Author Topic: Does Real Estate support higher withdrawal rates?  (Read 1411 times)

vand

  • Bristles
  • ***
  • Posts: 493
  • Location: UK
Does Real Estate support higher withdrawal rates?
« on: July 23, 2019, 04:19:11 AM »
Paula Pant of Afford Anything put out an interesting post recently which suggests that RE is able to support significantly higher safe withdrawal rates than traditional equities/bonds mixes, maybe even higher than multi-asset strategies such as the Golden Butterfly and Permanent Portfolio.

here is the post: https://affordanything.com/six-percent-is-the-new-four-percent/

the number she suggested was:

6%

That is significantly better than anything which conclusions from Trinity Study can offer, maybe especially pertinent if you extend the drawndown period past 30yrs where the 4% rule has much less certainty.

I can understand the reasoning:

- RE returns are highly biased towards cashflow
- RE is generally more stable than equities
- You don't generally draw down on the principle in RE
- Companies (ie equities) always having to compete with each other and have to invest in R&D and replacing outdated capital, sometimes just to stay relevant and keep their earnings stable. Competition benefits the consumers, but is not great for the owners of the businesses. RE investments don't suffer from this type of competition.

Of course, RE is not really a true passive investment... but it can be fairly close to it.



SwordGuy

  • Walrus Stache
  • *******
  • Posts: 6317
  • Location: Fayetteville, NC
Re: Does Real Estate support higher withdrawal rates?
« Reply #1 on: July 23, 2019, 06:25:37 AM »
Paula Pant of Afford Anything put out an interesting post recently which suggests that RE is able to support significantly higher safe withdrawal rates than traditional equities/bonds mixes, maybe even higher than multi-asset strategies such as the Golden Butterfly and Permanent Portfolio.

here is the post: https://affordanything.com/six-percent-is-the-new-four-percent/

the number she suggested was:

6%

That is significantly better than anything which conclusions from Trinity Study can offer, maybe especially pertinent if you extend the drawndown period past 30yrs where the 4% rule has much less certainty.

I can understand the reasoning:

- RE returns are highly biased towards cashflow
- RE is generally more stable than equities
- You don't generally draw down on the principle in RE
- Companies (ie equities) always having to compete with each other and have to invest in R&D and replacing outdated capital, sometimes just to stay relevant and keep their earnings stable. Competition benefits the consumers, but is not great for the owners of the businesses. RE investments don't suffer from this type of competition.

Of course, RE is not really a true passive investment... but it can be fairly close to it.

You need to be setting aside money every month for the big-ticket repairs that are on their way.  That roof, hvac, carpet, floors, paint, etc., are all wearing more and more every day.   Same thing for when the property is vacant.  You need to set aside money to cover your bills during that time.  I mention that because lots of RE investors don't seem to know that
So, profits aren't really as high as the cashflow appears.

If you don't update the property periodically it loses value.  It loses the abiity to quickly get new renters when a vacancy appears and it loses the ability to raise rents as often or as much.   That's no different than R&D costs, really.  If you aren't updating and maintaining the property it won't rise in value as much as neighboring properties and may go lower.   Not exactly the same as using up the principal but the end result is the same.

RE is less volatile than stocks.  Absolutely.   If you just have one rental though, and it's a single family home rented as such, your income can go from 100% to 0% and back.   Not as volatile but much bigger swings when it moves.   If you have a number of properties it's all going to even out so it's no big deal (unless the only factory in town shuts down and people leave town in droves).

We have 4 rentals and over the next three years I expect to have 6.   At that number the income is fairly stable, which I like.

Where RE made the big difference for us was in how much money we had to invest to get that income.  We bought our first 3 near the bottom of the RE market.   After renovation cost was added in we had spent about $150,000 for the 3 of them.  We would have had to invest over twice that amount in the stock market to get the same amount to live on. That's a big deal.  It's not technically double the withdrawal rate, but in effect, that's what I got on those three properties.

Now we're at the back end of boom times and RE prices are much higher.   Timing the market does matter in RE and it's something one has a fair chance of doing correctly.

