn't feel like a good time to be buying yet and am tired of being a landlord.

Taking your cap gains & depreciation recapture is the only way I know how to do it. You could probably sell it to a partnership in exchange for partnership shares (like selling your business to Buffett for Berkshire Hathaway stock) or sell over a period of years instead of all at once (in hopes of lessening the cap gains taxes) but there aren't many options.

There are plenty of companies who will 1031 your property into a TIC pool of residential or commercial real estate properties. That's probably the only way to divest yourself of real estate hassles without paying the taxes. But it's not much different from turning over your property to a management company, and unlike a property manager with a TIC you lose just about all control.

 

[free4now]

I currently have about half my net worth in real estate (my home), and I've decided it's time to sell it. When you are retired, you are counting on your money to earn for you. Given that the real estate market is not likely to appreciate much if at all in the next few years, and that rentals don't cash flow because of the high prices, there's no way for my money tied up in real estate to support me.

If I were in the OP's position, I'd probably sell off most of the real estate starting right away, and eat the inevitable tax bill.

 

[calmloki]

Thanks Nords - you pretty much confirm my opinion of managment companies. I was thinking that if i could continue to find rates like PenFed's, exceeding the inflation rate by a couple points, that the nest egg would gradually deplete over the next 33 years or so, leaving us with pretty much nothing but our house at year zero. This without the risk of dumping our whole nest egg into stocks in what could be a down year (reading that massive losses in the first years of retirement are the worst thing for a porfolio). Given that Larry Swedroe in "The Only Guide to a Winning Investment Strategy You'll Ever Need" and others are suggesting that stock earnings in the 7-9% range are plausible for the next decade or so I was thinking that our stock exposure should maybe be pretty modest, that the risk exceeded the necessary returns. Since i don't know where inflation or interest rates are headed, but suspect that up is a good guess, i didn't buy anything but 3 year PenFed certificates. I'm obviously not getting the importance of the non-correlation of returns between stocks and bonds. Can't understand why a PenFed cert that earns better than a bond but isn't moving in contra-lockstep to stocks isn't better than bonds. Money being fungible it seems that the more earnings the better. But stock and bond investing is not something we've done much of - and all i read says pick stock/bond allocation, with stocks being maybe 30-40% of a porfolio at retirement. Kinda a belt and suspenders guy - having a hard time thinking about investing our whole nest egg, going into something other than our well worn rental property path.

 

[spideyrdpd]

Why would you want to take the money out of real estate ?
I would just continue to collect the checks. Probaly cheaper to have a property manager than to sell and then deal with the stock market.

 

[calmloki]

Why would you want to take the money out of real estate ?
I would just continue to collect the checks. Probaly cheaper to have a property manager than to sell and then deal with the stock market.

I would be taking it out 'cause I'm turning into a lazy bum and because contrary to the IRS's contention that it is unearned income i find that the checks fail to land in our mailbox without any labor on my part. Getting tired of being a babysitter for supposed adults. Might keep a rental house or two just to keep some variety in the income stream, but most of our places aren't really conducive to having a manager - too many weird quirks. The only place that is normal enough and big enough they are going to want about 10% of the rent to manage - which gets way deep into the profit.

 

[macdaddy]

Why would you want to take the money out of real estate ?
I would just continue to collect the checks. Probaly cheaper to have a property manager than to sell and then deal with the stock market.

If they had kids to help them watch over things, this would be a better option. Unfortunately I have seen many couples try to manage rental properties into their 80s and 90s and more often than not some crooked property manager or real estate agent ends up ripping them off. It's sad when an 84 year old woman who has owned the same rentals for 30 years doesn't understand why they're suddenly cash flow negative (even though they're fully paid off) - duh, the property management company is stealing half the rent! Since they don't cash flow any more, "maybe we should just sell them" - along comes crooked real estate agent who flips them at 50% market value to all her friends. I am helping to deal with a case of this now. It's hard to bring a case of fraud against someone when the client who signed all the contracts is so old and "not exactly sure" of what was said.

