Author Topic: Reader Case Study - Opinion on this financial independence/retirement plan  (Read 4539 times)

HazelEyes

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I discovered MMM recently and have been reading the articles and forum posts. There seems to be a lot of good people here who have knowledge and a good set of values, so I thought I'd maybe get some opinions/advice on the investment/retirement plan my husband and I currently are working on.

Background: The two of us are in our early 40's, with no children, and we live in Placer County, Northern California. We are total homebodies and only go out when we must (grocery, important appointments, running chores), and since we work at home, we only go out about twice a month on average. We rarely eat out (I'm a pretty mean cook), don't drink, smoke, or get high. We don't have expensive hobbies or wander lust (did plenty of traveling when younger, and no longer have an interest), although hubby does creative work so his photography/audio/tech gadgets are the only significant spendings.

Experience: We've bought and sold apartments and houses abroad a  few times in the past, and have invested in stocks, bonds, gold, tea, etc, too, but we've only bought one house in the States (our current home), and have only recently started doing homework on investing in rental operties and stock investments for the U.S. market.

Income: Hubby currently does freelance work, and the money is not stable (used to be in the $40k~$55k range, but now due to growing competition, only around $30k, and will likely decrease with time). I'm a silent partner in a business that generates roughly $34k for my share a year, but this is also not stable, since the business fluctuates. Together, that's about $64k a year (if things are stable), and after taxes it's about $54k net for our household.

Current expenses:
Mortgage + Property tax + Property Insurance + Mello-Roos = $1,850
HOA (includes Internet) = $118
Food = $500
Utilities = $200
Car + Health Insurance = $300
Transportation = $100
Misc. = $200
Total monthly expense = $3,260

Assets:
One single-family house (current home), purchased in 2012 for $255k (now valued at $355k). We paid 20% ($55k) on a 30-year loan at 3.625% interest rate.

Two apartments abroad, valuing at $45k total (cash purchase), with 10% yearly return on rent.

Stock investment abroad, with roughly $390k that's generating about 11% yearly return (fairly consistent).

Insurance investment abroad, which is about to pay out $46k total.

Two Roth IRA's totalling $17.5k (we just started recently).

Liabilities:
Our current home has $196k remaining mortage. We have no other debts (we drive a used car about only twice a month, never owe any balance on credit cards, no other loans).

The question:
Is our plan listed below a good one, and what can be improved/changed?

Our goal is to attain total financial independence, with our assets generating enough income for a comfortable living (by our standards, which is only about $40k a year. But if we want to have some cushion, $50k would be better), so we never have to worry again about not making enough money through a job, or freelance gigs, or if a business stops being profitable. Hubby's passion is writing fiction/novels, and  since the chances of actually making a decent living at it is extremely slim (overwhelming majority of the thousands of books you see in  bookstores--they don't sell enough to even break-even, and only a tiny  percentage of authors can make a living with writing). So it would be  great if he could just focus on writing for the love of it, instead of  worrying about whether the books will be top sellers.

Our current strategy for reaching financial independence is through buying rental properties and stock investments. The basic strategy we have right now is this:

-Sell our current house. We think the mello-roos at $3k a year is too high, and also we can use the money to split into two cheaper houses for greater equity gain. The house should net us about $140k in total gain.

-Sell the two apartments abroad for roughly $45k total.

-We'll use the money from selling the house ($140k) and add about $205k from our assets in stock (this includes the $45k from two apartments abroad), and then buy approximately 6 rental properties (with one of them as our new home) at roughly $230k each, all with 25% down payment, 30-yr loans, around 4.87% interest.

The 5 rentals should fetch around $1,430 on average for rent each. They will pay for their own mortgages, without much left, so we're mainly looking at the long-term equity gain, which is roughly 7% yearly gain on average (based on the past 50 years, though in the last couple of years, it's been about 20% gain each year, but then again, California is crazy like that).

(To put things in perspective, the houses in the area we want to buy, the average price was around $345k back in 2005~2006, and they're now around $230k, slowly recovering from the crash. Using the same historical average of 7% gain per year, they should be about $39.1k ten years from now. If we just look at the Bay Area, the housing prices are now already back to where they were pre-financial crash, and it only took about three years. Many houses are now getting dozens of buyers competing with cash. Our area isn't that crazy, but we're close enough to ride a little bit of that coattail. Our current house in Placer County went from $255k in 2012 to $355k currently. That's 39% increase in just two years, right after a severe financial crash.)

In ten years, we'll still owe $825k mortage on all six properties (including the one we'll be living in). If we sell off two of them (estimated to be worth around $391k each by then), we can take the $782k and also another $43k from our stock investment to pay off the $825k mortgage we owe on all six properties. So now, two of the six properties are sold and the other four are paid off. One we live in, three are still being rented out.

The rent from the three properties should be around $1,881 each (estimated for inflation ten years into the future, using the rate of 3% rent raise limit per year as a basic guideline), so that's $5,643k total a month ($67,716 a year), and if we subtract $20k of expenses a year, we'll be left with $47.7k net income a year from the three rentals.

