Unjustified fear

[HI Bill]

Sorry, I don't have experience in the nuances of 1031 exchanges. But I have friends who do, and just want to ask you one thing. How long do you want to keep the rentals? At what age will they become too much? Some of my multi-millionaire friends sold their rentals when the hassles became too much. I'd come up with a phase-out plan, unless you have an heir who can take over management.

 

[jollystomper]

My quick estimation would be around 120K/year for the 4 of us, but I will need to do more home work on that. It might sound strange, but I have only recently given thought to FIRE, I need to think more regarding your last question.

Just my view _if you are considering FIRE, this is your number one priority to figure out before you look at your current investments. Having a good handle on what expenses will be (including factoring future events such as replacing cars, major home renovations, etc.) Will likely either address some of that unjustified fear, or justify some of that fear - but with the latter that just means you will have a better idea of the steps to address it.

 

[ut2sua]

Sorry, I don't have experience in the nuances of 1031 exchanges. But I have friends who do, and just want to ask you one thing. How long do you want to keep the rentals? At what age will they become too much? Some of my multi-millionaire friends sold their rentals when the hassles became too much. I'd come up with a phase-out plan, unless you have an heir who can take over management.

Hi HNL Bill, this is a good question. One option we have been thinking about is to live in one house after RE. It did occur in DW's and my mind that we could leave one or more properties to our sons (at a much later time). So your question addresses a topic we have thought about. Right now the properties are managed by a company so we don't suffer much. I do question the income over investment $ ratio in this particular investment of ours however.

 

[ut2sua]

Just my view _if you are considering FIRE, this is your number one priority to figure out before you look at your current investments. Having a good handle on what expenses will be (including factoring future events such as replacing cars, major home renovations, etc.) Will likely either address some of that unjustified fear, or justify some of that fear - but with the latter that just means you will have a better idea of the steps to address it.

Thanks for you input Jollystomper. I agree 100% with you. I need to work to come up with a sensible and believable budget. By convincing ourselves the budget is good and to show DW how/where the $ will come in to satisfy that budget, then we can have peace with our decision. I believe the lack of this data is causing the fear that I have had (as you and many in this thread have pointed out).

 

[pb4uski]

Late to the party but IMO the problem with residential real estate is concentration risk. You have 43% of your wealth in real estate. If that particular geographic area has issues (think like Flint, MI) then you're screwed. Also, even then the properties are not providing an attractive yield... mid-term CDs earn more than $48k on $2m with a lot less risk. If you love real estate then sell out an invest in a REIT where at least your risk will be diversified by geographic region and property type.... but I would never keep 43% of my wealth in real estate... not to mention in a single geographic area... it is like being overconcentrated in your employer's stock.

On what you asked about, I share your concern with bond interest rate risk... but to be fair I have for many years and rates have not risen. While you have to be patient, there are occasionally pretty good CD deals at credit unions.... I picked up some 3.5% 5-year CDs and some 3.0% 5-year CDs in 2019. In the meantime you can park the money in VMMXX or an online savings account at 1.7%.

 

[ut2sua]

Late to the party but IMO the problem with residential real estate is concentration risk. You have 43% of your wealth in real estate. If that particular geographic area has issues (think like Flint, MI) then you're screwed. Also, even then the properties are not providing an attractive yield... mid-term CDs earn more than $48k on $2m with a lot less risk. If you love real estate then sell out an invest in a REIT where at least your risk will be diversified by geographic region and property type.... but I would never keep 43% of my wealth in real estate... not to mention in a single geographic area... it is like being overconcentrated in your employer's stock.

On what you asked about, I share your concern with bond interest rate risk... but to be fair I have for many years and rates have not risen. While you have to be patient, there are occasionally pretty good CD deals at credit unions.... I picked up some 3.5% 5-year CDs and some 3.0% 5-year CDs in 2019. In the meantime you can park the money in VMMXX or an online savings account at 1.7%.

Thanks for your input Pb4uski. If I cash out now, the 2m will probably net 1.6m (capital gain tax + depreciation taxes etc.). 48k/1600k = 3%. VNQ is paying a bit more than 3% dividend (so it is close). So it boils down to VNQ vs real estate property appreciation over time right? Real estate value could crash but so is VNQ (I believe both would recover given enough time - VNQ probably will recover much faster, I would think). During a crash rental may (or may not) bring in the same income. VNQ would probably bring in less (I am not sure regarding this). Do you think I may miss something in my thinking here? Thanks for sharing your thought.