I'm not saying this can't happen in the stock market, because it certainly can, but I'd feel a lot more comfortable at that age having my money in index funds, with set instructions to a reputable broker or trustee at a bank, regarding disbursements.

 

[AltaRed]

I would be taking it out 'cause I'm turning into a lazy bum and because contrary to the IRS's contention that it is unearned income i find that the checks fail to land in our mailbox without any labor on my part. Getting tired of being a babysitter for supposed adults. Might keep a rental house or two just to keep some variety in the income stream, but most of our places aren't really conducive to having a manager - too many weird quirks. The only place that is normal enough and big enough they are going to want about 10% of the rent to manage - which gets way deep into the profit.

I agree with you. There is a time and place for everything and now it is time to shift your priorities according to your needs and desires as you move on in life.

 

[Nords]

Thanks Nords - you pretty much confirm my opinion of managment companies.

I've noticed that most of the website TIC firms (admittedly a shadier bunch than reputable real estate companies) offer rates that are lower than the CDs we could buy (with the prospect of property value appreciation) while their cost of capital is less than they'd have to pay for a mortgage or other bank loan.

Not a bad way to use other people's money.

I'm obviously not getting the importance of the non-correlation of returns between stocks and bonds. Can't understand why a PenFed cert that earns better than a bond but isn't moving in contra-lockstep to stocks isn't better than bonds.

You're not the only one. But that's a whole 'nother thread.

Brewer explained to me that PenFed is offering a temporary good deal on their CDs in order to adjust the overall duration of their entire portfolio, which makes their finances more attractive to ratings agencies as well as to other companies interested in buying PenFed's products. So theoretically PenFed is sharing the wealth with an expectation that a few basis points will stick to their fingers, but credit unions have a non-profit advantage to begin with.

 

[brewer12345]

Brewer explained to me that PenFed is offering a temporary good deal on their CDs in order to adjust the overall duration of their entire portfolio, which makes their finances more attractive to ratings agencies as well as to other companies interested in buying PenFed's products. So theoretically PenFed is sharing the wealth with an expectation that a few basis points will stick to their fingers, but credit unions have a non-profit advantage to begin with.

Uh, that was more like a guess than an explaation.

 

[Nords]

Uh, that was more like a guess than an explaation.

Sorry, not trying to put words in your mouth, but it makes a lot more sense than "asleep at the switch" or "blatant fraud"...

 

[cute fuzzy bunny]

Good guess.

I might also postulate that such a move brings in a fair amount of cash flow and that a predictable amount of that cash will 'stick' after the certificates expire. People being basically lazy but greedy may be drawn to it, then leave the money in less advantaged circumstances later. Maybe get a mortgage while they're at it. Maybe leave some money sitting in their low interest 'share' account a while.

Loss leader to create opportunity instances and some internal numbers finagling? Hell, advertising and toasters might cost more than an extra quarter to half percent.

 

[FinanceDude]

Good guess.

I might also postulate that such a move brings in a fair amount of cash flow and that a predictable amount of that cash will 'stick' after the certificates expire. People being basically lazy but greedy may be drawn to it, then leave the money in less advantaged circumstances later. Maybe get a mortgage while they're at it. Maybe leave some money sitting in their low interest 'share' account a while.

Loss leader to create opportunity instances and some internal numbers finagling? Hell, advertising and toasters might cost more than an extra quarter to half percent.

Absolutely hit the nail on the head. Be it credit union or bank, the easiest way to get money is to "steal it" from other banks or credit unions........

 

[tryan]

Here's a few ideas I looked at to divest RE:

1. SELL - tax rates are the lowest in decades and will only go UP if the democrats get the White House in 08.

2. SELL and carry the paper. If you have one good tenant in the 16 unit place, consider offering to carry a note for them. You piece is safe as long as you're in a first position. Only pay taxes on the payments made to you - as they are made.