-The $396k in stock investments--half of it we'd keep abroad, and the other half we'd like to move to the States to invest, using an investment management service (such as the new one Scottrade just started offering). I'm learning about index funds/Vanguard/S&P at the moment, but I don't know enough about them yet to be confident that I won't screw up, or that I could do better than an investment manager.

The stock investment abroad will continue to generate a steady 11% yearly return (for the time being. No idea when the laws will change in that country). In the States, the common consensus seems to be that 7% is a conservative estimate. We might do both conservative and higher risk, to see if we can match that 11% return from abroad. (The reason we don't want to just keep it all abroad, is because the relationship with the people we're investing with is a little complicated, and with human nature the way it is, it's safer to have full control ourselves.)

The money in stocks will basically act as our safety net, so when there's vacancy in the rentals, repairs, emergencies, or just not making enough money with our jobs/business, we can supplement with the 7% yearly gain, or when push comes to shove, dip into the assets to make ends meet.

-So with this plan, in ten years, we should be looking at the following summary:

Total value of all four properties (three rentals and the house we'll live in) should be about $1.564 mil.

Total assets ($356k in stocks and $1.564 in real estate) should be around 1.92 mil

The $356k in stocks, with 7% yearly return, which is $24.9k, and $47.7k yearly income from the three rentals. That's $72.6k income a year (debt free). For homebodies that live a somewhat frugal lifestyle, I think that's plenty enough even accounting for ten years of inflation?

Now, we're not experts in any of this. We're just using common sense and logic, and learning as we go. It's likely we might have overlooked or misjudged something. That's why I'm posting here, so I can get some help from people who are much more knowledgeable and experienced than we are. Any advice would much greatly appreciated.

former player

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Expenses about $40,000 per annum.

Income is $30K (photography, on the decline) + $34K (silent partner, unstable) + $9K (10% net rent from apartments abroad, possibly subject to currency fluctuations?) + $40K (11% stock investments abroad, stable but possibly also subject to currency fluctuations).  Total $113K.  Non income-generating assets are house equity of about $140K, Roth IRAs of $17.5K and cash from an insurance investment abroad of $46K.

You are looking at investing in real estate in California.  I think you need to ask a specific question on the Real Estate board for advice on that - it's a bit lost in the noise of your case study.

As far as I can tell, you are already where you want to be in terms of income.  A fair amount of it has a high degree of risk: you are subject to currency fluctuations on the investments abroad plus you have a "complicated" relationship involved in the stock investments abroad.  On the other hand, you are getting high returns on those investments, and overall have about $70,000 coming in each year over your expenses, which you could use to rebalance your holdings into potentially more stable investments in the USA.  If you need immediate security, you could sell out, but your income from secure investments is probably less than from your current riskier ones.

waltworks

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-I assume your stock investments are ultra-risky if you are making 11% annual returns on them. Sell all of that and dump into index funds.
-If your foreign apartments are actually returning $4500 net on a $45000 investment, you would be crazy to sell them unless they are now worth a ton more and you have a way to avoid the taxes/fees you'll pay on the sale.
-If investing in RE you should either assume no appreciation above inflation and make money on cash flow OR accept that you are taking on a ton of risk. At your income level and with no in-country rentals you are going to have a very, very hard time getting loans to buy the places, too. Might be doable but also might not.
-If you are a silent partner, does that mean you actually don't work? So, you're basically retired/FI now just from that even if hubby/investments can only bring in $10k or so a year? That's a withdrawal rate (assuming you have ~$500k to work with) of only 2%. Easy to earn that kind of return in near-total safety.

It sounds like you have a bunch of weird/risky investments and plenty of capital to make your desired lifestyle happen with much less risk. Get your money in safer places, forget your RE scheme, and enjoy your life.

-W

HazelEyes

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Thanks for your opinions/advice.

The reason we plan to invest in real estate/rentals instead of thinking we're already financially independent and in retirement, is because hubby's freelance work can dry up any minute without warning (it's happened before), and the business I'm a silent partner in can also go under very quickly without much warning (it's also happened before). Neither are stable, and it seems to us that if our plan works, then in the not too-distant future, we could just live off of the rentals, which seems to have a greater degree of control for us than any freelance gig or business. Also, this way he'll be able to focus on his writing (managing rentals isn't going to take up 5 days a week, 8 hours a day like a full-time job. It'll allow a lot of free time).


Sdsailing

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Your plan does not make sense to me.  Waltworks nicely summarizes some of the problems. In addition,


How do you qualify for 6 mortgages on your income?

You are proposing to sell very profitable rentals to buy new rentals.  I do not understand this.

Your numbers are not realistic.

Where will you be buying. As noted, Sacramento real estate is crazy right now. It is extremely bad timing.  Assuming you are looking somewhere else?

True it may be a good time to sell home in Placer county.  But then where are you going to buy?