CorpRaider

  • Bristles
  • ***
  • Posts: 437
    • The Corpraider Blog
Re: Does Real Estate support higher withdrawal rates?
« Reply #2 on: July 23, 2019, 06:50:06 AM »
If you assume a higher return your investments you can increase your projected SWR.  The data I've seen on the RE asset class doesn't, in my opinion, demonstrate that it has performed better than equities.  If it really had higher returns with less risk that showed up like clockwork, it would likely be arbitraged.

I saw another paper over the last week (from some folks out of Europe, I think) that adjusted some other real estate return data sets to better account for expenses and capital maintenance and, if memory serves, it got back to around the Shiller conclusions/data.

The 4% SWR is based on a model that factors in the historical experience of the Great Depression.  I doubt rental real estate with a 6% SWR survived that scenario. 

When people say it is less volatile, to me, they are saying it freezes up/you can't even get a quote, during periods of financial stress (transactions dry up, unless they are foreclosed on and the bank dumps REO).  I don't find that to be an attractive feature personally, but it could have some behavioral benefits by forcing would be panic sellers to sit it out (if they don't get asset seized by creditors).
« Last Edit: July 23, 2019, 07:04:37 AM by CorpRaider »

Papa bear

  • Handlebar Stache
  • *****
  • Posts: 1307
  • Location: Ohio
Re: Does Real Estate support higher withdrawal rates?
« Reply #3 on: July 23, 2019, 06:51:20 AM »
Seattlecpa has a bunch of write ups on this.  There’s a study that he’s read and blogged about that gives additional info.  He will probably chime in here.

I have some great cash flowing rentals and the amount I can spend off of them greatly exceeds what I would get in the market.  But real estate is very local and its value is all in one asset. So to come up with a general SWR for all investors would be damn near impossible.  I would even value each of my own investment properties differently in regards to a SWR based on different risks.


Sent from my iPhone using Tapatalk

terran

  • Magnum Stache
  • ******
  • Posts: 2563
Re: Does Real Estate support higher withdrawal rates?
« Reply #4 on: July 23, 2019, 07:33:56 AM »
I think what it comes down to is that real estate is a business, and no matter how much of the work you outsource to contractors, property managers, and real estate agents you still need to be somewhat involved and you still have some concentrated risk in the properties you own. If you really wanted to compare apples to apples you'd have to be comparing the SWR of stock market index funds to the SWR of REITs. But, if you're willing to put in the work, take the risk, and you're good at it, then yes, running a real estate business, even a fairly hands off one, can probably provide an income that you can live off of with less invested capital than you would have to invest in a totally hands off index fund portfolio to provide that same level of income.

A Fella from Stella

  • Pencil Stache
  • ****
  • Posts: 524
Re: Does Real Estate support higher withdrawal rates?
« Reply #5 on: July 23, 2019, 08:18:08 AM »
I would think you'd have a safer lower w/d because of the cash flow.

vand

  • Bristles
  • ***
  • Posts: 493
  • Location: UK
Re: Does Real Estate support higher withdrawal rates?
« Reply #6 on: July 23, 2019, 08:37:09 AM »
I think what it comes down to is that real estate is a business, and no matter how much of the work you outsource to contractors, property managers, and real estate agents you still need to be somewhat involved and you still have some concentrated risk in the properties you own. If you really wanted to compare apples to apples you'd have to be comparing the SWR of stock market index funds to the SWR of REITs. But, if you're willing to put in the work, take the risk, and you're good at it, then yes, running a real estate business, even a fairly hands off one, can probably provide an income that you can live off of with less invested capital than you would have to invest in a totally hands off index fund portfolio to provide that same level of income.

This is my view also. Your rentals won’t run themselves, but looking after them is a fairly mundane operation which can be done fairly easily and will enhance the return. It essentially leverages the value of your labour because of the large amounts of capital involved.

ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 1767
Re: Does Real Estate support higher withdrawal rates?
« Reply #7 on: July 24, 2019, 11:37:33 AM »
I have a hard time finding RE opportunities with a ROE on my down payment better than the yield on a portfolio of diversified REITs. On that basis alone, the idea of higher SWRs makes me skeptical. The spreadsheet shared on this forum has demonstrated the difficulty of earning high returns, especially when you realistically account for a month or two of vacancy per year, remods every decade or so, liability insurance, managers, accountants, etc.

