How to assess risk on rental RE vs. 60/40 AA?

[FIGuy]

Hello all,

Just joined your group after spending a dozen hours over the past few days reading and it seems most people advocate a "boggleheads" type investment strategy. I suppose I'm one of those types too, with everything paper assets in or approximating a Vanguard "Lifestrategy" 60/40 fund. However, my wife and I are primarily focusing on a few decent paid-off rental properties to cover our basic cost of living first. We can reasonably expect a 8% income return for a cash investment ("CAP rate" in the biz) and this assumes roughly 50% expenses, professional management, etc (I'm also a biggerpockets type).

Here's the question: why focus on a 4% or even 3% withdraw rate from paper assets when 8% can happen with rental real estate? Is it just the hassle (and it can be even with management!)? Is rental RE viewed as riskier for liability reasons? If I suddenly had 2 million, I'd buy a lifestrategy fund and be done. I view real estate as a quicker path to FI.

As a side note, I've already survived NINE layoffs in 7 years. I suspect this is a big part of my financial independence obsession. Anyone else share that? Did modern corporate America create this?

I'm looking for some honest feedback, please, particularly regarding the risk / reward trade-off between rental properties and paper assets for ER types.

Thanks for the forum! Nobody else I know plans to retire early and what few people I've told that I save 75% of net income seem to think I'm too extreme, but I have no desire to spend more at the moment. Friends / coworkers live in debt no matter how much they make it seems so I try not to share my philosophy there. Good to see some like-minded folk.

Thank you,

Chris

 

[REWahoo]

Here's the question: why focus on a 4% or even 3% withdraw rate from paper assets when 8% can happen with rental real estate?

Whatever floats your boat when it comes to your flavor of investment. Many of us don't have the stomach for real estate, especially once retired. It seems (at least to me) being a landlord is working for a living, the opposite of retirement.

As to 8% vs 3-4%, I'd suggest you be very careful with your numbers when it comes to inflated withdrawal assumptions and long-term sustainability.

 

[Meadbh]

How are you calculating the return on your real estate investment? Are you including equity gains over time? It would seem to be difficult to generate an 8% cash flow on managed properties. I certainly can't.

 

[FIGuy]

Hello,

An 8% CAP is achievable in decent areas of the rust-belt cities and may require a mild fixer-upper, but includes the cost to pay for that. You can find 12-15% in slumlord territory pretty easily. I don't bank on appreciation at all and these are cash deals. I'm talking Pittsburgh here, not SF or NYC where 3% might be common. Although, investing in a 2nd tier city carries some risk to it as well. I expect losing my working income before reaching sustainable FI @ 3% withdraw rates to be a bigger risk than everyone running away from Pittsburgh at the same time. We don't use mortgages.

I agree that rental properties are a bit of a side job, even with the professional management that we will always use. I don't swing hammers or deal with tenants directly, but of course everything affects the owner. That's why we plan to only buy enough to cover our current cost of living (approximately 30k NOI total over probably 2 buildings) and then load up on the 401k , Roth IRAs, and taxable accounts for a few more years past that. I expect to spend about 5 hours / month dealing with RE once it's up and running. Finding the deals and negotiating with the lying realtors / owners is the hard part!

The idea is: use real estate to hit FI fast, then build toward ER with paper assets.

I'm more interested in what risks might blindside us by depending on real estate instead of mutual funds from anyone with experience retiring with some rentals.

Thank you,

Chris

 

[REWahoo]

I expect to spend about 5 hours / month dealing with RE once it's up and running.

 

[Meadbh]

I guess properties in Pittsburgh (where I lived for several years) must have gone pretty low during the great crash. One has to wonder, if these properties are so cheap that you can buy them in cash, what type of maintenance has been done and what financial status the tenants have (or else they would be buying, not renting!). Depreciation and building renewal is a huge financial risk. Bad tenants likewise. Turnover with gaps in income.

 

[SumDay]

You can find 12-15% in slumlord territory pretty easily.