 

[Another Reader]

Late to the party but IMO the problem with residential real estate is concentration risk. You have 43% of your wealth in real estate. If that particular geographic area has issues (think like Flint, MI) then you're screwed. Also, even then the properties are not providing an attractive yield... mid-term CDs earn more than $48k on $2m with a lot less risk. If you love real estate then sell out an invest in a REIT where at least your risk will be diversified by geographic region and property type.... but I would never keep 43% of my wealth in real estate... not to mention in a single geographic area... it is like being overconcentrated in your employer's stock.

On what you asked about, I share your concern with bond interest rate risk... but to be fair I have for many years and rates have not risen. While you have to be patient, there are occasionally pretty good CD deals at credit unions.... I picked up some 3.5% 5-year CDs and some 3.0% 5-year CDs in 2019. In the meantime you can park the money in VMMXX or an online savings account at 1.7%.

Don't agree with this, especially not your assessment of real estate risk. I may not cash flow at the rate that stock appreciates over time, but I can beat most stock dividends and CD's and the real estate appreciates as well. I also have very favorable tax treatment of my real estate. I pay very little income tax thanks to the various write offs, Concentration risk? Perhaps, although the Bay Area and Phoenix have decent appreciation and rental market strength due to long term trends in employment. Flint never had a diverse economy, it was always dependent on auto manufacturing. I would never invest in a one horse town, especially when the horse is old and tired.

Having been involved in real estate valuation for three decades, I avoid most REIT's. Too much trading of the same pool of assets among them and the insurance companies. I have seen lots of mistakes made by these folks over the years and in my opinion a lot of overvalued assets are floating around. I will pass except for some special circumstances.

At this point I have a much higher percentage of my wealth in real estate than paper assets. On the current (likely unsustainable) trajectory, I will hit 8 figures in a few years. Prudent leverage in large part made that possible. IIRC, Senator is also over $5MM in net worth. Neither of us had high level corporate or consulting jobs, but we took advantage of leverage and value-add opportunities as they appeared to multiply our assets, while funding retirement and other paper asset accounts along the way. Of course, we were both able to retire early as a result.

 

[pb4uski]

Note I said, "If you love real estate then sell out and invest in a REIT"... I didn't suggest investing in a REIT.

I have a neighbor who owned commercial property in Flint, MI and it set him back big time... I'm not sure if he end up having to go through bankruptcy or not and I didn't want to ask since it wasn't my business.

I was also the financial manager for a hundereds of millions commercial real estate portfolio for an insurance company (amongst other duties).... we were very careful to diversify geographically and across property types... something that is almost impossible for an individual with only a couple million invested in real estate to do. I know that real estate has worked out very well for many of you and I don't have problems with the asset class, just that it is virtually impossible for an individual to diversify away geographic and property-type risk. The worst doesn't happen often, but whether you realize it or not you are betting your retirement on it and I just don't think it is a prudent risk to take when it is pretty easy to diversify the risk away.

I also manage a single tenant commercial property for my Mom so I'm familiar with the asset.... in her case it is perhaps 10% or so of her total portfolio but a large portion of her income but is still a high-risk venture. If that single tenant left it would be a much different situation but luckily she can afford to take the risk.

We regularly say that it would be imprudent to have more than 10% of your nestegg in a single stock (like an employer stock)... why wouldn't that same advice apply to investing more than 10% of your nestegg in a single type of real estate in a single geographic area? (Like apartments in northern California). The risks are very similar!

The OP has 43% of his wealth in real estate and it is very concentrated.

Another problem with real estate investing is the role that depreciation recapture and capital gains taxes play in causing investors to stay when they should get out... similar to golden handcuffs.... how many stories have we read on this forum of members who would like to divest from real estate but can't get themselves to do so because of the cost of deperciation recapture and capital gains taxes.

 

[Another Reader]

Note I said, "If you love real estate then sell out and invest in a REIT"... I didn't suggest investing in a REIT.

I have a neighbor who owned commercial property in Flint, MI and it set him back big time... I'm not sure if he end up having to go through bankruptcy or not and I didn't want to ask since it wasn't my business.

I was also the financial manager for a hundereds of millions commercial real estate portfolio for an insurance company (amongst other duties).... we were very careful to diversify geographically and across property types... something that is almost impossible for an individual with only a couple million invested in real estate to do. I know that real estate has worked out very well for many of you and I don't have problems with the asset class, just that it is virtually impossible for an individual to diversify away geographic and property-type risk. The worst doesn't happen often, but whether you realize it or not you are betting your retirement on it and I just don't think it is a prudent risk to take when it is pretty easy to diversify the risk away.

