Retiring with $0, or negative, net worth

[arebelspy]

Assuming you have sufficient cash flow, are there any major problems with having a very small net worth when retiring?

So let me make a hypothetical case. Let's say you own 15 properties that cashflow you 50k/yr. Naturally this is under the assumption that said cashflow takes into account mortgage, taxes, insurance (enough so if you are sued, etc you are covered, umbrella or what have you), maintenance/repairs, vacancy, legal fees, etc., so you are keeping 50k/yr.

You live on 40-45k/yr.

Properties are 100% financed (or have dropped sufficiently in value that you have no equity or are underwater on them, wiping out any down payments). You have no other portfolio. Thus $0, or negative, net worth.

You should be able to retire, yes?

This is less a question on real estate in particular, and more on retiring without a huge net worth, but just on cashflow. A huge net worth should be unnecessary as long as your cashflow is sufficient (and grows with inflation).

And yes, I've read every post in every thread in the real estate FAQ: http://www.early-retirement.org/forums/f47/faq-archive-landlording-real-estate-investment-43700.html and done several searches and read more threads on here. But every thread is on supplementing one's retirement or income with real estate, not specifically on retiring solely on cashflow.

I guess to put it in an easier way to understand.. if you had a pension that adjusts to inflation, and you were broke, but said pension brought in more than you spend per year, you should be able to retire? Seems sorta obvious when I put it that way...

Any links you can point to from past discussion, or any thoughts you have are appreciated.

 

[LOL!]

If you are working as a landlord, then you are not retired in my book.

 

[REWahoo]

If you are working as a landlord, then you are not retired in my book.

Yep. Maybe the thread title should be "Changing careers: Full-time real estate management"

 

[W2R]

I think it depends a lot on your risk tolerance. Personally I would not want my income flow to come from any single source, be it real estate, pension, stocks, or whatever. Also, I would want a substantial emergency fund to deal with the unexpected.

 

[GregLee]

Assuming you have sufficient cash flow, are there any major problems with having a very small net worth when retiring?

Though I know nothing about real estate, I don't see how there could be any problem with that. You need to assure incoming cash flow -- if you can do that, why should it matter what your net worth is?

OTOH, I don't understand your hypothetical. If your properties are financed, you must be paying interest, and it seems that if the properties are appropriately valued, if the interest rate is rational, and your net worth is 0, your income from the properties should equal the interest you have to pay. So your cash inflow should be zero --- can't retire on that.

 

[kumquat]

Without searching forums, I'd suggest that any source of cash has a NPV that can be calculated. Just because current (local) market conditions don't view it as positive doesn't mean your NW is negative on an investment that produces positive cash flow.

Would I do it? Who knows.

 

[arebelspy]

If you are working as a landlord, then you are not retired in my book.

Yep. Maybe the thread title should be "Changing careers: Full-time real estate management"

Funny REWahoo.

I think you two missed the point of my question, though, especially when I noted that this wasn't specifically about real estate, that was just the most convenient example of something generating cashflow while having no net worth. A stock paying dividends could give cashflow, but then you'd likely have net worth based on the stock.

That's why being broke with a pension was the other example I gave.

But alright then, if you two are stuck on the Real Estate thing being work.... Change the original scenario to say you have 17 houses, and the cashflow from those two extra houses pay a management company to handle all of them (and everything else is already included, taxes, maintenance, etc). Or say that was already included in the 15 houses. Whatever.

Comments?

 

[arebelspy]

I think it depends a lot on your risk tolerance. Personally I would not want my income flow to come from any single source, be it real estate, pension, stocks, or whatever. Also, I would want a substantial emergency fund to deal with the unexpected.

Good point. What are the risks of having all your income coming from real estate (assuming a sufficient number of proprieties)? Or from a pension?

And an emergency fund is a good thing to note.

Thanks.

 

[arebelspy]

Though I know nothing about real estate, I don't see how there could be any problem with that. You need to assure incoming cash flow -- if you can do that, why should it matter what your net worth is?

OTOH, I don't understand your hypothetical. If your properties are financed, you must be paying interest, and it seems that if the properties are appropriately valued, if the interest rate is rational, and your net worth is 0, your income from the properties should equal the interest you have to pay. So your cash inflow should be zero --- can't retire on that.

Okay, that's what I was thinking.

The real estate was only an example of my larger question of retiring with no net worth, only cash flow.

That being said, I don't think it's an impossible example. Your assumption is one of rationality. If the properties AREN'T properly valued, so that you can rent them out to cover all expenses (including interest on said loan), you can have cashflow.

You are correct that in a perfect world, it probably wouldn't work.

 

[REWahoo]

In theory, as long as you have an income stream to pay your expenses net worth shouldn't matter. In the real world retiring with zero net worth is a high wire act with no safety net. In your example an ill wind in the RE market (real estate never experiences boom/bust, right?) can interrupt your cash flow, and with no reserves you're likely screwed.

