Retiring with $0, or negative, net worth

[FUEGO]

In theory, properties that yield cash flow of $50k a year have some value to them (even if they are fully mortgaged). Residential owner occupied appraisals don't consider discounted cash flow as a method of valuation, but commercial or rental properties can. Hence, you may actually have a valuable asset.

In reality, I would need more than $50k cash flow from fully leveraged rentals to make me feel comfortable expecting $40k a year in perpetuity. Let's say I have $300,000 a year in rental revenue and $250,000 a year in expenses. My cash flow is $50k. Oops, the recession hits, unemployment shoots up a few points, and my new rental revenue drops by 20% (to $240,000) due to lower average rents and higher vacancies. Now I am cash flow negative by $10,000 a year. ER plans fail.

 

[Meadbh]

The most important purpose of having a positive net worth in retirement is to generate income (i.e. cash flow). Any asset that generates income (including property) can be assigned a value. For an individual without significant net worth, the only ways to generate cash flow would be with a sustainable annuity or pension.

 

[arebelspy]

I figured using real estate may be a bad idea cause people would get hung up on that and the many aspects and risks involved, but I basically got my original question answered, so this diversion is fun.

And is raising other questions to think about.

So the last 3 posts in a row said that a property that is generating income, even if fully leveraged, has value. None said, however, how one might calculate that.

Anyone have ideas on that?

I'll make up some nice round numbers in case having an example is easier. 100k house. 100% financed. Cash flows 5k/year (after taxes, insurance, etc etc .. and a property manager, for those that hate landlording ). Is worth $0 on the owner's net worth balance sheet (100k asset offset by 100k mortgage liability). How does one calculate the "worth" of that asset then?

Just pretend it's a 5k/year annuity I suppose? Any other ideas?

In reality, I would need more than $50k cash flow from fully leveraged rentals to make me feel comfortable expecting $40k a year in perpetuity. Let's say I have $300,000 a year in rental revenue and $250,000 a year in expenses. My cash flow is $50k. Oops, the recession hits, unemployment shoots up a few points, and my new rental revenue drops by 20% (to $240,000) due to lower average rents and higher vacancies. Now I am cash flow negative by $10,000 a year. ER plans fail.

Good point. At what point would you feel comfortable? If you could sustain a 20% drop and still have enough cashflow to cover expenses? A 30% drop?

This gets back to the cushion idea from earlier in the thread, and the comments of not being able to project risk. Still curious as to your response.

 

[Meadbh]

I'll make up some nice round numbers in case having an example is easier. 100k house. 100% financed. Cash flows 5k/year (after taxes, insurance, etc etc .. and a property manager, for those that hate landlording ). Is worth $0 on the owner's net worth balance sheet (100k asset offset by 100k mortgage liability). How does one calculate the "worth" of that asset then?

Just pretend it's a 5k/year annuity I suppose? Any other ideas?

Exactly.

 

[arebelspy]

Exactly.

Alright. So what do you count the "worth" of a property as: the amount the cashflow as an annuity would be worth, or the equity?

If you sold, you'd get the equity. If you don't sell, you get that annuity-like cashflow, but can't ever access the equity.

When or how do you decide to value that property as one or the other?

 

[fritz]

See, this is what I DON'T want to do. No offense, I think it's amazing you have that extra amount (honestly, I'm really impressed at that), and I'm sure it helps you sleep easy.

I just don't want to keep building and building my net worth, which to me is just a number, and delaying retirement to do so. I want to retire with enough money to support me. Not with a big net worth, unless those happen to coincide.

Your ideas on a cushion are spot-on, and the cushion amount is different for everyone. I'd like to build up a cushion (/emergency fund/what have you) that's enough to sleep easy and have as a small fallback, but other than that, not worry about net worth at all, just income.

The social security was another great example of this, thanks Gumby!

I think you missed my point with your comment about building up more and more net worth. I only gave you my experience (what it took for me to bow out of the work-a-day-world rat race) as an example of an allowed cushion in my available cash flow.

I have been fortunate in that although I don't have 15~20 real estate rentals - I have been able to save/invest enough to tell myself that I have sufficient cash flow to retire. A lot of responses somewhat point to those "what if" scenarios where cash flow cushion planning is appropriate. I would compare my example to yours like as if you only needed 80% of the rental cash flow to retire on, or that you required only the rent from 12 of the 15 houses owned to pay your bills.

If you had enough cushion in your current real estate cash flow that allowed for contingencies in your retirement - what's the difference?

