Can we retire now? How to factor in risk of rental real estate?

[sunsnow]

So, I think DH and I are closing in on FIRE, but I am having trouble telling how close we actually are. I'd like us to have around $100K per year in retirement. DH and I have private individual health insurance, and it is not too expensive, so I don't think that is a big issue in our decision.

Our portfolio in stocks and cash is around 1M. Our investment real estate portfolio is hard to value. We paid around $875 for it, and judging from comparables, I think we could clear around 1M for it today; currently, the net income (after management, repairs, generous reserves, etc) is 60K per year. Between the two parts of our portfolio, it seems like we may have enough to FIRE--but I have a nagging suspicion that I am not doing a good job of taking into account the risk of our rental real estate, so even though I can get the numbers to come out "right", I don't feel any confidence in them.

When I use FIREcalc to run a retirement scenario, I plug in $60,000 as an inflation-adjusted annuity. But real estate income is probably less dependable than a pension. Our real estate portfolio is fairly well-diversified: 10 high quality units in a two different states, and many different (all stable) neighborhoods. The vacancy rate so far has been under 5%, but I only have a couple of years of data.

I am curious as to what people would suggest I do to capture the riskier nature of this investment compared to a pension. For example, I could pretend the real estate is invested in stocks and plug that into FIREcalc. But the FIREcalc tool uses historic stock market performance, which is not the same as historic real estate rental performance--so how relevant would the result really be to my situation?

Just looking for ideas on how people would approach this question: can DH and I retire now?

Thanks and much appreciate any thoughts

 

[MasterBlaster]

On the surface your portfolio and rentals could give you your 100k/year income.

Rental property though doesn't fit nicely into those retirement calculators. The income and maintenance can be irregular. Rents can go with the lifespan of the neighborhood perhaps declining in real terms slowly over the decades. Countb on expensive major repairs every decade or so that will really affect your cash-flow.

You won't find a nice little model for rentals anywhere. Perhaps consider modeling rents falling in real terms (not nominally) maybe 1% a year. It all depends on the neighborhood.

There is no good answer here.

What do you think ?

 

[traineeinvestor]

I have a similar issue in that a large part of our retirement income will come from real estate investments. I "dealt" with the problem by running FIRECalc three times - once just putting in the raw numbers, a second time discounting the value of the real estate by an arbitrary 10% and the third time by increasing my retirement needs by an (also) arbitrary 10%. This is crude and almost certainly inaccurate, but it gives be a measure of comfort that I have not overestimated my ability to maintain our desired lifestyle in retirement.

 

[FIREd]

I had a similar question and almost posted it a few weeks ago.

I basically decided to treat my rental real estate as a COLA'd pension. I figured a very conservative number for rent income net of maintenance, taxes, insurance, vacancies, property management fees, etc... and used that number in the calculators. I figure that using a conservative number upfront helps to compensate for the riskier nature of rental real estate as opposed to an actual pension. The net yield on my rental properties is not that high (right around 3%) and there could better capital allocation opportunities in the future.

 

[HillCountry]

I think FIREd treatment of rental income is more realistic than MasterBlaster. As housing is the major part of living expense. So rental show go up along with inflation.

 

[tryan]

I FIRE'd almost exclusively on rental income ... but I had 15 years of data. The best gaudge will be your view of the future. Having "survivied" the majority of the tumble (2005-2012) ; I'ld say your future is bright.

A few bumps in the road - sure - but no more so than what a market correction will bring.

 

[HillCountry]

Can you please share some of your data, tryan? Or please DM me. Thanks.

 

[sunsnow]

Thanks for the feedback, everyone. Sounds like this is a puzzle for others with rental property -- not just for me. That is reassuring, because at least I don't have to feel like I'm missing something obvious about how to do this. I have been very conservative with my income estimates, and tried to over-estimate expenses. I'm also setting aside about 10% of gross revenue for reserves (roofs, furnaces, etc). That should help with the predictable issues. But there are definitely some big unknowns such as what will happen to a given neighborhood in 40 years...

 

[tryan]

Can you please share some of your data, tryan? Or please DM me. Thanks.

What I used was specific to the properties I own. Cashflow and expense figures going back 15 years for SF properties. To summarize allow/expect: 12% maintenance, 5% vacancy, 10% taxes, 7% insurance (fire and liability), 5% water/sewer, That leaves less than HALF the rents for a mortgage payment (assuming you want to make a profit month to month).

Your results may vary ... I have one in southern NH that takes 3 MONTHS RENT to pay the property taxes (OUCH!)

 

[sailor]

5% water/sewer

Is it common in the places you are landlord to provide water/sewer?
I would expect it to be billed directly to the tenant.

 

[freebeer]

Managing 10 rental units you by definition can't be "retired". You will still have a job: landlord.

 

[pb4uski]

....I am curious as to what people would suggest I do to capture the riskier nature of this investment compared to a pension. For example, I could pretend the real estate is invested in stocks and plug that into FIREcalc. But the FIREcalc tool uses historic stock market performance, which is not the same as historic real estate rental performance--so how relevant would the result really be to my situation? ....

I think you are on the right track. I would make sure the $60k annual net income is realistic and includes a reasonable provision for vacancy and then plug it in as an inflation adjusted annuity.

Another alternative (just for comparison purposes) would be to assume you sell all and pay any applicable taxes and then reinvest in stocks/bonds consistent with your AA.

If each way has an acceptable level of failures, then go for it!

 

[tryan]

Is it common in the places you are landlord to provide water/sewer?
I would expect it to be billed directly to the tenant.

In these parts the town/city bill the land owner and put liens on the property if unpaid. Really don't want the tennie in charge of that.

 

[sunsnow]

Managing 10 rental units you by definition can't be "retired". You will still have a job: landlord.