 

[arebelspy]

In theory, as long as you have an income stream to pay your expenses net worth shouldn't matter. In the real world retiring with zero net worth is a high wire act with no safety net. In your example an ill wind in the RE market (real estate never experiences boom/bust, right?) can interrupt your cash flow, and with no reserves you're likely screwed.

Fair enough.

So how would one plan for retirement in that case? Like, say you use the FIRECalc and put in a spending amount of $40k and off chart spending reduction of 50k. A portfolio of $0 gives a 100% success rate. So you have a pension giving you more than your spending level, FIRECalc says you're set.

So how do you even plan for retirement beyond that? Having an emergency fund, as noted above, is good. But how do you tell what portfolio you'd need unless you can project the ill winds that might occur.

Or going to the Real Estate example, how do you project what a bust market would do? Assume 50%? 100%? vacancy for .... a bunch of years, and get a big enough portfolio to cover that?

It seems that you should be able to retire if cashflow > expenses, and you don't care about your net worth, but how do you decide how much "extra" you need by projecting those disasters?

I do appreciate the comments, they're very helpful.

 

[Danmar]

I think the pension example is more realistic and I don't see why that wouldn't work. Obviously inflation and health care might be a concern but in theory these could be covered by the pension. Not sure why this wouldn't be self evident?

 

[arebelspy]

I think the pension example is more realistic and I don't see why that wouldn't work. Obviously inflation and health care might be a concern but in theory these could be covered by the pension. Not sure why this wouldn't be self evident?

Right, assume health care is already factored into your expenses.

Yeah I feel the pension example makes it a bit more self evident than the real estate one, but I'm basically wondering about retiring based on cashflow, rather than net worth. I can't find much discussion on that idea (which is odd, to me, as building passive income seems a good way to retire early, and many people do it as a supplement, but I can't find much discussion on that being the primary income in retirement, with basically no portfolio withdrawals).

The pension works better, I think, because it's more stable. Real estate has many risks, so people are focusing on that.

Or, for a third example, let's say you had website set up that gave you passive income of 50k or 100k or whatever and they have been doing so stably for 10+ years. There's lots of reasons why that might stop, forcing you out of retirement, but in theory, if it was stable enough, you should be able to retire.

That's what I'm wondering about, basically. Not the building websites, but building up items that generate cash flow, rather than building up a million dollar portfolio.

It does all depend on how stable they are though. If there is a problem (like with the Real Estate example and the renters market is bad, or pension example and... they stop paying out I guess?) you're in a bad spot. Though I guess if you're heavily in the market and that tanks you can be in a bad spot as well.

 

[plex]

You have to assume these properties have a positive new cashflow of $50k for the RE hypothetical to work, that means you have $50k of income AFTER all costs are factored in, especially the mortgage interest. Otherwise your income would be 0 or even negative.

It would be completely undiversified. This means you are opening yourself up to unnecessarily high risk for a similar return. You could spread some of the risk by having the properties in significantly different locations, but this would only cover the local risk factor. The market risk factor would always be there, and is unavoidable.

The local risk factors are hurricanes, floods, tornadoes, termites, fire, degentrification, re-zoning, earthquakes, etc.... Every area has one or more of these local risk factors. If the properties are close together, they can all get wiped out by the same risk factor. Ask people in or near New Orleans what happened to their RE.

Market risk should be obvious, these are fundamental shifts the housing market, overproduction of new homes, financial instability, depopulation, etc...these are factors which hit large areas of the country or the whole country, e.g. the subprime fiasco of a few years ago.

Finally, as for your main question, if you have a management company, it is semi-retirement, if you don't it is a near full time job. Even with a management company, you have to supervise to a degree. This is not the same sort of situation as with investments where your investments are guaranteed by the government or at least institutions that are much less likely to go under. Management companies are like employees, they can and often will do the minimum necessary to keep your business, so if you supervise they will shape up or get replaced, but if you don't, expect the minimum.

As for other types of income, such as from a web business, you would need to either keep working, or income would steadily drop off during the time you stopped growing the business. Businesses stagnate or even immediately die without constant work. Royalties tend to go down the older a work becomes, except in the rare case when it becomes a classic (often after the authors death, go figure).

 

[Moemg]

. Though I guess if you're heavily in the market and that tanks you can be in a bad spot as well.

As most people found out just two years ago !

 

[Danmar]

Retirement is always based on cash flow, not net assets. For most people the issue is how much sustainable cash flow the net assets can provide coupled with how much cash flow is required. You have assumed these issues away so I think the obvious answer is yes.

 

[REWahoo]

So how do you even plan for retirement beyond that? Having an emergency fund, as noted above, is good. But how do you tell what portfolio you'd need unless you can project the ill winds that might occur.

