Question re: Income stream preferences

[Lisa99]

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.

 

[Major Tom]

I wonder how long it will be before someone mentions Wellesley.......

 

[FIREd]

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.

 

[Lisa99]

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.

 

[MichaelB]

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?

 

[Lisa99]

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.

 

[haha]

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.

Ha

 

[Bestwifeever]

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.

 

[Lisa99]

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.

 

[MichaelB]

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?

 

[Lisa99]

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!

 

[FIREd]

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...

 

[Nords]

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.

 

[Lisa99]

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.

 

[akck]

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.

 

[Lisa99]

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.

 

[67walkon]

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.

 

[Onward]

I don't want any more rental property.

Same here. Been there, done that. Give me portfolio income any day.

 

[Tif7]

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.

T

 

[sheehs1]

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.

 

[haha]

Lisa have you considered the tax implications of your income streams from rental properties against tax free stock market investments

Could you explain what a tax-free stock market investment is? Where is it found?

Ha

 

[Aiming_4_55]

Rentals would be my choice but agree with all the points on maintenance, vacancies, capital repairs.... add liability/lawsuits as a concern for me. Also, timing may be a factor for you. I'm 42 now with rentals and a very small mortgage... holding onto cash for a lowball offer on a future REO. I plan to hold at least for 12 - 15 more years then reduce holdings, but hold the best as income. I manage all the properties now and put it toward my slush fund & kid's 529 fund.

I'm very diversified now and plan to be in ER ... small pension at 55 or delay until 62 for more. I will probably delay until 62 and select survivor benefit at 100%, but depends on our health.

I'm conservative with 2 young kids, so I plan to have my barebone budget mostly funded by rentals. Equities to be my mad money (vacationing) and back-up (can cover 100% barebone budget at 4% SWR).

 

[Ed_The_Gypsy]

Real estate is not liquid. And it is a pain. And you can lose money (like anything else).

I would go/am going with stocks and mutual funds. If you want real estate, buy REITs (try Vanguard's index fund). You can sell them in a day. You can move and take long vacations and not worry about being an absentee landlord.

 

[arebelspy]

2. Income is the same after tax for both the real estate and stock market choices.

Given the above from the first post, and independent of market conditions, paper.

Though personally if I were in your situation, being a dirty market timer, I may stick with real estate for a decade until prices pick up (and they will, it's cyclical) and then exit to a mix of stocks and bonds.

 

[sheehs1]

Could you explain what a tax-free stock market investment is? Where is it found?

Ha

Ha, I'm talking about tax free muni bond funds, ETF's and even some closed end funds. There are closed end funds trading at double digit discounts (bought for 75 or 80 cents on the dollar) yielding 6% 8% and some at double digit returns (12%, 13%). For some of the closed end funds some percentage of the monthly or quarterly distribution can be made up of return of capital which makes it tax advantageous. Return of capital is not necessarily a negative IF the fund has unrealized gains it has not taken specifically to make the distribution tax advantageous by "categorizing it" as return of capital. Some are managed with this specific purpose in mind.

All of these trade like stocks which is probably why I categorized it as "tax free stock market investments". I own a few of these closed end funds now. Bought some at deep discounts. Some are now trading at a premium...so not only did I get the higher yield typically associated with a well managed closed end fund , I have gotten appreciation on top of it (at least for now). Where are they found? My broker recommended some and I researched them. Nuveen , Eaton Vance, Blackrock, Principle...all have them. You can do some research at either each of their investment websites or at
www.cefconnect.com/
I was a little skeptical of this niche in the stock market until I did further reading and investigation and then saw what the funds I was interested in invested in. These funds are as varied as the market. You can buy all stock funds, or bonds funds or balanced funds (returning 8%), funds that write covered calls using their core portfolio...which helps give them the yield (figure they can do it better than me)....etc. Best to buy at a discount....and sell as it reaches a premium. Might take a while or might not.
Also, they trade like stocks, meaning when you sell that is the price you get rather than waiting for an "end of day" price like we have to do with mutual funds.
Hope that answers your question. I think there is a thread on here about "closed end funds" too.