 

[clifp]

A rental properties, pensions, royalty checks any form of cash flow has a value associated with it. You can figure it easily enough with financial calculator and plug in, the cash flow, the number of payments (generally equal to your life expectancy) and interest rate.

I would say that even in today's market it is pretty much impossible to have a property that is cash flow positive that doesn't have positive equity.

 

[audreyh1]

Funny REWahoo.

I think you two missed the point of my question, though, especially when I noted that this wasn't specifically about real estate, that was just the most convenient example of something generating cashflow while having no net worth. A stock paying dividends could give cashflow, but then you'd likely have net worth based on the stock.

That's why being broke with a pension was the other example I gave.

But alright then, if you two are stuck on the Real Estate thing being work.... Change the original scenario to say you have 17 houses, and the cashflow from those two extra houses pay a management company to handle all of them (and everything else is already included, taxes, maintenance, etc). Or say that was already included in the 15 houses. Whatever.

Comments?

I don't see how you can own several properties, and getting enough income from them to live on after all the expenses, and have no net worth. Seems like if you didn't have any equity, most of your income would be going to all your expenses and paying loans until you did build some equity and the expense/loan payment burden reduced.

Audrey

 

[Gumby]

I'm not certain the OP owns any real estate at all, although his responses have been a little coy about that. I took his initial post as a mere hypothetical, although I am not yet certain what his ultimate aim may be.

 

[calmloki]

I don't see how you can own several properties, and getting enough income from them to live on after all the expenses, and have no net worth. Seems like if you didn't have any equity, most of your income would be going to all your expenses and paying loans until you did build some equity and the expense/loan payment burden reduced.

Audrey

You know, I agree that the rental scenario is very unlikely, but it just dawned on me that that is just the scenario we offered to a young man who may figure large in our estate. Suggested selling him several of the properties for no money down and interest only payments at market value. He would make annual income because of the limited outflow and depreciation, we would pay no taxes on the sale until we received some principal payment (like never?) and our income would all be interest income and not too far off our current rental income - like selling and putting all the proceeds in a fat savings account.

Seemed like he would have very low risk - if property values went up he would gain equity, if they went down he could walk away from the property. He opted not to take the offered deal.

Thinking about it, I'm not sure he would have had any value had he opted for the deal - if he sold right off the bat he wold have lost 6% - fair market value minus RE commission. Over time he might have made money if values went up, but otherwise his only value was having a rental management job. If he walked away from the job he would have had nothing but past earnings. Do we say that a job has a value? Can you sell a job?

(one of the issues for him would have been loss of stepped up basis if he inherited property at our deaths rather than forgiveness of loan.)

 

[tryan]

Many teachers in MA retired with 80% of thier pay. Apparently there was a short window opened to get some of the more seasoned to retired.

I am sure many jumped with little/no NW ... I would too.

FWIW, it would be very difficult to generate a living with upside down property. Rents will drop around you as your neighbor pays significantly less for his house and undercuts your rents (stealing your best tenants).

 

[tryan]

Suggested selling him several of the properties for no money down and interest only payments at market value.

He'll be kicking himself in a few years ... I would have jumped on that one (in my youth).

 

[rescueme]

For an individual without significant net worth, the only ways to generate cash flow would be with a sustainable annuity or pension.

Or a wor*ing spouse that's willing to share ...

 

[Mulligan]

Many teachers in MA retired with 80% of thier pay. Apparently there was a short window opened to get some of the more seasoned to retired.

I am sure many jumped with little/no NW ... I would too.

FWIW, it would be very difficult to generate a living with upside down property. Rents will drop around you as your neighbor pays significantly less for his house and undercuts your rents (stealing your best tenants).

That is essentially what I did. I have a small amount of assets that can cover various emergencies, but will NEVER be enough to be a meaningful stream of income to live off of. A poster from a previous thread said my pension was equivalent to a 1.8 million annuity which I had never thought of it that way.

 

[Spanky]

A poster from a previous thread said my pension was equivalent to a 1.8 million annuity which I had never thought of it that way.

That's a very generous pension. Assuming a payout of 25 years and an inflation rate of 4%, a net present value of $1.8 million equals to annual payment of $80,000 (inflation adjusted).

 

[Independent]

I can't get my mind around the idea of someone getting $50k from real estate without putting in any capital or labor. So the hypothetical just doesn't compute for me.

Taking a more realistic case, if I had some combination of SS and a CPI-adjusted pension that provided all my likely expenses plus a 10% annual cushion, I could imagine retiring.

The risk is that my actual spending won't follow the CPI. That may be offset by some conservatism in my spending estimate (I may have some luxuries in there that I know I could give up in response to bad times.)

Personally, I'd work a couple more years.