I inherited some of these when my folks died. I wouldn't wish it on my worst enemy, let alone saddle my children with them. You're not going to get brain surgeons interested in renting these. The people you will get, well, I won't say more, but it gives me VERY regular heartburn. I don't give a rat what kind of return I could get, I wouldn't have more real estate. And I only own promissory notes - I don't even have to handle maintenance!

 

[FIGuy]

Hey Folks,

This thread stumbled on one of my other concerns regarding RE in America actually and I'd love to hear from someone else banking on it.

Take Pittsburgh as an example, but this pretty much applies to much of the center of America, where rents are $500 rather than $1000-$2000 for a 1BR. The bubble really didn't make much impact on the upside or the downside. Housing stock is pretty old (mostly 1920s-1960s), but that extra maintenance is factored into the NOI consideration and thus rental property value. Likewise with vacancy / turnover and other expected costs. One of my biggest concerns is actually tenant financial health. We don't plan to fill up with section 8 rentals, but I'm concerned that less government transfer policies / welfare reductions will significantly affect the spending power of middle America overall. We almost have 2 countries at this point already. I hope the center of the country (where I came from and currently live) gets better in the future, but I'm lacking a vision of how that's going to happen right now.

We've had one 6 unit rental building for a few years now and currently put in a few hours per month managing the business (management calls, we say "fix it", and basically trade money for time...), but perhaps 5 hours a month for 2 buildings is optimistic. I'm assuming that's the smiley face message. I'd be fine with more time now. Some months it's 15 minutes of work and I love those checks. Some we work more for. Maybe any work will be too much in 30 years? Maybe it's the month to month variability? I suppose I understand that. I guess the income from those hours would be ~(8%-3%)*350k invested / (120 hours / year) = $146 / hr. I guess that's a job, but not bad pay for part-time retirement. I actually hadn't calculated that before

It sounds like the concern over time and capital expenses are the main concerns. I can accept that perspective.

Thank you,

Chris

 

[samclem]

Many people, me included, think of real estate investments as "buying a job." That's less true if one outsources the maintenance and tenant screening/collections, but 1) there are problems with getting these jobs done right when others are doing them and 2) it gobbles up a lot of the potential income stream. If 8% return--after paying these expenses, taxes, accounting for vacancies, etc, was normal, lots more folks would be doing it, I would think. There's a ton of money looking for places to be invested today, after all.
But, maybe you can do it. You can see why I don't try.
If you go this route, it might make good sense to choose your paper investments so they are likely to offset any losses in your RE holdings.

 

[Onward]

Here's the question: why focus on a 4% or even 3% withdraw rate from paper assets when 8% can happen with rental real estate?

Just one word, FIGuy. Mold.

O wait. Another. Litigation.

And while we're at it ... Vacancy.

That is all.

Not quite. Tenants' rights.

 

[SVHoper]

Hi,

Happy to explain my thinking, but it is all based upon my lack of ability to predict returns.

I, as do quite a few others on this board, like rental real estate for a significant % of assets (depending how you count mine could be 50+%). I am afraid I don't get anywhere near 8% from rents and will hope?/expect?/(past performance, no guarantee) capital appreciation and leverage to sweeten my return. I expect more than bond return from rents.

Effort is minimal.

My main reason for significant stocks is diversity: international/sector/size/economic cycle and my ability to predict returns are sub-optimal to say the least, so I can't judge whether my stock portfolio or real estate will have a better return. - hence the 50/50.

If I could guarantee 8% with minimal effort.... I might weight real estate even higher.... but then I might not VB gave me a great run since Aug 2011

 

[FIGuy]

Hi SVHoper,

Glad to see someone else further down the route I've been considering chime in. Our approach is to keep our total RE holdings low (only targeting 30k NOI for my wife and my current cost of living) and then loading up on the Vanguard stuff beyond that. I used to think RE was all I wanted, but a few years in this industry has made me reconsider. I want to "own part of the world" through total market index funds. If that ever goes away, we can kiss it all goodbye so why worry long term?

