Author Topic: Reader Case Study: reaching FI with rental appartments and 2 kids in Germany.  (Read 6070 times)

mustachian_germany

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Reader Case Study: reaching FI with rental appartments and 2 kids in Germany.

I am not asking help on how to save money, reducing expenses or paying back crdit cards or mortgages.
We are on our way to financial independence and in a few years we'll have enough income form our rental appartments to cover all our expenses. We're doing fine. But we have a dilemma and we need your help.

So, even if you don't live in Germany, please read it.

US:
- Me, 31 years, IT consultant, webdesigner
- Her: 31 years, translator, docu writer. Doesn't like her job

KIDS:
- Kid 1 born in  2012
- Kid 2 born in  2014

Income:
My wife is employed, and is on parental leave until end of July 2015. After that She's going to work part time.
I am self employed:IT consulting, webdesign, have an own portal which generates some income.

Income HER: 1500€ Gross/Month

Income Him:
- 4500€ (before tax) from fixed customers/month
- 130€ (more or less) passive income from website maintenance
- 1000€ from websites/portals (Ads) /Month

Income Misc:
- Child Benefit for 2 Kids, total: 368€/Month
- (planned from 2015) caretaker for the house we live in: 270€/Month (net, not taxble, minijob)


Total Taxable Income per year HIM: 5630 x 12 = 67560€
Total Taxable Income per year HER: 1500 x 12 = 18000€
Total Not-Taxable income per year: (360+270) x 12 = 7560

ASSETS:
We own our own appartment. Allready paid off. No mortgage. Value: 300K€
We have 5 rental appartments which produce 36000€/year total rent (Kaltmiete). This is all used to pay their expenses, mortgage, interest, tax etc.

Object1:
Purchase date: 2010 Feb
Price:   129.000 €
Interest rate: 4,09% fixed until 2020 Feb
Loan: 137000€ (we covered the expenses/tax as well)
In Feb 2020 (after the fixed interest rate) we'll have 120K € mortgage left.
Repayment+Interest per Month: 575€
Not possible to pay it of sooner. (Keine Sondertilgung)

Object2:
Purchase date: 2012 Sept
Price:   103.100 €
Interest rate: 2,48% fixed until 2022 Sept
Loan: 87.000
In Sept 2022 Sept we'll have  37K € mortgage left
Repayment+Interest per Month: 550€
Possible to pay 10% of the original loan back each year on top of the standard repayment (Sondertilgung)

Object3:
Purchase date: 2012 Sept
Price:   112.000 €
Interest rate: 2,48% fixed until 2022 Sept
Loan: 95000€
Repayment+Interest per Month: 533€
In Sept 2022 Sept we'll have  49.5K € mortgage left
Possible to pay 10% of the original loan back each year on top of the standard repayment

Object4:
Purchase date: 2013 july
Price:   100.000 €
Interest rate: 2,23% fixed until 2023 July
Loan: 77000
Repayment+Interest per Month: 550€
In July 2023 Sept we'll have  22,8K € mortgage left
Possible to pay 10% of the original loan back each year on top of the standard repayment

Object 5
Purchase date: 2014 march
Price:   54.000 €
Interest rate: 2,79% fixed until 2024 March
Loan: 40.000€
Repayment+Interest per Month: 350€
In March 2024 we'll have  4.5 K € mortgage left
Possible to pay 10% of the original loan back each year on top of the standard repayment

CASH
- we have a blocked 67K in a bank account with 4,25% interrest rate ending in Juli 2016. We can take all money (80K) out at that point with the interest.
- cash 65K €
- Total cash: 80+65=145K €

EXPENSES
- Total expenses (without the costs with the appartments): 25K-30K/year
- we save as much as possible, we don't have a car, we don't commute and live a very frugal lifestyle and  monitoring our expenses very closely.
- We can save 30.000€-40.000 per year (after ALL expenses, after we paid taxes, after i paid in the pension plan)
- most of the appartments generate a positive cashflow which is not calculated in the income. It is saved as a buffer for taxes and repair.
- Healthinsurance
-- Her: insured by the state insurance plan and the money is taken from her salary. The kids are insured for free as long as she's employed.
-- Him: private insurance: 130€/month (allready included in the expenses above)

PENSION
- SHE: pays standard state pension
- HIM: 150€ per month goes in a (by 75%) tax deductible private pension plan. (Rürup Rente). The money is invested in funds but they guarantee the money invested in it. They'll only pay out when I'm 60.
 
