Greetings - 50YO Male with rental real estate

[pdoherty972]

Glad I found this forum - it discusses the FIRE concept which is something I've been working on for years (trying to invest/save for FI and prepare to retire early) but didn't know there was an acronym for it. Any advice is appreciated on how best to arrange things to FIRE sooner rather than later.

Portfolio:

- 366K in 401K/IRA accounts.

- I have my personal house plus 5 more single-family-home rental houses, with a combined equity of 618K (170K of that is equity in the house I live in). Removing my personal house equity leaves 448K in rental home equity. The rental houses pay for themselves, cashflowing together about $1500-$2000 a month which covers maintenance expenses and if any vacancy occurs. Total combined value of houses (not equity) is 1.37 million (my house being 400K of that).

- I have 100K in money-market/savings/checking.

The real estate market is hot around here and I've been considering cashing in one or more of the rentals for their appreciated value. But if I do I'll pay 15% capital gains (plus the costs to sell) unless I 1031 into a new property (which I'd like to do but that same high-priced environment that makes me want to sell also makes me not want to be buying). Is there some better investment I could do with proceeds of a house sale?

Any advice appreciated.

 

[rodi]

Welcome pdoherty972 -

I don't have any advice on whether to sell/cash in one of the houses, but wanted to offer welcome to the forum.

 

[Senator]

Do not forget, you will pay a 25% tax on any recaptured depreciation. You may pay more than 15% capital gains too. Plus RE commissions.

Keep saving. Only $100K in an after tax account can go fast, if you have to live on it, and get a bad tenant and need a lot of repairs.

What are your mortgage interest rates? That may be the best risk-free return you can make, and give you additional cash flow.

I have most of my buildings paid off. You are getting only ~sub 4% on your equity, with plenty of risk. I would suspect that more put towards principal would give you a better return.

 

[pdoherty972]

Welcome pdoherty972 -

I don't have any advice on whether to sell/cash in one of the houses, but wanted to offer welcome to the forum.

Thanks!

 

[pdoherty972]

Do not forget, you will pay a 25% tax on any recaptured depreciation. You may pay more than 15% capital gains too. Plus RE commissions.

Keep saving. Only $100K in an after tax account can go fast, if you have to live on it, and get a bad tenant and need a lot of repairs.

What are your mortgage interest rates? That may be the best risk-free return you can make, and give you additional cash flow.

I have most of my buildings paid off. You are getting only ~sub 4% on your equity, with plenty of risk. I would suspect that more put towards principal would give you a better return.

Thanks for the feedback. I forgot about depreciation recapture, you're right.

Is it normal to discuss return on equity as opposed to return on what I actually put down, cash-wise, to purchase the houses (downpayment)? The additional equity is, of course, from the rent paying down the mortgage, and from value appreciation in the market. The way you're calculating it, the houses become less and less of a good investment value years after purchase, even though they're cashflowing as much or more, have less owed on them, and are worth more.

I guess what you're really saying is the amount of value tied up in equity is only returning ~4%? But even there I'd question whether that's a valid calculation. Real estate in this area has run up 8-10% each year the last two years. Plus, as mentioned they are having less owed on them every year as well due to paydown (by the renter) of the mortgage amount owed. That paydown and value increase from the market increase are additional "invisible" income (above the actual cashflow) that equals tens of thousands per year, per house.

 

[papadad111]

I think you're too leveraged for your low amount of liquidity and overall net worth. I would de-lever.

You're one or two bad tenants plus a normal bear market away from losing all that equity.

 

[pdoherty972]

I think you're too leveraged for your low amount of liquidity and overall net worth. I would de-lever.

You're one or two bad tenants plus a normal bear market away from losing all that equity.

So are you saying then that I should liquidate some of the rent houses and invest it into something more liquid like an ETF? Is there a rule/guideline you follow for knowing when you have too much equity in them and should spread it out more? I sort of did this recently (~1 year ago) as one of the rentals (when I had 3) was completely paid for; I took an equity loan out for about half its value (leaving it still cashflowing nicely) and used the proceeds to buy two more, bringing me to my current 5 rentals.

 

[Senator]

So are you saying then that I should liquidate some of the rent houses and invest it into something more liquid like an ETF?

I would say keep maxing out your 401K, IRA, HSA and save all of that $2K a month until you get a larger after tax account balance. It can be stocks or bonds, but needs to be available for the inevitable $10K+ fix you will have to do.

Does your rental income include 10% of rents for maintenance? Do you do the maintenance yourself, or hire it out?