Your current income / cashflow will decrease significantly with the current plan. Do you realize this?

Edit: another way to think about this is that your current assests are well invested and making good returns. You are proposing to mess with that in order to try for much higher returns, which are unlikely (this is true independent of whether the new plan is reasonable).

Your best bet is to stick with investment status quo and add income, to add to savings.  Perhaps the new income could be invested in a rental, if that is really what you want to do.  But i think you need to really understand the economics of re investing, because it is not what you think it is.
« Last Edit: August 30, 2014, 07:54:18 PM by Sdsailing »

HazelEyes

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@Sdsailing - Some lenders can allow you to qualify for one rental, then use the proposed rent you can collect on it and apply 75% of it towards the next rental property, and so on like a domino effect.

The reason why the two apartments in Japan are undesirable, is because they are far away and the management company is very inefficient. There's also language barrier (we rely on a relative to help us with communication, and she's quite a handful to deal with at times). Those apartments also have zero equity gain--the market in that area of Japan is dead, and the prices are actually falling too.

We will be buying in the Yuba/Sutter area.

We do know that we're taking away from our current investments that are going well, and then risking them for higher returns elsewhere. It doesn't make sense to a more conservative approach to investing, but like I said, we made all of our money to date precisely because we were willing to take risks. Higher return investments are always risky, aren't they? California's real estate is not for the faint of heart or the timid--you have to be able to bear the pressure and take calculated risks. I hope that's what we're doing here, instead of simply committing financial suicide. :D

I have a question: How come in the replies, no one mentions or acknowledges the uniqueness of California's real estate market and the high equity gains, and that our projections in the context of N. California market is not just wishful thinking? Are we missing something here?


Sdsailing

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I am a california re investor (among other things).

"California" is not a re market.  Re market is local.  Hence my comment about the bay area being nothing like placer county.

Your area is not a metropolitan area.  I would never invest in a non metro area for sfr re.

You are planning to buy at a market high. Why didn't you buy 2 years ago when sacramento was half of current prices?

HazelEyes

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I am a california re investor (among other things).

"California" is not a re market.  Re market is local.  Hence my comment about the bay area being nothing like placer county.

Your area is not a metropolitan area.  I would never invest in a non metro area for sfr re.

You are planning to buy at a market high. Why didn't you buy 2 years ago when sacramento was half of current prices?

We did buy our current home two years ago, and then soon after, we wanted to start investing in rentals, but our loan agent at the time discouraged us, telling us we "have life by the tail already" and we should just enjoy it, and that we couldn't afford a decent priced rental house anyway at the time. Now we're using a different lender and our situation has changed too.

What I've heard a lot from real estate agents, is that there are more and more Bay Area people moving north because how expensive the BA has become, so there's some ripple effect.

My hubby agrees with you that buying away from a metro area seems counterintuitive--that's his objection too. But we were told that a military presence is good for rentals for the reasons I already stated previously. Also, the area is slower and behind the Sacramento area by about 18 months, so there's room for equity growth still.

waltworks

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Facepunch time: Look, you got your answer: you already are pretty close to set. You have a great situation. You are proposing to throw a bunch of your assets into a venture that is *universally* considered stupid by the folks here who know something about RE investing. California is not magic and houses in CA are not going to just keep appreciating at near-double digit rates forever. Period. How many times did you hear "this place is different/special" during the bubble?

Further, you seem very naive about what it takes to maintain a rental, keep tenants in it, manage it, etc. Your costs will mean that you are losing significant money every month on these places over the long run. Sure, the next Google might set up shop in Yuba City and you'll be rich, but I wouldn't bet on it - again, especially when YOU DON'T NEED TO. You should be taking what you have, figuring out what you need, and then doing the safest and most boring thing you can with the money to accomplish that. Then go live your (FI) life, free of worrying about bad tenants and clogged toilets.

-W

HazelEyes

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Thank you for your honest opinion and advice. I just replied to the other thread, but I'll say again here that I really appreciate you guys taking the time to dispense your wisdom.

All the advice we've gotten has been to abandon our plan, and at this point, we'll have to either come up with a less risky plan but still do something to leverage whatever possible earning potential we see around us, or we just stay put and keep doing what we've been doing.

frugaliknowit

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First, you are doing great!  However, I do see some a number of risks in your plan that I am uncomfortable with:

1.  Assuming an average 7% appreciation rate on new real estate investments.
2.  Please clarify your 10% yearly return on the apartments.  Is that cash on cash, capitalization rate (after expenses), in what currency?  If it is for real in something like Euros, Yen, Swiss or British Pounds, I would keep them (echoing others).
3.  Upon your plan implementation, the percentage of your assets in rental properties (pre-mortgage(s)) is very high.
4.  The fact that you are adding to your mortgage debt.  5 rentals plus 1 that you live in with 75% mortgages...sounds easier than it is.  A better plan might be buying a multi unit and living in one (might be easier to manage).

I hope that helps.