If we use the 10% extra repayment options, we can repay all our mortgages by Feb 2020 and be financially free.


Expected ER (Early Retirement) expenses: 20-25K €

Expected ER income (per year), Gross:
- Real Estate: 32K Gross (after expenses)
- Web Projects: 15K Gross
- Other things: 10K Gross
- Caretaking + Child allowance: 7.5K Net
Total net: 60K

I can't wrap my head around this: if we pay the mortgages back asap, we're going to be financially independent in 4-5 years. By that time our kids are going to go to shool and we have plenty of time to earn money (if and however we want to do that). We're not going to sit around doinf nothing. It's in my DNA and a hobby to make money out of everything (including finding things o the street and selling them on ebay)

On one hand, we'de like to be financially independent asap. On the other, we know that we could invest the cash better (somehow) instead of repaying the mortgage. It can't be very difficult to have an interest rate of more than 2.5%.

Specific Questions:
- should we pay the mortgages back asap or should we invest the money instead
- where should we invest the money?
- what should we do with our cash? Pay back the mortgage, or invest it?
- What would you do?

SingleMomDebt

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impressive. Especially for your age. I am not one fit to give advice on this case study. But look forward to its responses and following the thread.

mustachian_germany

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Are you from germany?

SingleMomDebt

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No. California. But of German descent. Does that count? ;)

Hugerat

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I'm confused about one thing. You say in RE your rental income will net to Eur 32K per year, but previously you said that all of your gross rental income goes to cover mortgage and expenses. Does that include a 10% early repayment, when possible? I assume your RE income assumption presumes that you've already paid off your mortgages. How do you plan to do this in 4-5 years if you are only able to repay an additional 10% of principal each year?

theonethatgotaway

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I've just ran through your numbers. Back of the napkin math- you owe the banks about 420,000 ish Euros before your loans are paid off. If you currently save 30,000k per year and throw all of that at the mortgage repayments it will take 14 years. If you are bringing in 30k rent for MORTGAGE-only income (no expenses/taxes) that would cut it to 7 years.

Based on your numbers- Looks like you are somewhere around 10 years from this.

I'm not sure what the 10% thing is- is that the limit as to how much more mortgage you can pay?

mustachian_germany

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Sorry of that sounded confusing. The tennants are paying back a part of the mortgage. You will See how much mortgage is left 10y after the loan was taken. On top of that i can pay back 10%/y of the original mortgage ammount

mustachian_germany

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See object 4. I can do 7700 € payments per year on top of what the tennants pay. That's about 50k in 5y. Without extra payments, in 2023 We would have 22,8k left. With the 10% extra payments, its paid long before.

mustachian_germany

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Sorry.. Its 38.5 in 5 y. But if i do extra payments i save some interest as well as i dont have to pay interrest on that extra ammount anymore

theonethatgotaway

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Sorry I'm not understanding the math of repayments.

So what you are saying is that in your current situation the tenants will have your mortgages almost paid off in 10 years. Is this correct?

plank

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Just a bit of background about mortgages in Germany. "Translating" it to American:  Essentially all mortgages are 5, 10,15, or 20 year (nearly) interest only ARMs. Sometimes you can only pay a certain amount of principal per year and sometimes you can pay as much as you like.

I believe I have that all correct. Please correct me if I'm wrong.

mustachian_germany

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So. Let's take Object 4:

Purchase date: 2013 july
Price:   100.000 €
Interest rate: 2,23% fixed until 2023 July
Loan: 77000
Repayment+Interest per Month: 550€
In July 2023 Sept we'll have  22,8K € mortgage left
Possible to pay 10% of the original loan back each year on top of the standard repayment

The original repayment plan looks like this (without extra payments):
End of 2013: After paying 2873€ Prinicpal and 976€ interest: mortgage left: 74126
End of 2014: After paying 5012€ Prinicpal and 1587€ interest: mortgage left: 69114
....
End of 2023:  After paying 1981€ Prinicpal and 218€ interest: mortgage left: 22778

The repayment plan with extra  payments:
End of 2014: After paying 2873€ Prinicpal+ 7700€ extra +976€ interest: mortgage left: 61414€
End of 2015: After paying 5012€ Prinicpall+ 7700€ extra +1587€ interest: mortgage left: 48590€
....
End of 2018:  After paying 5475€ Prinicpal+ 7700€ extra and 1124€ interest: mortgage left: 0€

Now this calculation does not include the fact that I have to pay less interest altogether since i do extra paiments but i think we can ignore this in a rough calculation.