I also manage a single tenant commercial property for my Mom so I'm familiar with the asset.... in her case it is perhaps 10% or so of her total portfolio but a large portion of her income but is still a high-risk venture. If that single tenant left it would be a much different situation.

We regularly say that it would be imprudent to have more than 10% of your nestegg in a single stock (like an employer stock)... why wouldn't that same advice apply to investing more than 10% of your nestegg in a single type of real estate in a single geographic area? The risks are very similar!

The OP has 43% of his wealth in real estate and it is very concentrated.

The risks are not at all similar. A single company can easily do an Enron on you. You have little knowledge of the inner workings of the company and zero control. A single property with one tenant is somewhat less risky, but still has more risk than I would want to take, especially a commercial property with a limited tenant pool. A couple of dozen properties in two strong markets have worked out well for me for over 25 years. I don't see a need to diversify away from geographic or property type risk, because those risks have proven very small over the same time frame.

Said another way, I know my business and I am confident in my business decisions. However, I invest in diversified stock funds and ETF's because I don't know the businesses of all those companies and I do need to diversify to reduce risk to my investments.

 

[pb4uski]

Well, you're wrong but I guess we can agree to disagree.

....Said another way, I know my business and I am confident in my business decisions. ...

I'm pretty sure I could find numerous quotes similar to this by Enron senior management 18 months prior to its implosion.

...The world of technology opened up the Internet, and the IPO market for technology and broadband communications companies started to take off. In January 2000 Enron announced an ambitious plan to build a high-speed broadband telecommunications network and to trade network capacity, or bandwidth, in the same way it traded electricity or natural gas. In July of that year Enron and Blockbuster announced a deal to provide video on demand to customers throughout the world via high-speed Internet lines. As Enron poured hundreds of millions into broadband with very little return, Wall Street rewarded the strategy with as much as $40 on the stock price—a factor that would have to be discounted later when the broadband bubble burst. In August 2000 Enron’s stock hit an all-time high of $90.56, and the company was being touted by Fortune and other business publications as one of the most admired and innovative companies in the world....

By April 2001 other skeptics arrived on the scene. A number of analysts questioned the lack of transparency of Enron’s disclosures. One analyst was quoted as saying, “The notes just don’t make sense, and we read notes for a living.” Skilling was very quick to reply with arrogant comments and, in one case, even called an analyst a derogatory name. ...

In February 2001 Lay announced his retirement and named Skilling president and CEO of Enron. In February Skilling held the company’s annual conference with analysts, bragging that the stock (then valued around $80) should be trading at around $126 per share. ...

On November 30 the stock closed at an astonishing 26 cents a share. The company filed for bankruptcy protection on December 2. ...

Source: https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html

 

[Another Reader]

Well, you're wrong but I guess we can agree to disagree.



I'm pretty sure I could find numerous quotes similar to this by Enron senior management 18 months prior to its implosion.

The difference is that it's only me. I know exactly what's going on at all times. Can't pull the wool over the eyes of employees while committing corporate fraud because a) no employees and b) no one to defraud.

 

[pb4uski]

I'm guessing that my friend/neighbor who had big problems with his real estate located in Flint, MI would have said the same thing.... that he knew his business and was confident in it.... but he was blindsided by something that was none of his doing.... with the problem being that his real estate was a significant portion of his net worth at the time and was in one locale.

OP is in California... one big one and a large part of his net worth could be rubble. How do you insure against that risk?

 

[Another Reader]

I'm guessing that my friend/neighbor who had big problems with his real estate located in Flint, MI would have said the same thing.... that he knew his business and was confident in it.... but he was blindsided by something that was none of his doing.... with the problem being that his real estate was a significant portion of his net worth at the time and was in one locale.

Anyone could have seen that Flint was a dying city long before the lead issue. I would have sold when the auto industry problems started to surface. Cut my losses immediately and moved on.

There are things I cannot foresee. There will be an earthquake in the Bay Area and no one knows when. Eventually water will get to be a problem in the desert and Phoenix may no longer be an attractive place for businesses and their employees to relocate. I can insure against the earthquake loss and diversify away from the temporary loss of income by investing in a place where people will relocate near term when the SHTF in California. When the opportunities appear again, I will probably add a third market to the property portfolio.

Meantime, I suspect that despite all your years of high paying work with those elite corporate clients, my net worth with my lazy real estate portfolio might be a bit higher than yours. So maybe I'm not as stupid or blind as you think.