Fast forward ~ 10 years: The wife and I are planning the option to divest out of RE if/when the paper assets get big enough. The idea is to get to FI quick with apartments, then replace it with the low maintenance stuff. This approach is definitely influenced by those 9 layoff rounds. Given some 1950s Leave it to Beaver world, I'd happily chug along for 20 years (I enjoy my job) and just buy funds until we retire.

I'm fairly comfortable with the numbers out of our building and have spent far too many hours researching that world. I didn't intend for that to be the point of my post. We bought our current property in need of some rehab when nobody else was buying so we actually did quite a bit better than 8% on that one and have over a number of years now. This is a small building though and those tend to do better as they're more work per tenant. We're talking 6 units here, not some 150 unit complex. I used 8% to reflect what the market can afford now and it does take some looking of course. The good ones go quick. I believe that 95-99% of the properties in any market aren't worth buying at anywhere near asking price and maybe half aren't worth any price. We looked at hundreds of buildings to find our current one and probably more than that already looking for the next one. It is definitely drying up across the country as things get bubblier in general. I will say that finding a decent rental property is a considerable part-time job. The search is a bit of fun, but the industry seriously lacks integrity and that wears on you. Most sellers are just looking for the bigger sucker so be careful anyone reading this if you go this route. They lie shamelessly. Run away from any listing with the words "pro forma" in it!

I guess my question should have been "given a choice between a real estate investment returning 8% rents on a cash purchase and a balanced index fund portfolio with an expected withdraw rate of 3-4%, why choose the latter?". "Managing the manager" on rental real estate is a part-time job that may not pay well enough for the potential gains seems to be the consensus. I think it pays well now, but am going to plan as though I won't feel that way later on. I hadn't actually considered that since I'm working now, it may not seem like a big deal to have a part-time job. "I'm retired!" may feel better without the side gig. Ha, even if I'm ranting to myself in a forum full of strangers, it's pretty valuable to get that insight. I will offer that some folks spend way too much time structuring and re-balancing their portfolios in retirement in my opinion and I don't like even looking at mine. Funny, actually.

Hopefully, this sounding board will serve some purpose to your community.

Thank you,

Chris

 

[someguy]

FIGuy, 9 layoffs in 7 years suggests to me that you are either making poor job selections up front or you are not very good in your field. If you have simply moved on in a permanent way from the standard job world, then that is fine. But maybe you're just in the wrong line of work?

On the other front, there are a number of current and former RE investors here, including me (mostly now in the latter category myself). BiggerPockets is a good forum and you are way ahead of some of the RE newbies that filter through here, but there is a lot of collective wisdom here and some of it has come through -- vacancy, fire, unexpected capital risks (repairs, lawsuits, etc). I got out of RE because of two primary reasons: 1) I didn't want to be the kind of person that it took to really make money in RE and 2) I found that RE took more time than I admitted to myself and that I'm really good at making more money in other ways. Obviously #1 is a purely personal/subjective thing. With #2, 3-4% on a "standard" portfolio was better when I factored in my time and how it benefited other businesses I have.

 

[steelyman]

This seems a little rough on this guy.

Hopefully, I am not a "newbie", I know I've gotten nice comments, and no one's come over to my house to beat me up yet.

I don't know anything about real estate but that's why you come to places like this.

 

[FIGuy]

Hey folks,

My language was somewhat vague I realize. I survived 9 layoffs in 7 years in the sense that I was NOT fired 9 times, but remember watching grown people crying and being treated like criminals as they packed up their provided box and were gone in 30 minutes of coming in to work. I have thankfully never been laid off in my adult life. This was pretty much industry standard in my field over the past decade for what it's worth and I still love my career and am glad to have chosen it.

I didn't "survive" in the sense that I didn't run off some cliff after being let go / downsized / rightsized / biggie sized / whatever BS 9 times. I agree something must be wrong if I was fired 9 times in 7 years, but I know folks who have pushed half that number while working much harder than I do. Even getting 9 full-time jobs in 7 years seems to be an accomplishment in the USA right now.