So: The  question is: should i use these 77000€ repayments and pay back the principal asap or should I invest the  money instead?




plank

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I would pay off the houses. You have a low risk, short time frame path to FI by getting rid of the mortgages.  There is no tax advantage to holding debt or investing as there is in the US.  Once they are paid off you are set for life and you can snowball them to have them paid off before you know it.

Hugerat

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I still don't think some of your math works out. You can't repay all of your mortgages in 4-5 years because your largest doesn't have any Sondertilgung provision. This also happens to be by far your most onerous mortgage and in 10 years you will still hardly have any equity in this property. The remaining value will have to be either paid off in a lump sum or rolled into another term.

I think I see what your dilemma is though. You're wrestling between getting the best long-term rate of return for your money, while trying to reconcile this with needing sufficient cash flow so that you can retire early in 4-5 years. While your rental units generate only modest cash flow now, they will be massively cash flow positive once the loans are paid off. I would make a few general comments:

1. Your interest rates are extremely low. Prepaying this debt means getting an extremely poor rate of return (as low as 2.23%), that you can almost certainly beat by investing elsewhere. You're even getting over 4% on a (I presume) bank guaranteed CD. I would also be averse to prepaying a mortgage that your tenants are already paying for you.

2. You are carrying quite a bit of debt at the moment, and even though your rental units are cash-flow positive right now, this leaves you with considerable risk of a poor rental market, long vacancy, or major repair. That means you will need to maintain a significant liquidity buffer. Your current cash on hand should be more than sufficient to cover these things. If you can still get interest rates in bank deposits that are higher than the rate on your mortgages, why not invest the necessary cash buffer in certificates maturing at staggered intervals of something like 3 or 6 months?

3. If you choose not to repay 4 of your mortgages early, and invest your money elsewhere instead, you need to be prepared to make either large lump sum payments, or roll the remaining balance into a new term at potentially higher interest rates. This may not be a huge issue since the loan balances will be smaller, but it is still a risk.

4. If you retire in 4-5 years time, most of your mortgages will only have 4-6 years left on them. At the end of those terms the remaining balances will be miniscule, and even if you roll these into new loans they will be generating a lot more cash for you, so your personal savings may only need to get you through the first 5 or 6 years of retirement.

I really don't know what the best answer to your question is. You need to decide whether you need the increased cash flow NOW by ridding yourself of a couple of the mortgages, or whether you want to generate the highest possible return on your investments. Why not do a little of both? If you save Eur 30k this year put half of it toward repayment of a couple of the mortgages to improve your cash flow now, while investing the other half in stocks and bonds. Check out the many investing threads here for advice on the latter.

mustachian_germany

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Hi Hugerat. Thank you very much for your thoughts!
Something in me wants that huge debt (which still feels very low risk though) to go away asap and at the same time I know I can ganarate a lot more ROI with the cash in my accounts. Maybe the truth is in the middle and i should follow you advice to do both: some extra payments, some investing.

Here's something els though which I don't quite understand: if i decide to do (let's take the same object 4) the 7700€ extra payment, that saves me to pay that 2,23% interrest rate which is, not an orgasmic ROI. BUT I am also buying an investmens that generates revenue at the same time, don't I?

Object 4 cost 100K. It generates an income (after expenses, before tax) of: 8000€/Y. That's an ROI of 8%, isnt't it? Ok, i pay back the mortgage with it but at the same time I "buy" 8000€ worth of real estate every year? Plus the 2.23% interest rate that I save by paying that part back.

That means, when I invest that extra yearly payment of 7700€ I am basicall making an ROI of 10% = 770€ with it. Every time I pay that expra payment.

If that's correct, why should I invest elswhere? 10% is not bad...

Am I making a mistake here?  Help!

mustachian_germany

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Bzw. Object one doesnt look good in theory but it allready incrrased in value by a lot. It's a new building and i dont expect many problems with it. It generates some cashflow even. Most of the cash buffer i have  now could be used to pay it off in a lump Sum in Feb 2020. Or i could pay it partially and get a New mortgage..we'll see. But anyway, i hope i didnt make any mistake in calculating that the mortgages could  be paid off in 2020. FI could be reached even 2 Years before that by paying off some of the other flats.