A better reason to think one could get by on a higher SWR is the idea that rents are less volatile than stock market total returns. That is, rents continue to be paid during market panics, recessions, and lost decade bear markets (note assumption), whereas people with paper asset portfolios are forced to liquidate an increasing number of assets during such events. It is the liquidation of assets that depletes a portfolio and leads to failure. So the thinking goes that by locking oneself into an illiquid but semi-reliable source of cash flows, one can ride out the bear markets without selling assets and that translates into less risk of portfolio depletion.

I would argue that a portfolio diversified with RE is less vulnerable to stock market SORR, but more vulnerable to idiosyncratic events such as broken pipes, hail storms, meth labs, depreciating neighborhoods, local tax hikes, vandalism, lawsuits, termites, mortgage rate hikes, demographic inflows/outflows, mold, squatters, and scented candles that burn the whole place down. As a landlord, one is trading market risks for these risks.

So overall, I wouldn’t say the portfolio containing RE is less risky or could support a higher WR. Yes, you are diversifying your risks but it doesn’t necessarily matter if the long term after tax ROE < WR.

Tyler

  • Handlebar Stache
  • *****
  • Posts: 1162
Re: Does Real Estate support higher withdrawal rates?
« Reply #8 on: July 25, 2019, 08:49:58 AM »
If you really wanted to compare apples to apples you'd have to be comparing the SWR of stock market index funds to the SWR of REITs.

Since 1970, the 30-year SWR using a simple Total US Stock Market index fund like VTI was about 4.3%.  The SWR using an REIT index fund like VNQ was 5.4%.  So even looking at passive index alternatives rather than active rentals, the article quoted in the OP raises a good point about the desirability of real estate in a retirement portfolio.  To be clear, I personally wouldn't recommend going 100% in any one investment type but I think it has a place in a diversified portfolio of stocks, bonds, and other assets.

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5159
Re: Does Real Estate support higher withdrawal rates?
« Reply #9 on: July 25, 2019, 09:12:51 AM »
The fundamental difference between a SWR from paper asset markets and the net income from real estate investments, is that you will sell some of the underlying assets using the paper asset SWR.  The assumption is that the growth in value of the paper asset portfolio will cancel the effect of selling some of the underlying assets over the SWR period.  Rental income is somewhat analogous to spending only interest and dividends from a paper asset portfolio.  You retain all of the underlying assets, taking only the net income.

My view is owning both real estate and paper assets provides a lot of diversification and protection of both your net worth and your income stream.  This approach worked very well in the Great Recession.  As long as the real estate was not over leveraged, the rental income was stable and in fact grew in that time frame.  Another Great Depression might do more damage, but would be more likely to wipe out those needing income exclusively from paper assets.

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1527
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Does Real Estate support higher withdrawal rates?
« Reply #10 on: July 25, 2019, 09:57:30 AM »
Seattlecpa has a bunch of write ups on this.  There’s a study that he’s read and blogged about that gives additional info.  He will probably chime in here.

I have some great cash flowing rentals and the amount I can spend off of them greatly exceeds what I would get in the market.  But real estate is very local and its value is all in one asset. So to come up with a general SWR for all investors would be damn near impossible.  I would even value each of my own investment properties differently in regards to a SWR based on different risks.

If anyone is interested in the first blog post @PapaBear mentions to look at, here that is: Rate of return of everything line charts.

Also, this thread which many of us already commented in has lots of good comments and criticisms:
People say you don't lose money in the stock market if you hold on long enough...

FWIW, I personally think one should be able to boost their SWR by including direct real estate investment in their portfolio and for three reasons:
1. In general, the study says real estate has produced a higher rate of return.
2. The variability of real estate returns is lower than equities.
3. There's lower correlation between equities and housing and that should make it possible to build a stronger portfolio.

This tangential aside: It looks to me as if a meaningful allocation to direct real estate investment "solves" the 1966 scenario.

