Cash out rentals to invest in the markets ?

[fire53]

We have some paid-off rentals that we are in the process of cashing out 850K at a 3.4% interest rate:

1. Plan to invest 50/50 stock ETFs/Bonds but not sure that is the right move as we approach RE. If not, what would you do?
2. We plan to RE in 2-3 years, so we thought it is easier to re-finance/cash out now while we still have jobs.
3. Another reason to refinance now while the rate is still relatively low is that when we RE, we would like to keep our income low so we can qualify for ACA.

Any thoughts or advice is much appreciated.
BTW, we are both 54, I think we can RE now but DW wants to wait for another 2-3, that is another topic but for now, I am following the "happy wife, happy life" advice.

Happy holidays everyone.

 

[Magus]

Personally, I'm more bullish on real estate than the stock market and definitely the bond market (which is stupidly overvalued in current inflationary situation) so I'd probably invest in more rental properties IF you are in a state/county that has reasonable tenant/landlord laws. Can also do that passively now with sites like Fundrise. My AA right now for new money is 50% RE, 35% stocks and 15% cash/bonds/alt investments.

The nice thing about buying rentals with a mortgage is you tend to not have much net income the first few years even with strong cash flow which is helpful towards the ACA.

 

[chassis]

You have the answer, don’t you? Your wife gave it to you.

What do you want to do? In my opinion the market will do at least as well, in fact better in my view, than RE. With no leaky roofs or late paying tenants.

If it were me I would sell the RE and put it in the market.

 

[bobbyr]

I like RE as a diversify portfolio item. Several important items:

• return must make it worthwhile
• good neighborhood that allows for high pricing
• ability to manage it without too much trouble

We've had good results and are pleased. We have a backhouse on a rental, that will be our home base when we are eventually able to travel.

 

[Magus]

Rental returns when done property will always be significantly better than stocks due to low cost interest expense in todays world. Here is the expected first year return for my last rental purchase 60 days ago

1) 237k purchase price on 3/2.5ba townhome in nice part of town
2) 20%+ down plus minor closing cost bring total out of pocket to ~$50k
3) 3.25% fixed, $1,750 property tax, $145/mo HOA (includes insurance), $75/mo maintenance fund
4) Rent of $1,695/month to very strong tenant

$20k/yr income
$14k/yr cash outlay
$6k cash / $50k investment = 12% cash yield
plus $3.8k principal paydown = 7.6% yield
plus $7k principal gain at 3% appreciation = 14% yield
$16.8k net worth gain in one year / $50k outlay = 33.6% ROI
(I do not factor in vacancies since between other fees like pet fees and early lease terminations I usually come out ahead there)

And in a year where property values are going up 10-20%, rents going up 10%+, I've been hitting 80-100% ROI on rentals I bought a year ago, and 150% ROI on rentals I bought 2-4 years ago. These are in all the larger markets in the Carolinas.

Key is to buy properties in nice areas that aren't ancient and are in pretty good shape and only rent to quality tenants. Fortunately, with Zillow/Trulia/etc its so easy to find and screen tenants these days. Every property I've bought in the last 4 years have outperformed my underwriting in the first year. That said, I would never buy a bunch of rentals in states with extreme tenant friendly laws (they also tend to have lower cap rates/ worse returns even without worrying about that)

 

[Starsky]

I definitely endorse the idea of getting all the leverage you need before retiring, as it is very difficult to borrow in ER with no W2 income. It would be great if you have a line of credit to draw from rather than a loan that requires immediate repayment. That way, you can time your investments while managing your monthly loan payment. Investing $850K in the market, and maintaining a minimum 3.5% return looked easy a few weeks ago, but today it's looking much harder.

P.S. Retired at 53 when we made our number and DW was not happy (she wanted a bigger cushion). Had a heart attack at 55 - would have definitely been dead if I kept working - DW's very happy now; and against expectations, we're a lot wealthier now than when we retired. Sometimes you gotta do what you gotta do...

 

[Aerides]

If I had rentals in this market I'd be very tempted to sell. I sold my last home in 2005, at what ended up being a peak that it didn't reach again until this past year.