 

[pb4uski]

.... So maybe I'm not as stupid or blind as you think.

I suspect that you are right....

Just kidding. I challenge you to quote any of my posts where I have stated or even inferred that you were stupid or blind. Not my style. So put up or shut up.

 

[ut2sua]

Another Reader and pb4uski, you both have shared different views looking at real estate investment from different angles. These are the kind of input from various angles that I was looking for when I started this thread. Your different opinions gave me (and perhaps other readers) new perspectives that will help me/them with picking the right AA that is right for us going forward.
pb4uski, FWIW, we will probably live in one of our beautiful houses post RE, and that will effectively cut down the real estate investment portion in our AA (even if we don't change anything).
I got a consensus from both of you that my rentals are not bringing in adequate ROI, and I agree. I will be looking for better investment opportunities if possible (whether a change in location, or investment type or taking more leverage)
Another Reader, I like your thought on using leverage. I was able to do that earlier, but currently I have none which is not too good. This is something I need to think hard on. Congratulations to you for being very successful in your investment strategy. It is great any time I hear of a successful story.
Thanks to both for sharing your thought Another Reader and pb4uski. Please have a great weekend.

 

[ncbill]

OP, are your houses paid off or is that cash flow after paying mortgages?

If they are paid off, yes, that capital could better be used elsewhere, perhaps a 1031 exchange?

 

[ut2sua]

OP, are your houses paid off or is that cash flow after paying mortgages?

If they are paid off, yes, that capital could better be used elsewhere, perhaps a 1031 exchange?

Ncbill. The houses were paid off. We paid off the last 2 properties just a couple months ago. I have been thinking along the line you mentioned, but it will take some understanding/research on my part to know what/where to go next.

 

[ut2sua]

Following many's advice, I worked on our budget
I went back to look at my 2019 expenses and the below looks like a budget
Utilities = 3k
Property tax + insurance (for house to FIRE in) = 9k
Other expenses = 70k
Federal Income tax = 9k (assuming MAGI ~80k/yr)
State tax = 3k
HI = 20k (premium + OOP $)
Extra = 6k (to cover for short on taxes and/or HI)

So it looks like roughty $120k/yr for the 4 of us (could be +10k if I underestimate taxes and/or HI)
I am leaning toward having a separate budget for vacation and/or fun stuffs.
I will also wanted to look at our 2018 expenses, but many statements were not available and need to be requested.

 

[scottpush]

Hi all,
I am new to this forum (and the idea of FIRE), but I have came up recently with the realization that time is more important than $ at some point in our lives, and I am hoping I can FIRE in a couple years if not sooner. I have some unjustified fear on certain investments, and I am asking for input on what may look like not-very-smart-investment decisions on my part. My thanks in advance to all for your comments.
DW and I are 49 and 53
2 sons: 24 and 21 both in college
My current NW
850K in my 401K - just switch from 100% S&P500 to VTTVX (Vanguard balanced fun - retirement in 2025 - ~60/40 mix)
450K in my pre tax IRA (rolled over from previous 401K) 60/30/10 Stock/bond/VNQ
750K in DW pre tax IRA 100/0/0 - VTI
600K cash (all in short term CD); having fear putting any of these into stock/bond or anything other than CD
~2000K worth of rental properties (4 houses) <- generating net ~4K/month income (after tax, insurance, maintenances etc.). Here I am fearless feeling more at ease with real estate renting (this could be unjustified too since things could go wrong with tenants; generated income is lower etc.)

Right now, I have this uneasiness of putting $ into bond because I believe interest rate will rise; I also feel like the stock market may go back down, so I am looking for some safety, but the bond funds don't look like a safe place.
I am leaning toward converting DW IRA to have more bond $ just to go against my fear (and trying to not time the market).
What would you do if you were me?

Many thanks in advance for your valuable thought

I'd FIRE! You're in really good shape. Unless you get something out of Megacorp besides the almighty $$. I retired at 58 and the only regret is not doing it sooner. Although money is fun also.

 

[Time2]

I also have concerns about the real estate, unless the value is growing at a high rate, I don't see it throwing off much cash.
Do you have a management company? Do you do the maintenance?
If you are also doing the work for that 3%, that makes it worse. Do you want that work after you retire?

 

[ut2sua]

I'd FIRE! You're in really good shape. Unless you get something out of Megacorp besides the almighty $$. I retired at 58 and the only regret is not doing it sooner. Although money is fun also.