Stipulation: While an allocation to direct real estate ownership would have probably fixed the worst-case SWR scenario of the last fifty years, who knows what the worst case scenario of the next fifty years looks like and what it'll take to "sidestep" that risk.

A final thought: I kind of feel like this sort of "real estate SWR" effect is a new angle on preparing for retirement. The same way that no load mutual funds were 3 or 4 decades ago... and the way that index funds were 2 or 3 decades ago. And the way this should all work seems pretty foggy at this point. To mention one issue that confounds easy implementation, to get real estate to work the way you really want it to, you need to at least partially minimize the unsystematic risk (aka idiosyncratic risk). How does one do that? Is the answer, for example, to emphasize a passive portfolio of equities (ala Bogleheads et. al.) but then invest both in owning your own home and a rental property with your brother who lives in Chicago?


BECABECA

  • Bristles
  • ***
  • Posts: 346
  • Age: 38
  • Location: Huntington Beach, CA
  • Retired since July 2017, not bored yet!
Re: Does Real Estate support higher withdrawal rates?
« Reply #11 on: July 25, 2019, 10:18:36 AM »
...
A better reason to think one could get by on a higher SWR is the idea that rents are less volatile than stock market total returns. That is, rents continue to be paid during market panics, recessions, and lost decade bear markets (note assumption), whereas people with paper asset portfolios are forced to liquidate an increasing number of assets during such events. It is the liquidation of assets that depletes a portfolio and leads to failure. So the thinking goes that by locking oneself into an illiquid but semi-reliable source of cash flows, one can ride out the bear markets without selling assets and that translates into less risk of portfolio depletion.
...

Right, it’s all about avoiding selling a large chunk of your assets when they’re significantly undervalued. Instead of being a landlord full time, I would first just plan to be a little tighter with my discretionary spending in severely bear years. If that wasn’t enough, my next step would be to pick up a small side gig or rent out a room in my primary residence. That way I don’t have to deal with the hassle of being a landlord unless I really need its reliable cash flow.

Greenback Reproduction Specialist

  • Bristles
  • ***
  • Posts: 479
  • Location: Running barefoot thru Idaho mountains
Re: Does Real Estate support higher withdrawal rates?
« Reply #12 on: July 25, 2019, 04:50:10 PM »
To the OP question:

I'm not sure if it supports a higher SWR or not, at least against the principal in equities. But the way I see it, If I can get a 10% ROI on rental property, it will increase my overall monthly cashflow and make my situation less dependent on selling equities to live on.

What I think we are going to do is the following,

- Set aside 2 yrs expenses to act as a market buffer and as an emergency fund for the rental(s).
- 50% in rental properties (cashflow at about 10%, which should be doable without a mortgage payment).
- 50% in diversified stock and ETF portfolio (withdraw at 4%).


vand

  • Bristles
  • ***
  • Posts: 493
  • Location: UK
Re: Does Real Estate support higher withdrawal rates?
« Reply #13 on: July 26, 2019, 03:37:51 AM »
It's a slightly different topic, and one that has been discussed to death already, but one idea that I think warrants consideration is that when calculating/estimating the risk adjusted return of stocks or other investment on a personal level is that you can, to all extents and purposes, use your current mortgage rate as the effective risk-free rate of return for the calculation. Doing this could shift your preference towards the mortgage. I think on some subconscious level this is what a lot of people do, which is why they prioritize their mortgage over their liquid investments.

reeshau

  • Pencil Stache
  • ****
  • Posts: 753
  • Location: Dublin, Ireland
Re: Does Real Estate support higher withdrawal rates?
« Reply #14 on: July 26, 2019, 04:04:49 AM »
An aspect of the safe withdrawal rate that is difficult to understand until you see it, is that it is highly variable.  Most of the time, stocks also allow you a much higher withdrawal rate.  There are very narrow windows that define "safemax" (aka the 4% rule).  The problem is that you don't know at which point you are living, until you live it.  And you can't go back, so the rule is defined conservatively.  Comparing a nominal return vs. a trend this long is still not apples to apples.