 

[arebelspy]

I'm not certain the OP owns any real estate at all, although his responses have been a little coy about that. I took his initial post as a mere hypothetical, although I am not yet certain what his ultimate aim may be.

Heh, sorry, I wasn't trying to be coy, just trying not to focus on the particulars of my situation or even real estate in general, just trying to get at the idea of retiring based on cash flow rather tan net worth.

Estimating the value of said cash flow as an annuity is the key idea I hadn't thought of.

Not that it matters, but I do have 3 rental properties. One of them is indeed upside down, but providing positive cash flow.

Thinking about this, I took the idea to the logical extreme of "what if I had a bunch of properties, all providing cashflow, all of which were 100% financed or values had dropped so you had no equity, could you retire with no net worth."

I also am a few years into a job with a COLA'd pension, and wanted to know about living just off cash flow, rather than building up a huge net worth.

In any case, there is huge other issues with relying on one source of income, with having real estate, with being a landlord, etc. etc., which is why I didn't want to sidetrack into those discussions.

But my basic question was answered (i.e. it's not that you have no net worth, you do have net worth by treating the cash flow as an annuity.. the problem is that if you sell, you have basically no net worth, so you have no liquid net worth)

The social security example was another good way to think of it.

Thanks for the thoughts everyone!

 

[arebelspy]

I can't get my mind around the idea of someone getting $50k from real estate without putting in any capital or labor. So the hypothetical just doesn't compute for me.

I never said they didn't put in any capital or labor. Just that said equity (cash or sweat) no longer exists.

Plenty of people right now have real estate that they put in capital or labor, but is not adding to (or is even subtracting from) their net worth.

 

[Spanky]

I can't get my mind around the idea of someone getting $50k from real estate without putting in any capital or labor. So the hypothetical just doesn't compute for me.

I am not sure why so many posters exert so much energy on hypothesis. What's the real scenario faced by the OP?

If the income stream (or cash flow) is predictable, reliable and sufficient to fund all your future expenses, you can retire!

 

[SecondCor521]

Anything that throws off $50k a year in net passive income has economic value, whether that is a spouse, a business, a website, a SS check, a pension, annuity, stock, bond, TIPS, real estate, or whatever.

The actual dollar value depends on the risk of continuing to receive the $50k a year into the future. The lower the risk, the higher the economic value -- TIPS that throw off $50k per year may be assigned a relatively low "risk" of 2%, so the $50k / 2% = $2.5 million. The higher the risk, the lower the economic value -- real estate in a bad part of town may be assigned a relatively higher "risk" of 10%, so the $50k / 10% = $500k.

If you have $50k in income and are assigning it a value of $0, then either the risk is infinite (perhaps you believe that the US dollar is going to experience hyper-inflation in the next few months), or you are mis-pricing the value or the risk.

2Cor521

 

[kcowan]

I think the issue is one of confidence in those cashflow projections. If they are close to 100% along with a COLA, then they are better than most pensions.

Properties can indeed supply positive cashflow when their equity would suggest otherwise. This is the inefficiency in the rental market reflecting a lag to current market values. How many renters in Las Vegas have had their rents reduced by over 40%?

 

[haha]

Anything that throws off $50k a year in net passive income has economic value, whether that is a spouse...

How is the market for spouses lately?

Ha

 

[clifp]

Heh, sorry, I wasn't trying to be coy, just trying not to focus on the particulars of my situation or even real estate in general, just trying to get at the idea of retiring based on cash flow rather tan net worth.

Estimating the value of said cash flow as an annuity is the key idea I hadn't thought of.

Not that it matters, but I do have 3 rental properties. One of them is indeed upside down, but providing positive cash flow.

If you don't mind I'd be interesting in more detail (how much you paid, worth and rent) on the underwater house. If the market value of house gets cut in 1/2 the rent should drop also, although probably not by 1/2.

 

[Livefree]

Rents are actually on the rise. I live in the Boston area and there's been a spike in rents. I think it's due to the economy coming around, kids moving out of their parents houses etc.

It also may be due to foreclosures, and people needing to rent a place..and some that don't want to own anymore, and would rather just rent.

 

[clifp]

Rents are actually on the rise. I live in the Boston area and there's been a spike in rents. I think it's due to the economy coming around, kids moving out of their parents houses etc.

It also may be due to foreclosures, and people needing to rent a place..and some that don't want to own anymore, and would rather just rent.

All real estate is local. AFAIK Boston prices didn't appreciate as fast or fall as far as California. One of the implications of real estate market where it is more expensive to rent than own, is that expectation of future housing prices will continue to decline.