 

[Magus]

2005 homes were bought with nothing Down, 1 year arms, no income documentation, low credit scores, low inflation environment and massive supply increases. Average home buyer today has pristine credit, huge down payments or entirely cash, strict underwriting, limited supply and new homes cost more to build and inflation is rampant and 95%+ fixed rates. Oh, and institutional buyers have joined the game due to how well rents held up. Very different circumstances.I think we are going repeat 1975-1984 with housing and inflation and prices today will look dirt cheap in 5 years

 

[Finance Dave]

We are "kinda" FIRE'd (I do a bit of handyman work, but only make about $10k/year from it). We have 5 rentals, all paid for. A few thoughts....

1) I got into rentals as a diversification OUT of equities...so cashing out to get into MORE equities would make no sense for me.

2) We are selling our first of the 5 rentals in early 2022 (tenant already out). Our plan is to sell 1-2/year until gone...ideally before I'm 65 (just turned 60). Make sure you understand the tax implications of selling...unrecaptured depreciation impact on ordinary income

3) In general I don't like the idea of leveraging further...adds too much risk IMO...but I know many on here disagree. Consider how you'd feel if you do this and the equity markets drop 20-25% over the following year...that would make my stomach uneasy if I was close to FIRE. If anything, I'd sell the units now while prices are high, and invest the funds into some passive real estate, such as REITs or similar...this keeps your asset allocation/diversification strategy clean

4) To address what some folks have mentioned about it being hard to get a loan with no W-2 income, we opened a HELOC for $200k before we FIREd. We borrowed against it once just to make sure it "worked", but have since paid it down to zero but kept it open. This gives us access to the cash almost instantly.

 

[captain3d]

Similar here with recent cash out refis to take gains out of rentals to rebalance the portfolio of

Rentals
Stocks
Long bonds
Gold
Crypto

Because who knows what the future is going to be. I am sure Ido not want money locked away in the paid off property prison. Also want to minimize taxable income each year while I do Roth conversions.

 

[Another Reader]

Beginning to sound like 2005-06 around here...

Not selling, not leveraging. The portfolio is completely paid off and is currently managed by a property manager. I bring my own people in for rehabs, set the rental rates, and other than that I deposit the monthly net rental check. Some goes to savings for the next decline, some goes to paper investments, and some gets spent.

Looking forward to buying more when the market shifts.

 

[MichealKnight]

Rental homes - I have (3)

I consider rental homes as 2 modes of investment:

Diversity of asset class.
*******************
Crypto! Gold! Reserve Currency! Smarter people than me will decide just how all those things shake out. I just feel that even if the new currency is shark's teeth - people will pay me shark teeth to live in a house. Other than generational crashes like 2008, it's not subject to daily, weekly reactions to talking heads saying "strong buy! "Conviction!" - when many times these people never ran a lemonade stand. Again I'm not saying it'll be better than stocks, I dont' expect that. Americans send in the 401K money every payday, and you got more and more money chasing the same few stocks so of course , long term stocks return strong.

It's the bond section of my portfolio
*****************************
And long term I want physical real estate - to be at parity in my AA with stocks.

I feel I'll get the diversifying I mention above, and realistically.

Put side leveraging and mortgage which can increase ROI, for simplicity pretend I pay cash - which I did on my last townhome in metro Atlanta.

At these nutty high prices - I think my pure yearly ROI is 3.6-3.75%

IF homes appreciate....3% per year....an I hold the home five years....

After all transaction costs, my ROI annualized is 5.5% and this is after ALL maintenance, repairs, etc. And of course, any travel, hotel, lunches, office supplies will also be charged against taxes.

But, legal depreciation....keeps the profit in my LLC at almost zero....which means, the 1st $80,000 or so of Qualified Divs and Cap Gains - are 0% taxed. Also, it keeps my income at an advantageous level for ACA subsidies. Yes, in the end there will be depreciation re-capture taxes, but with luck maybe I can sell a house in a year where I don't sell stocks . Also, it's uptown each individual and their CPA just how ..... skilled they want to be to lower depreciation recapture taxes.

I fully realize it's not great ROI but again, for me it's diversity of asset classes and if I hit 5%+ on something I don't consider that high risk, at least for the next 5-7 years...oh well, I'll take it,

There's other benefits that can be legally harvested....but to avoid judgement I won't write those here but again, that's up to you and your CPA. And yeah, I'll admit....it sort of makes me feel I'm still "somebody"....as I've gone from having businesses that had 40 employees+ and tons of sales.....to hanging out at home

 

[MichealKnight]

One more thing....