3. 1031 exchange into what will become your primary residence. Rent the joint out for a year (to pacify the IRS like-business exchange rule) then move in and live there for at least two years - or forever. Sell your current primary residence for a nice tax free gain.


Management companies are a rip-off. Turned a positive cash flow into a negative one as plumbers are sent for toilet clogs and electricians are sent to change light bulds. Never worked for me.

Hope this helps.

 

[Jane_Doe]

Calmloki,

My husband and I are in a similar situation. All our money is invested in a commercial strip center that we built years ago. We look forward to being able to sell it and not have to worry about maintenance, repairs, collecting rents, etc. We actually have really good tenants, but things change sometimes. It is hard to go on vacation and relax when there is bad weather back home as we are hands on and normally "handle" snow removal or repairs from wind damage, etc. That is one main reason for us to sell out - peace of mind.

That being said, we are ignorant of investing and though I have been reading here and also books on finance, I am uncomfortable putting a very large sum of money into the stock market. I am sure the whole thing will tank as soon as we put our money in! I would be thrilled to just let it sit in a bank account and earn interest, but I understand that is just plain foolish due to inflation. There has to be a happy medium for those of us who need the belt and suspenders.

Uncle Mick touts the Wellesley fund from Vanguard and there are Life Strategy funds, too, that have some conservative mixes. Anyway you look at it, though, there are stocks as a portion of the portfolio. Again, I am sure this is (supposed to be) good, but for people like us who are used to having real estate and just regular old bank accounts, it is intimidating to think of a downward market taking a huge chunk out of what we have worked so hard to accumulate.

We are waiting to sell until some development issues in our area come to fruition - it is a matter of being patient - in the hands of polititions! So, we will continue to be landlords for the time being. Meanwhile, I will continue to read. I just bought the "BogleHead's Guide to Investing" off Amazon for Christmas and will start reading that soon. I heard it was less complicated than "The Intelligent Investor" or the "Four Pillars" both of which I find b-o-r-i-n-g .............. Sorry, Nords!

Gotta go. Hope this thread continues. TRyan is probably the most experienced Real Estate poster on this board and always has good advice.

Thanks all for listening (reading this) ........

Jane

 

[honobob]

I thought it was pointed out that the lower LTCGs didn't apply to real estate. I'm not selling so I didn't pay too much attention.

A strategy might be to give free rent for a manager to handle the "bad" aspects of self management. (toilets, trash and tenants) Seems like there's always someone that can use a second job they can work around their regular job. You do the easy stuff and have a buffer between you and the tenants.

Any possibility of going condo and selling and carrying the note to spread out the Cap Gains and getting an above market rate on your money?

I would 1031 the approx. $1.6M into 4 $400K units that I know and then net $8,124 monthly ($97,488 cash to you each year) AND count on $144K appreciation per year (don't believe in 30 years of historical data? Drop the appreciation to 5% per year and you're still pocketing $80K a year in appreciation. Harvest thru equity lines or refinance. Move into each unit/live for two years and sell and pocket $500,000 tax free!! Rinse, Repeat.

Still dealing with a few rentals but my almost 30 year experience has been never having ONE day of occupancy, never a three day notice/evicition, maybe one or two stern "that's not what we legally agreed to" and this done from 500 to 3,000 miles away. Even if you did a 10% property mgr. you'd still net $85K a year + the $80-144K appreciation a year.

I do have a friend that sold a $7M+ rental in SF and 1031'd to office TIC property and he is very happy. He is older and absolutely does not want to landlord.

FYI Some SF office sales
71 Stevenson 8/00 sale 84.5M Height of .com
Resold 9/06 105M

555 California BOA 9/04 795M
3/06 1.05B

100 First 5/00 135M
12/05 180.5M

50 Fremont 7/00 259M
12/04 323M

410 unit Arches Apartment in Sunnyvale recently sold for $82.5M, $32.5M more than it purchase price in 2004(65%increase in less than three years!)