You say you account fro vacancy. Do you set aside 5% of rents for vacancy?

Do you have enough to pay all mortgages for 6 months? It appears you owe ~$750K, and only have $100K as a back up. To me, that is not too much.

 

[pdoherty972]

I would say keep maxing out your 401K, IRA, HSA and save all of that $2K a month until you get a larger after tax account balance. It can be stocks or bonds, but needs to be available for the inevitable $10K+ fix you will have to do.

Does your rental income include 10% of rents for maintenance? Do you do the maintenance yourself, or hire it out?

You say you account fro vacancy. Do you set aside 5% of rents for vacancy?

Do you have enough to pay all mortgages for 6 months? It appears you owe ~$750K, and only have $100K as a back up. To me, that is not too much.

Interesting feedback, and good food for thought, thanks. I can't imagine what scenario could occur that would require me to pay the mortgages of all 5 houses myself (seems to assume all 5 will be without renters at the same time). In my experience this is extremely unlikely, and if it did occur by extreme chance it wouldn't be for more than one month. And if it did go for a month I could list any of the houses and liquidate them in 45-60 days, netting the profits after taxes from the significant equity I have in each.

I felt it was wasteful having 100k just sitting on the sidelines earning next to nothing, but the feedback I'm getting here is making me question that (since you guys are indicating it's not enough).

 

[robertf57]

Thanks for the feedback. I forgot about depreciation recapture, you're right.

Is it normal to discuss return on equity as opposed to return on what I actually put down, cash-wise, to purchase the houses (downpayment)? The additional equity is, of course, from the rent paying down the mortgage, and from value appreciation in the market. The way you're calculating it, the houses become less and less of a good investment value years after purchase, even though they're cashflowing as much or more, have less owed on them, and are worth more.

I guess what you're really saying is the amount of value tied up in equity is only returning ~4%? But even there I'd question whether that's a valid calculation. Real estate in this area has run up 8-10% each year the last two years. Plus, as mentioned they are having less owed on them every year as well due to paydown (by the renter) of the mortgage amount owed. That paydown and value increase from the market increase are additional "invisible" income (above the actual cashflow) that equals tens of thousands per year, per house.

Just some thoughts. I would suggest you be very careful in considering the the economic benefits of you rentals. For example, the pay down of your mortgage that you attribute to your renters is actually double counting those rents and, as was seen in the last downturn, there is no way you can count on an 8% to 10% increase in value each year. Return on equity is an important metric. Money is fungible: what you have tied up in your rental real estate could be deployed to other assets. It is quite appropriate to evaluate your real estate by considering what the equity could do for you in another investment.


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[Senator]

Interesting feedback, and good food for thought, thanks. I can't imagine what scenario could occur that would require me to pay the mortgages of all 5 houses myself (seems to assume all 5 will be without renters at the same time). In my experience this is extremely unlikely, and if it did occur by extreme chance it wouldn't be for more than one month. And if it did go for a month I could list any of the houses and liquidate them in 45-60 days, netting the profits after taxes from the significant equity I have in each.

I felt it was wasteful having 100k just sitting on the sidelines earning next to nothing, but the feedback I'm getting here is making me question that (since you guys are indicating it's not enough).

It is unlikely. I had a mortgage that required me to have that much in the bank to qualify. In addition to 30% down and a 740+ credit score. I figure there must be some statistic out there that they created that criteria from.

You could easily have two move outs at the same time. Both needing cleaning, carpet, and paint. Maybe a few other fixes or appliances, and a month+ of vacancy to do the work. Most tenants look 6-8 weeks out to rent. If you are unrealistic in your rents, you could go vacant longer than a month.

I turn apartments, do maintenance, advertise, show and do virtually 100% of the work on my 25 rentals. 11 turns last year, only about 90 days vacant between all of them, and that was planned for maintenance, mostly on one unit. I work FT too, so I have to take a bit longer...

It doesn't take too much to spend $10K on a property. If you rent to subpar tenants, your maintenance bills will be considerably higher than 10% of rents.

You do not need a special account, but you need ready access to cash. An investment account, a HELOC, credit card, hard money lender, etc. A 401K loan is not going to do it for you. It can be invested in the market, but know you have to sell if/when you need it. I have ~$80K cash in various accounts. Plus plenty of stocks $400K+ in an after tax account. plus a $180K HELOC. Plus 25 rentals that are mostly paid off, 8 building, 3 mortgages. And no mortgage for my own home.