Right now I keep (5) years cash in bank at 0.5% FDIC, up to 1.25% non FDIC. But I am strongly considering stealing from the cookie jar.....and taking 1-2 years of that cash, buying a townhome..... earning 3.5% on rent.....and then sell it when I need to pay for college, etc.

 

[calmloki]

A lot of talk about relying on HELOCs before retirement or selling or whatever. Don't I recall banks closing HELOCs during at least one of the financial difficulties? Like 2010 era?
If the value of the securing property drops significantly and below the potential amount of the HELOC the bank can turn off the spigot:
https://www.mortgageloan.com/heloc-cancellation-are-you-at-risk-2439
Just saying, we all take varying amounts of risk. We have a fair amount of paper cash on hand - we earn nothing from it and risk theft or government dissolution, but maybe reduce the risk of banks closing their doors or saying "no, we know we said we'd loan to you, but new deal - we won't".

 

[ducky911]

So if I am reading this right you are taking a loan out to invest in the market.
good news I think the interest will be deducted against rental income.

I also have paid off rentals in California that I can't sell for the tax bill (30% state plus fed).

I have always been against the idea of getting a loan to put $ into the stock market. And really against a loan to buy bonds.

 

[OldShooter]

Borrow money to invest in the market? What could go wrong? Market returns are guaranteed, right?

William Bernstein on investing for retirement: “Make no mistake about it: The object of this particular game is not to get rich – It’s to not get poor.”

 

[Magus]

One more thing....

Right now I keep (5) years cash in bank at 0.5% FDIC, up to 1.25% non FDIC. But I am strongly considering stealing from the cookie jar.....and taking 1-2 years of that cash, buying a townhome..... earning 3.5% on rent.....and then sell it when I need to pay for college, etc.

You can get much higher cap rates investing in the sun belt for rentals and with less risk for tenant friendly laws. 6-10% cap rates are standard in most of the sun belt and others areas of the south, plus strong rent growth. I do have some with Fundrise where I can't manage myself.

I agree with you though that rentals are the bond part of my portfolio. Rents barely dipped in 2008-2009 and only in the extremely overheated markets - most of the US didn't drop at all. With tax deduction and low interest %, I still prefer to put a 3% mortgage on rentals, though with about 65% LTV although I did buy one townhome all cash this year for $200k + $10k in repairs/upgrades.

 

[Another Reader]

You can get much higher cap rates investing in the sun belt for rentals and with less risk for tenant friendly laws. 6-10% cap rates are standard in most of the sun belt and others areas of the south, plus strong rent growth. I do have some with Fundrise where I can't manage myself.

I agree with you though that rentals are the bond part of my portfolio. Rents barely dipped in 2008-2009 and only in the extremely overheated markets - most of the US didn't drop at all. With tax deduction and low interest %, I still prefer to put a 3% mortgage on rentals, though with about 65% LTV although I did buy one townhome all cash this year for $200k + $10k in repairs/upgrades.

Really? How are you calculating the cap rate? In Phoenix, good luck getting anywhere near those rates at current prices and rents...

 

[Magus]

Really? How are you calculating the cap rate? In Phoenix, good luck getting anywhere near those rates at current prices and rents...

Cap rates equal to (annual Cash rent - all ongoing cash expenses (no mortgage) excluding maintenance - maintenance reserve of 5-10% of revenue) / purchase price. Levered is obviously higher returns.

I haven't personally bought any in Phoenix but my returns in Fundrise with locations there are easily seeing that. Most of my investments have been in Charlotte and Raleigh but you also have to know the best types and locations to buy for rentals 2 and 3 bedroom townhomes in the up and coming nice but not rich part of town tend to have the best cap rates that I've found. They tend to be too small for most homebuyers looking to move out in the burbs but renters barely discount the rent vs a 400-600 sq ft larger SFH. YMMV a bit. 4 Bedroom 2.5 bath SFHs that HAVEN'T been upgraded also make great rentals with strong cap rates. One of the main mistakes rental investors make is thinking renters value things like a buyer would, and that simply isn't the case. Also, a lot of landlords still haven't figured out rents have gone up 15-20% in the last 15 months.

 

[captain3d]

Borrow money to invest in the market? What could go wrong? Market returns are guaranteed, right?

William Bernstein on investing for retirement: “Make no mistake about it: The object of this particular game is not to get rich – It’s to not get poor.”

Every person who holds stocks/bonds AND a mortgage are borrowing to invest.