I do believe that a lot of people on this forum may share my push to FI as a result of the insecurity of modern corporate life and put that out there to see if anyone else had thoughts on it.

Thanks,

Chris

 

[pb4uski]

My dad had residential rental property and my BIL has one as well. My dad got rid of his - too much hassle with stupid tenants. BIL still has his but he lives less than a mile away but has had long periods of vacancy. Given the hassle/return ratio I would prefer to just stick with stocks and bonds.

OTOH, Dad had (and Mom now owns) a nice commercial rental that is virtually no hassle at all but we have a great long term corporate tenant. I'm still perplexed why they continue to rent rather than buy the building but we're happy to continue collecting rent.

 

[LandlordInvestor]

FIGuy,

Wife and I are using rentals to retire early as well. We self manage currently, but also both hold Full time corp jobs. So far this arrangement is going fine (in year 6) with 8 properties now.

The rentals are a big part of our ER strategy, but we also max out retirement accounts and are building that portfolio too. We are capping a bit higher than 8% on our class C stuff and around 7-8% on our Class A and B stuff. We bought many of them in 07 and 08 and are so happy we did. Not currently in acquistion mode any longer, but will pull the trigger if something falls in our lap.

I think you question was what risk do you see to this strategy. I think its the typical liability issue for us. We keep a large umbrella and might start using LLCs as we get them paid for. We have our management streamlined and don't have any issues with vacancies, late night toilet calls, unruly tenants, or any of the fear - uncertainty - doubt issues that you hear about all over the place.

Exit strategy is something we are always discussing. We own all SFR so I feel we have more options for exiting. OUr ideal plan is to sell them and hold the paper - continue the income stream, but lose the maintenance. If we get into trouble and need cash, we could sell one. I think rentals give you lots of options...

Good luck..

 

[Fishingmn]

I also came to believe rentals are the way to go to finance my FIRE. As a Realtor I could get access to seeing the options out there easily and make money on commissions in buying my own places.

My strategy was to buy all townhouses so that the outside maintenance was not an issue and to buy newer (1995+) so that they would be in better condition and appeal more to most buyers. These are all in outer ring suburbs so they are in nice neighborhoods.

I own 10 properties now (all owned) and estimate my current return at 9.45%. That doesn't factor in depreciation or appreciation. I do all of my own property management so that return would be less if I hired it out.

I have yet to have any tenant issues - I screen pretty well and my properties appeal to a decent type tenant. As a Realtor I actually allow tenants to break their lease if they use me to buy a home and have had 3 clients do that so far which has brought in quite a bit in commission income as well.

This has definitely been a good decision for us - I only wish I'd bought more of them 2-3 years ago when they were so much cheaper. It's getting hard to find anything out there right now as prices are up and there are way more investors in the market. I'm estimating that the homes we have are worth about 30% more than I paid to give an idea of how much things have changed.

Hope that helps.

 

[calmloki]

Rentals pretty exclusively for us for the last 30 or so years. Been real happy with the returns, though we self managed for the majority of that time and still put in way over 5 hours/week. Our units are in Oregon and are mostly one bdrm running around $440. Since 2010 we've spent 1/2 our time down in the sunshine of SoCal - about to head there real quick as Oregon is showing off the grey days we can now afford to avoid.

Divesting is a major problem - Even if we carry the contracts, which are an attractive brain-dead way to assure a certain interest income, the offers on the properties are few and paltry - hard to justify considering them as continuing to rent them out will bring in thousands more/year. Then there is the 25% or better tax hit we stand to take on the fully depreciated value of the places. Now and again I envy the folks who can sell their stocks with a few clicks and don't worry about the "service dog" some tenant suddenly has or dealing with visitors using someone else's parking spot or any of the other BS people come up with and want solved.