Or going to the Real Estate example, how do you project what a bust market would do? Assume 50%? 100%? vacancy for .... a bunch of years, and get a big enough portfolio to cover that?

If we knew the answer to those questions would we be giving out [-]questionable[/-] advice on this forum or making millions charging for our ability to see into the future?

There are no answers to your question as no one can accurately predict what hazards lie ahead. All any of us can do is develop our own level of income stream/asset allocation/emergency fund, etc., then decide whether it is sufficient to allow us to sleep at night when "bad things" happen. You have to determine what level of safety net/assets you need to amass so that you can be prepared to weather your personal expectation of what could happen to you in the future - which will likely fall somewhere between replacing the transmission in your car and surviving an asteroid strike. ...

 

[calmloki]

I think the pension example is more realistic and I don't see why that wouldn't work. Obviously inflation and health care might be a concern but in theory these could be covered by the pension. Not sure why this wouldn't be self evident?

Not only self evident but by Gawd - It's the Amurican Way! Retire as one lives - on cash flow, not net worth. What matters is the monthly payment - or payout, not total cost or net worth.

All that having a positive net worth gives you is a sense of security, which could be false if the insurance company you bought an annuity from goes banko or the derivative traders make off with all the cheese or your gold get irradiated in a nuclear blast or your government pension evaporates with the government or....



(belt,suspenders,rentals,and gold for me - )

 

[GregLee]

... but I'm basically wondering about retiring based on cashflow, rather than net worth.

An approximation I've seen others use in similar discussions is to multiply annual COLA'd cash inflow by 25 to get equivalent net worth, or go the other way and divide a portfolio of assets appreciating at the inflation rate by 25 to get the corresponding approximate COLA'd cash inflow. This gives you the conceptual basis to translate back and forth from the cash flow/pension/annuity view to the portfolio view, and to approximate more complicated situations where you have several portfolios and several pensions which will all add up to support your retirement.

 

[arebelspy]

An approximation I've seen others use in similar discussions is to multiply annual COLA'd cash inflow by 25 to get equivalent net worth, or go the other way and divide a portfolio of assets appreciating at the inflation rate by 25 to get the corresponding approximate COLA'd cash inflow. This gives you the conceptual basis to translate back and forth from the cash flow/pension/annuity view to the portfolio view, and to approximate more complicated situations where you have several portfolios and several pensions which will all add up to support your retirement.

That makes sense. Thanks!

 

[Gumby]

It seems to me that, every year, millions of people do precisely what you posit - they retire solely on the cash flow provided by social security with no other assets of note.

 

[Moemg]

It seems to me that, every year, millions of people do precisely what you posit - they retire solely on the cash flow provided by social security with no other assets of note.

or very little !

 

[fritz]

Whether you get your cash flow from real estate, pension, financial investments or some combination thereof - I find the question to be "do I have enough cushion?"

A combination basket is the traditional advice for minimizing risk, but I found that when I determined I had the amount cushion I was comfortable with to retire - I pulled the trigger. This involved knowing what I needed in cash flow as a minimum and knowing what my investments could conservatively generate. I use 4% as my benchmark off investments, but only need/withdraw <3%. I view social security (in two years) as supplemental and not crucial to my base line retirement plans. I also have 20% of net worth (if all else fails) that I do not include in my withdrawal strategy plans.

This may sound like an ultra conservative cushion, but it was what made my decision to retire possible. I realize that poor health, or some other unforeseen issue could seriously derail my retirement. I see the unknown as beyond my control. If they should unfortunately occur - my conservative withdrawal strategy hopefully has enough of a cushion to offset them.

I would think that if you find yourself with enough cushion in your plans to be comfortable - retirement might be an option you'd be happy with...

 

[arebelspy]

I also have 20% of net worth (if all else fails) that I do not include in my withdrawal strategy plans.

See, this is what I DON'T want to do. No offense, I think it's amazing you have that extra amount (honestly, I'm really impressed at that), and I'm sure it helps you sleep easy.

I just don't want to keep building and building my net worth, which to me is just a number, and delaying retirement to do so. I want to retire with enough money to support me. Not with a big net worth, unless those happen to coincide.

Your ideas on a cushion are spot-on, and the cushion amount is different for everyone. I'd like to build up a cushion (/emergency fund/what have you) that's enough to sleep easy and have as a small fallback, but other than that, not worry about net worth at all, just income.

The social security was another great example of this, thanks Gumby!

 

[haha]

Your ideas on a cushion are spot-on, and the cushion amount is different for everyone. I'd like to build up a cushion (/emergency fund/what have you) that's enough to sleep easy and have as a small fallback, but other than that, not worry about net worth at all, just income.

Net worth is just capitalized income. If you have done your accounting correctly, and you have income from from capital investments, you automatically have net worth.

You can't get income from worthless properties, because then they are not worthless.


Ha