I think that is a good idea

 

[captain3d]

Rents and property price ratios vary dramatically

In SF California a $1mill property rents for $3500 a month.

In Columbus OH $1mill of properties rent for $10,000 a month

I choose to rent where I live and invest in other places.

 

[Another Reader]

Cap rates equal to (annual Cash rent - all ongoing cash expenses (no mortgage) excluding maintenance - maintenance reserve of 5-10% of revenue) / purchase price. Levered is obviously higher returns.

I haven't personally bought any in Phoenix but my returns in Fundrise with locations there are easily seeing that. Most of my investments have been in Charlotte and Raleigh but you also have to know the best types and locations to buy for rentals 2 and 3 bedroom townhomes in the up and coming nice but not rich part of town tend to have the best cap rates that I've found. They tend to be too small for most homebuyers looking to move out in the burbs but renters barely discount the rent vs a 400-600 sq ft larger SFH. YMMV a bit. 4 Bedroom 2.5 bath SFHs that HAVEN'T been upgraded also make great rentals with strong cap rates. One of the main mistakes rental investors make is thinking renters value things like a buyer would, and that simply isn't the case. Also, a lot of landlords still haven't figured out rents have gone up 15-20% in the last 15 months.

I think you make some astute observations about profitable niches but you omit vacancy and collection loss from your calculation. Based on the solicitations I receive from the i buyers and local partnerships plus smaller institutional investors, current cap rates with stabilized expenses look like 3 to 5 percent. I don't see a good exit strategy when interest rates and unemployment rise. I'm a "hold" in this market.

 

[Another Reader]

A lot of talk about relying on HELOCs before retirement or selling or whatever. Don't I recall banks closing HELOCs during at least one of the financial difficulties? Like 2010 era?
If the value of the securing property drops significantly and below the potential amount of the HELOC the bank can turn off the spigot:
https://www.mortgageloan.com/heloc-cancellation-are-you-at-risk-2439
Just saying, we all take varying amounts of risk. We have a fair amount of paper cash on hand - we earn nothing from it and risk theft or government dissolution, but maybe reduce the risk of banks closing their doors or saying "no, we know we said we'd loan to you, but new deal - we won't".

Wells Fargo and a couple of other majors have shut down HELOC lending. I have a useless HELOC with Wells. I also have a lot of cash hanging around with no job to do. I am reluctant to commit to any other asset class in the current environment. Sometimes, doing nothing is the best choice...

 

[Magus]

I think you make some astute observations about profitable niches but you omit vacancy and collection loss from your calculation. Based on the solicitations I receive from the i buyers and local partnerships plus smaller institutional investors, current cap rates with stabilized expenses look like 3 to 5 percent. I don't see a good exit strategy when interest rates and unemployment rise. I'm a "hold" in this market.

Actually if anything I'm being very conservative. I am averaging a negative effective vacancy with < one week turn around between openings combined with 1 out of 2 tenants paying 1 to 2 months to vacate their lease early (and they let me show it one Saturday or Sunday afternoon for 4 hours usually). Plus things like pet fees and security deposits usually cover most of the actual repairs and maintenance so my actual maintenance has averaged closer to 2%. Anyone that has more than a month vacancy is overcharging on price. 5 weeks of vacancy is effectively a 9% reduction in price.

On the issue of collections - Never have had any. I only rent to 700+ credit with at least 3.5x income to rent and a stable history or require monstrous security deposits. Most of my tenants pay early, some several weeks early, and I've even had tenants do capital improvements on my properties believe it or not. I'm sure I'll eventually have one - I am up to 9 rental properties now - but not even during covid did anyone get more than 14 days late. I keep very good relationships with my tenants - I even sent one to Hawaii this year with some of my HGV timeshare points with her partner. I've found that goes a lot of ways to keeping your place in good shape, the payments continuing and if something bad does happens being open and flexible.

 

[foxfirev5]

Wells Fargo and a couple of other majors have shut down HELOC lending. I have a useless HELOC with Wells. I also have a lot of cash hanging around with no job to do. I am reluctant to commit to any other asset class in the current environment. Sometimes, doing nothing is the best choice...

Yes and regarding Calmoki's post. Back in '06 and '07 DW and I made note of the number of cranes on high rises in SE FLA. We promptly paid off our HELOC and mortgages. By 2010 the HELOC was cut in half and many of the small business owners I dealt with had their line of credit pulled. 40 year businesses down the drain. It can happen again.