 

[FIGuy]

Hey Folks,

I really appreciate the feedback. I definitely agree that self-managing is at least a part-time job and probably full-time some weeks. Some people I've met actually enjoy the interaction and that's great for them. My thinking is that I've trained for my career and actually enjoy it, but won't handle much more stress than what it gives me. For liability reasons alone, I'll let a management company deal with the tenants. Plus, I don't ever want to personally receive some email saying "I can't pay my rent on time" with "sent from my iphone" at the bottom! If I wanted to do property management, I'd start a management company and take care of other people's buildings. Same goes with being a plumber, roofer, painter, etc. The biggest time spent is actually the mental time I've spent worrying over little stuff over the years and that's just in my head. I have learned to ignore that more and trust my management to get things done, which they eventually do. A box of chocolates sent to the staff office every Christmas seems to help. A good management company is the business as much as the assets, maybe more. Most companies aren't great. Our first one was terrible!

I'm almost certain ESR over FIRE is the path for me as I've been thinking about it over the past few weeks and (personally) can't see not working being fun for a long time. The trick will be figuring out how to keep a stimulating career with a non-traditional work schedule that lets me take off for months at a time. I guess cheap pay and no benefits is my leverage? Others seem to pull it off so I'll figure it out.

I'll hit that 30k cash flow with RE and then stop as I'd like to minimize the hassle beyond that. I just want to be FI and work when / how I want and am going to start moving toward that early next year. We'll certainly build toward a higher passive income over time through retirement accounts, my wife's business, any money I decide to earn, etc. But spending the rest of our lives with that little Pittsburgh LLC paying the rent, food, gas for the cheap cars, and enough fun funds brings enough income peace of mind to pay for the stress it generates. It may become a LLC in some other location as the years roll on, but we'll keep it paying the bills wherever it's based.

Good luck everyone!

Chris

 

[sunsnow]

We use rental real estate to fund our basic expenses (about 50% of our investment portfolio). The properties are all under professional management, and even so there is a bit to think about and deal with (maybe 5 hours per week). This has been going on for four years now, and our cap rate looks to be 7-8%. We chose B properties in A neighborhoods. Our typical renters are young single professionals. The viability of rentals varies greatly according to the building and location. I never buy a property I wouldn't live in myself, and have generally found high quality tenants. Anyway, no regrets so far. Good luck to you!

 

[WestLake]

I've bought almost a dozen SFH (and one duplex) over the past 30 years. I've now paid them all off and have been maxing the 401K and Roth (same full-time j*b for 26 years). Would I be FI (assets about $3 million) without the real estate?

Hell no.

 

[knucklehead 61]

i like rental real estate & am currently trying to buy a few more. i have 13 currently, many with no mortgages. most are making better than 10% cash on cash returns.
i plan to fire with about 60 to 70% of my income stream coming in from the rentals, the rest of my 125k gross income will need to come from my taxable equity accounts. should be able to pull the rip cord in 3 years at 50.

 

[eta2020]

Just one word, FIGuy. Mold.

O wait. Another. Litigation.

And while we're at it ... Vacancy.

That is all.

Not quite. Tenants' rights.

+1

maybe some lawsuit

 

[arebelspy]

One thing not discussed very much in this thread: the question in the title. That is, how do you assess the risk?

You can get an 8% cash on cash return net of all expenses, management, etc.? Okay.

That's an average, and doesn't take into account some years will be good, some will be much worse (as multiple repairs, vacancies, etc. hit at the same time), i.e. variance.

How about geographic risk? If all of your properties are in the same geographic area, what happens if that area declines? Your rents decline even while inflation is increasing your expenses.

There are other things to consider beyond "I can get 8%, so I can retire on 375k of real estate to get 30k annually for life."

This thread seemed to split into replies that consist of "I don't do real estate for reasons X, Y, and Z" or "I do real estate, it's part of my FIRE plan," but with not much discussion of the nuances - just simple yes or nos.

Hopefully some will chime in with other considerations not yet brought up.

(Disclaimer: real estate is the vast majority of my portfolio, and I anticipate 100% of my FIRE income to come from rents, with my equity holdings to just sit and compound.)