If I had placed the money I have into the market and got the 10%? gain I would have a little over $250,000 today instead of the almost $2,000,000 in real estate equity that I have today.

I know nothing about stocks and have been pumping a couple thousand a month the last several years tax deferred but the pile doesn't look too big today. Not sure if I'm doing something wrong.

 

[tryan]

GWB lowered RE LTCG to 15% - that was a good thing. What sucks is the alternate minimum tax ... we'll all hit this on any property sale; and it grabs at your gain like ordinary income (YIKES!) which are also lower (but still too high).

The idea of a live-in property manager is a good ... but I wouldn't trust the guy/gal to fill vacancies. And with 16 units at 5% vacancy you've got alot of vacancies to fill. We can all agree turning over a vacancy is the lions share of RE "work".

The 4 high end properties ($400k) would certianly work in CA/HI/east-coast cities. Not sure where OP property is, but this wouldn't fly in many states. Of course, moving 4 times is a quality of life issue (especially with a spouse and kids).

Yeah, my RE has out performed my stocks ... and I wouldn't want to lump-sum into the stock market at all time highs. Buuut, having been pre-occupied by frozen pipes the last couple weeks ... makes Mr. Market look pretty tempting. Maybe a DCA approach into index funds?

Point being, anybody who already has ~2m is thinking more about preservation than they are growth; preservation comes with enough diversification.

 

[Nords]

GWB lowered RE LTCG to 15% - that was a good thing. What sucks is the alternate minimum tax ... we'll all hit this on any property sale; and it grabs at your gain like ordinary income (YIKES!) which are also lower (but still too high).

I haven't paid attention to real estate cap gains in EGTERRA, but IIRC they're still taxed at the 25% rate. The 15% rate applies to stocks.

And then there's the additional thrill of depreciation recapture.

Yeah, my RE has out performed my stocks ... and I wouldn't want to lump-sum into the stock market at all time highs. Buuut, having been pre-occupied by frozen pipes the last couple weeks ... makes Mr. Market look pretty tempting. Maybe a DCA approach into index funds?

Let's see, if we could invest in stocks with a 10% down payment, a fixed-rate 30-year mortgage, and dividends of 4-8%-- then I suspect the market would grow a lot faster too!

I've never had my brokerage call at 3 AM to complain about the furnace or the toilets, either...

 

[calmloki]

I haven't paid attention to real estate cap gains in EGTERRA, but IIRC they're still taxed at the 25% rate. The 15% rate applies to stocks.

I don't know what EGTERRA is, but our long time tax lady, picked because of her extensive family exposure to rental ownership, sent me a blurb on how to figure the potential tax (exclusive of the AMT) which uses 25% on depreciation recapture and 15% on the balance of profit minus depreciation.

[/quote]And then there's the additional thrill of depreciation recapture.[/quote]

Yeah. Thrilling. That's the word that comes to mind when doing the math.

[/quote]Let's see, if we could invest in stocks with a 10% down payment, a fixed-rate 30-year mortgage, and dividends of 4-8%-- then I suspect the market would grow a lot faster too!

I've never had my brokerage call at 3 AM to complain about the furnace or the toilets, either...
[/quote]

 

[Nords]

I don't know what EGTERRA is, but our long time tax lady, picked because of her extensive family exposure to rental ownership, sent me a blurb on how to figure the potential tax (exclusive of the AMT) which uses 25% on depreciation recapture and 15% on the balance of profit minus depreciation.

OK, that's where I'm confused. I stand corrected.

 

[calmloki]

GWB lowered RE LTCG to 15% - that was a good thing. What sucks is the alternate minimum tax ... we'll all hit this on any property sale; and it grabs at your gain like ordinary income (YIKES!) which are also lower (but still too high).