Freebeer, it's true that owning these properties is more work than having a passively managed portfolio of indexes. Because they are professionally managed, though, it's not really a job. Together, the properties require between 0 and 5 hours a month of work on my part, most of which is due to upgrades I am making to save myself time later.

Another alternative (just for comparison purposes) would be to assume you sell all and pay any applicable taxes and then reinvest in stocks/bonds consistent with your AA.

Pb4uski -- That's an good alternative way of looking at things. I don't pass that test, though. I could clear a little over 1M, which would give me a total income stream of around 80K (20K short of where I want to be). I guess that is one of the reasons I am in real estate -- to juice up the income. But who knows if I should count on being successful at that...

 

[rodi]

I had a similar question and almost posted it a few weeks ago.

I basically decided to treat my rental real estate as a COLA'd pension. I figured a very conservative number for rent income net of maintenance, taxes, insurance, vacancies, property management fees, etc... and used that number in the calculators. I figure that using a conservative number upfront helps to compensate for the riskier nature of rental real estate as opposed to an actual pension. The net yield on my rental properties is not that high (right around 3%) and there could better capital allocation opportunities in the future.

We have a small rental unit - this is how we treat the income projections... very conservative rent estimates, less maintenance/vacancy/taxes expenses.

 

[Meadbh]

Our investment real estate portfolio is hard to value. We paid around $875 for it, and judging from comparables, I think we could clear around 1M for it today; currently, the net income (after management, repairs, generous reserves, etc) is 60K per year. Between the two parts of our portfolio, it seems like we may have enough to FIRE--but I have a nagging suspicion that I am not doing a good job of taking into account the risk of our rental real estate, so even though I can get the numbers to come out "right", I don't feel any confidence in them.

Thanks and much appreciate any thoughts

You paid around $875 K, but what was the total downpayment? Perhaps your returns would be better calculated on that.

 

[clifp]

What I used was specific to the properties I own. Cashflow and expense figures going back 15 years for SF properties. To summarize allow/expect: 12% maintenance, 5% vacancy, 10% taxes, 7% insurance (fire and liability), 5% water/sewer, That leaves less than HALF the rents for a mortgage payment (assuming you want to make a profit month to month).

Your results may vary ... I have one in southern NH that takes 3 MONTHS RENT to pay the property taxes (OUCH!)

I have heard the rule of thumb of 1/2 rents for properties. Still adding up your number it is only 39%. I guess throwing another 8% for property management makes the total 47%. Is there something else I'm missing. In Vegas property tax is a bit less than 1 month rent.

 

[tryan]

Other than mortgage and PROFIT ... no you're not missing anything.

Lot's of first-timers get caught maxing out the mortgage and thinking "well, the rents will cover it" ... completely oblivious to the other 47% (your number).

Then there are the likes of HonoBob who peddle (and own!) $400k condos that rent for $1500/mo. When confronted about the negative cashflow he said things like: "suck it up". How's THAT working out for ya?!?

Anybody with a negative cash flow - eventually - wishes he was DCA into a no load mutual fund (been there, done that).

 

[heyguy]

Other than mortgage and PROFIT ... no you're not missing anything.

Lot's of first-timers get caught maxing out the mortgage and thinking "well, the rents will cover it" ... completely oblivious to the other 47% (your number).

Then there are the likes of HonoBob who peddle (and own!) $400k condos that rent for $1500/mo. When confronted about the negative cashflow he said things like: "suck it up". How's THAT working out for ya?!?

Anybody with a negative cash flow - eventually - wishes he was DCA into a no load mutual fund (been there, done that).

If you look at the actual honobob post he said he bought the $400,000 condo for $35,000 with $2000 down & a 15 yr mortgage and had negative cash flow for only a few years. With about 9% appreciation. & 7% rent increases he's got about $800000 from that $2000: I follow him on bogleheads. There's a link that shows rents have doubled over the last few years



I follow him on bogleheads

 

[REWahoo]

I follow him on bogleheads

Are you a Honohead?

 

[Nords]

Are you a Honohead?

Possibly the honohead himself, "gone traveling"...

 

[blanston]

greaT question

Congratulations on succesfull real estate diversification! But , I have found that most people on this forum don't really know much about this area. I have been a real estate broker, mortgage broker and real estate investor and property manager for many years. My simple rule of thumb is to project 60% of projected income as net. My actual net over the past 5 years has been closer to 72%- I will use 50% as my number for any retirement income projections. And that should be fine. Good Luck

 

[obgyn65]

This is exactly the way I would do it (simulation using an annuity). I would simply spend less money in years with higher vacancy rates.

When I use FIREcalc to run a retirement scenario, I plug in $60,000 as an inflation-adjusted annuity. But real estate income is probably less dependable than a pension. Our real estate portfolio is fairly well-diversified: 10 high quality units in a two different states, and many different (all stable) neighborhoods. The vacancy rate so far has been under 5%, but I only have a couple of years of data.

 

[sunsnow]

Congratulations on succesfull real estate diversification! But , I have found that most people on this forum don't really know much about this area. I have been a real estate broker, mortgage broker and real estate investor and property manager for many years. My simple rule of thumb is to project 60% of projected income as net. My actual net over the past 5 years has been closer to 72%- I will use 50% as my number for any retirement income projections. And that should be fine. Good Luck

That really makes sense. Thanks so much! I'm going to use the 50% of gross rents figure in the COLA'd annuity line. This puts me a little short of my goal, which is what my gut says anyway.

 

[tryan]

$400,000 condo for $35,000 with $2000 down & a 15 yr mortgage

wow .... don't remember those numbers ... and now it's worth $800k (in THIS market) ?!?!

(Welcome back Hono ... I miss you)