Thanks for your encouragement Scottpush. DW and I have worked all our lives, and we need to learn to switch from saving to spending mode (which is causing all the uneasiness)

 

[ut2sua]

I also have concerns about the real estate, unless the value is growing at a high rate, I don't see it throwing off much cash.
Do you have a management company? Do you do the maintenance?
If you are also doing the work for that 3%, that makes it worse. Do you want that work after you retire?

Thanks for asking Time2. We have a management company taking care of all our rental work, so there is no pain there. When we started out many years ago, there was a lot of work because we didn't know where/how to get help.

 

[2177V]

Hi all,

My current NW
850K in my 401K - just switch from 100% S&P500 to VTTVX (Vanguard balanced fun - retirement in 2025 - ~60/40 mix)
450K in my pre tax IRA (rolled over from previous 401K) 60/30/10 Stock/bond/VNQ
750K in DW pre tax IRA 100/0/0 - VTI
600K cash (all in short term CD); having fear putting any of these into stock/bond or anything other than CD
~2000K worth of rental properties (4 houses) <- generating net ~4K/month income (after tax, insurance, maintenances etc.). Here I am fearless feeling more at ease with real estate renting (this could be unjustified too since things could go wrong with tenants; generated income is lower etc.)

What would you do if you were me?

Many thanks in advance for your valuable thought

My observations: (1) I was a landlord and owning rental real estate gives you some "diversification protection" during a stock market crash. (2) $600K cash is a wise decision because it gives you "liquidity" during hard times. (3) I favor treasury bonds over corporate bonds because of a 2019 Stanley Morgan Report which warned that a large percentage of BBB corporate bonds should be rated "junk" due to over leveraging. This means some corporate bond holders are exposed to more risk and less reward. (4) Your portfolio looks pretty healthy to me. (5) The fear versus greed will always be with everyone. If I were you, I would consult a professional Financial Advisor who is licensed and certified by the FTC to review your portfolio. Be advised that the first question he or she may ask is "what is your risk tolerance?" For example, can you take a 50% short term loss in exchange for a long term gain? A one hour consultation should cost about $300 and it appears you can afford this. Getting professional advise is always a good thing. IMO this is better than getting advise from unlicensed people who is unregulated. I believe Charles Schwab has a computer program that can program your portfolio and conducts a risk assessment based on a Monte Carlo simulation.

 

[ut2sua]

My observations: (1) I was a landlord and owning rental real estate gives you some "diversification protection" during a stock market crash. (2) $600K cash is a wise decision because it gives you "liquidity" during hard times. (3) I favor treasury bonds over corporate bonds because of a 2019 Stanley Morgan Report which warned that a large percentage of BBB corporate bonds should be rated "junk" due to over leveraging. This means some corporate bond holders are exposed to more risk and less reward. (4) Your portfolio looks pretty healthy to me. (5) The fear versus greed will always be with everyone. If I were you, I would consult a professional Financial Advisor who is licensed and certified by the FTC to review your portfolio. Be advised that the first question he or she may ask is "what is your risk tolerance?" For example, can you take a 50% short term loss in exchange for a long term gain? A one hour consultation should cost about $300 and it appears you can afford this. Getting professional advise is always a good thing. IMO this is better than getting advise from unlicensed people who is unregulated. I believe Charles Schwab has a computer program that can program your portfolio and conducts a risk assessment based on a Monte Carlo simulation.

Thanks for your input Vchan2177. Your points are all valid. #5 in particular could be what I should try. Your #3 worries me a bit because I know my Vanguard retire etf has quite a bit of BBB bonds

 

[2177V]

Thanks for your input Vchan2177. Your points are all valid. #5 in particular could be what I should try. Your #3 worries me a bit because I know my Vanguard retire etf has quite a bit of BBB bonds

My #3 caused me to reallocate my corporate bonds to treasury bonds. Here is the report in italics:

A Morgan Stanley research report suggests that, based on leverage ratios alone, 45% of investment-grade corporate bonds would be rated junk right now. The report further suggests that around 60% of corporate bonds currently rated BBB would be rated junk by the same leverage-ratio metric.Jan 17, 2019.

Junk bonds are supposed to have high risk/high reward. BBB investment bonds are supposed to have medium risk/medium reward. However since the BBB bonds should be rated junk, this means BBB bonds are high risk/medium reward.

I am not saying the BBB bond market will crash. What I am say the risk/reward ratio is inappropriate and investors who are not aware of this issue are getting being exposed to more risk in their portfolio.