The idea of a live-in property manager is a good ... but I wouldn't trust the guy/gal to fill vacancies. And with 16 units at 5% vacancy you've got alot of vacancies to fill. We can all agree turning over a vacancy is the lions share of RE "work".

The 4 high end properties ($400k) would certianly work in CA/HI/east-coast cities. Not sure where OP property is, but this wouldn't fly in many states. Of course, moving 4 times is a quality of life issue (especially with a spouse and kids).

Yeah, my RE has out performed my stocks ... and I wouldn't want to lump-sum into the stock market at all time highs. Buuut, having been pre-occupied by frozen pipes the last couple weeks ... makes Mr. Market look pretty tempting. Maybe a DCA approach into index funds?

Point being, anybody who already has ~2m is thinking more about preservation than they are growth; preservation comes with enough diversification.

We're up in Oregon - manage to keep our vacancy rate below 2.5%, but with 53 units that translates into 4-5 turnovers/month. I am quite sure our vacancy rate would be higher with management that didn't have the incentive i do. Figure that's about 1 turnover/unit/year, which seems pretty optimal to me, though when in the midst of co-ordinating 4 or 5 leaving and getting them cleaned and repaired and filled it feels pretty busy. Moving to take advantage of the tax free nature of personal residence sales appeals to my thrifty nature but would not fly with SWMBO. We spent about 6 years doing an extensive remodel (new plumbing,wiring,staircase,walls,foundation...)on this house to make it just what we wanted. We've considered a winter home, and buying a rental house that later converted might work for one of our house sales. Wouldn't address getting the majority of the profit out of Unca Sam't fingers. Don't need,can't afford a giant second home, need to have a 1031 exchange property(ies) be equal or greater in price to the exchanged property. SWMBO has put the DCA onus on me as a condition of transfer into the stock market. We tend to reinforce cautious behavior in each other.

 

[tryan]

the potential tax (exclusive of the AMT) which uses 25% on depreciation recapture and 15% on the balance of profit minus depreciation.

This is consistent with the taxes I paid selling a SF rental in 2005.

need to have a 1031 exchange property(ies) be equal or greater in price to the exchanged property

Many trip over this (online help is unclear) ... buuut you can 1031 a small portion of a gain and pay taxes on the rest. For example, a few years ago I did a 1031 selling a duplex (for ~170k gain) and bought waterfront raw land (for ~100k). And paid taxes on the excess gain (~70k).

 

[calmloki]

This is consistent with the taxes I paid selling a SF rental in 2005.

Many trip over this (online help is unclear) ... buuut you can 1031 a small portion of a gain and pay taxes on the rest. For example, a few years ago I did a 1031 selling a duplex (for ~170k gain) and bought waterfront raw land (for ~100k). And paid taxes on the excess gain (~70k).

Wasn't aware of the potential to trade down on a 1031 and pay tax on the remainder - that opens up some options.

 

[Jane_Doe]

Two items:

I know someone who sold a shopping center for several million a couple years ago. He 1031'd it into a whole bunch of single family homes (and pushed up the local RE market while he was at it!) It worked but I would use a good atty and accountant on this.


Second --- more of a question,

I thought I understood that the AMT only applies to EARNED income, not cap gains. Am I wrong? IF so, I need to refigure how much we would net upon sale of our property ..........

Anyone know for sure on this one?

Jane

 

[tryan]

I thought I understood that the AMT only applies to EARNED income, not cap gains. Am I wrong? IF so, I need to refigure how much we would net upon sale of our property ..........

Anyone know for sure on this one?

Yeah, I know for sure because I've been hit with AMT EVERYTIME I sold a property. Problem is the "trigger" is not set to inflation so every year more and more people are getting snagged. GWB raised the trigger from 49k to 63K for couples ... figure the first 63k will be taxed at the "teaser rate" (15%) after that it's ordinary income (28%??).

DISCLAIMER: I've used an accountant for my taxes for 20 years ... I am NO tax expert!