Hugerat

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I like the term "orgasmic ROI." I shall always seek to earn orgasmic returns on all of my investments. Yes, you are making a mistake in how you are thinking about your returns. You ALREADY own 100% of the income generated by this investment. Whether you pay off the loan early doesn't have anything to do with this fact. 2.23% was the cost to you to borrow the necessary capital to buy this income stream. You don't add these two numbers together, but rather subtract them from eachother. Subtracting your cost of capital from your annual income yield comes to 5.77%. Paying it back early has only improved your income yield by 2.23%.

This is a perfectly good income yield, but your specific problem is that you want to retire well before these loans amortize and so you will have a window when you still have significant expenses and liabilities and potentially not enough income to cover it all. You do know that at some point, the rental properties will have paid for themselves and are generating enough income to live on indefinitely. That may be 5 years, or 10 or 15. Ordinarily repaying a 2.23% loan on an income generating asset would be a lousy idea, but in your specific case it might be necessary to bridge this gap. Of course, if you truly do earn as much income in retirement as you expect, then there is almost no gap to fill and you can probably retire right now.

If I were you, I would try to model it out in Excel, year by year. If you retire in 5 years time, where is your income going to come from in year 1 of early retirement? What will your expenses be? When are your loans coming due? Then year 2, year 3, etc until you reach the year you know the rental properties will be earning enough to live on indefinitely. Assume certain living expenses, a certain level of personal assets, as well as a large enough margin of safety to be able to deal with problems relating to the rentals.

If I do a quick, back of the envelope calculation, if you invest your annual savings of Eur 35k (splitting the difference between 30k and 40k) and invest it earning a 5% return, you can have Eur 321,025 in 5 years of personal savings. This assumes a starting value of Eur 100k and 45k of your cash left over to deal with the rental units. If you believe that the apartments will be generating enough income for you to live on by (for example) year 8 after retirement, then these personal savings only need to get you through 8 years and you can probably draw them down faster than the normal 4% rate. If as you plan you find that you will likely need more cash flow in the earlier years, then pay off a couple of the mortgages early. If you don't have that need, then focus now on earning higher long-term returns.

This all gets fairly complicated and there are lots of moving parts, which is why you need to plan it out very carefully.

Or you can just do what plank suggests and pay it all off now. There are fewer things that can go wrong with that plan.

mustachian_germany

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Hugerat. I think you have some mistakes in your numbers. Can you or anyone else do an example calculation with these numbers?
Lets stay I bought a flat for 100k with 30k down, 70k loan, 2.5%interrest rate. I get 8% dental roi (8k rent per year) which pays for the loan and interrest.
It would help a lot to see a step by step ROI calculations for these alternative scenarios: A: You pay back 7k to the Bank on top of that wach year.
B. You Invest that money with 5% interrest rate.

mustachian_germany

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Anyone?

Raay

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It can't be very difficult to have an interest rate of more than 2.5%.

Of course that can be difficult when the interbank overnight Euro loan rate is 0%. Why do you think you get such "great" financing conditions - a gift from the financial sector? Current (before Abgeltungsteuer tax!) yields for euro government bonds (e.g. DE000A0YBRZ7) are 2.96%, liquid corporate bonds (e.g. DE0002511243) are 3.29%, covered bonds (e.g. DE0002635265, probably the least volatile of the three) only 2.19%.

You're even getting over 4% on a (I presume) bank guaranteed CD.

If you open a 5 year deposit with a Bulgarian bank you'll get 3.70% (it used to be great on Cyprus, too, until the assets were stolen in the name of the law). In Germany the best you will currently get is 2.60% for a 10 year deposit (don't do that!). But hey, we have 0.85% inflation.

If/when interest rates (and along with them, yields) rise, then real estate values and the prices of the above mentioned securities are likely going to decline.

German real estate market in many major cities is pretty crazy, with exceptionally low rents and very high property prices because Germans like to think that their Betongold is a safe bet (it's not, unless you somehow manage to buy for bargain prices - see https://www.youtube.com/watch?v=KIICRTp5AsE for a realistic discussion of real real estate returns).

If I were you, I would consider diversifying from rental properties into other long haul asset classes (particularly stock indexes) rather sooner than later, unless you're sure that your properties were purchased for exceptionally low prices and are safe on the downside.

mustachian_germany

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Hi. I am pretty much aware of the fact that real estate is not 100% safe and I am prepared to diversify, even sell them at some point. But, learning from the last crisis and the stability of the real estate market I just have a good feeling about it. We bought them at (i think) good prices and only on good locations. I simply don't see (yet) what could cause a decline here. But again. I am keeping my eyes open. My plan is to invest in index funds when the market cools/crashes down again. But that's a different question...