Note that the years in this graph are the beginning years of retirement--so you can live well even through the tough times, if you have the right starting conditions.

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1527
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Does Real Estate support higher withdrawal rates?
« Reply #15 on: July 26, 2019, 07:07:46 AM »
To the OP question:

I'm not sure if it supports a higher SWR or not, at least against the principal in equities. But the way I see it, If I can get a 10% ROI on rental property, it will increase my overall monthly cashflow and make my situation less dependent on selling equities to live on.

What I think we are going to do is the following,

- Set aside 2 yrs expenses to act as a market buffer and as an emergency fund for the rental(s).
- 50% in rental properties (cashflow at about 10%, which should be doable without a mortgage payment).
- 50% in diversified stock and ETF portfolio (withdraw at 4%).

So you may or may not realize this, but your portfolio with maybe 10% in cash and then sort of 45% each in equities and direct real estate is a very "modern portfolio theory" - ish portfolio.

I like it.

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1527
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Does Real Estate support higher withdrawal rates?
« Reply #16 on: July 26, 2019, 07:12:57 AM »
It's a slightly different topic, and one that has been discussed to death already, but one idea that I think warrants consideration is that when calculating/estimating the risk adjusted return of stocks or other investment on a personal level is that you can, to all extents and purposes, use your current mortgage rate as the effective risk-free rate of return for the calculation. Doing this could shift your preference towards the mortgage. I think on some subconscious level this is what a lot of people do, which is why they prioritize their mortgage over their liquid investments.

Agree with you on this... And I actually think at some point after achieving adequate liquidity, an investor can/should pay down a mortgage rather  than invest additional amounts in bonds.

For US investors, early mortgage repayment can make particular sense given the way taxes work for high balance mortgages.

P.S. This is a little dated in terms of tax law because itemized deductions don't get phased out in the same way, but it steps someone through the math: https://evergreensmallbusiness.com/why-early-mortgage-repayment-makes-sense-for-high-income-investors/

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1527
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Does Real Estate support higher withdrawal rates?
« Reply #17 on: July 26, 2019, 07:20:58 AM »
An aspect of the safe withdrawal rate that is difficult to understand until you see it, is that it is highly variable.

@reeshau I think we agree. But the other part of this is that the recent "rate of return of everything" study that looks at a bunch of different countries (though not Ireland) suggests that (1) housing produces high returns than equities and (2) housing returns show less variability at least at a national level.

I did a blog post that produces line charts depicting the study's data when possible here: Rate of Return of Everything Line Charts.

But to show the "typical" situation, look at the 100-year-ish history for Sweden. Housing not only beats equities, it delivers more stable returns:


ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 1767
Re: Does Real Estate support higher withdrawal rates?
« Reply #18 on: July 26, 2019, 11:22:17 AM »
It's a slightly different topic, and one that has been discussed to death already, but one idea that I think warrants consideration is that when calculating/estimating the risk adjusted return of stocks or other investment on a personal level is that you can, to all extents and purposes, use your current mortgage rate as the effective risk-free rate of return for the calculation. Doing this could shift your preference towards the mortgage. I think on some subconscious level this is what a lot of people do, which is why they prioritize their mortgage over their liquid investments.

I wonder about this a lot. Stock valuation is based on the risk free rate. As the risk free rate rises, investors should be willing to pay less for stocks because the appeal of the risk free rate becomes greater. Technically speaking, the risk free rate is the discount rate applied to future cash flows from an investment. For example a series of future cash flows discounted at 2.5% will be worth more than the same series of cash flows discounted at 3.5%.

If my risk free rate is my mortgage rate, but for the market makers who set stock prices it is the 10 year treasury or similar, then I have a risk free rate that is about a percent higher than my competitors. Therefore, I should always require a lower price than they are willing to pay. Therefore I might never see stock prices low enough to justify buying if I’m using a DCF methodology. The standard DCF math will never work for individuals.

The only rational reason I’d buy stock at prevailing prices is not for the cash flows, but because I expect I can sell it back to the market maker at a price based on their discount rate. This is disturbing because it implies we are all greater fool theory investors, paying mathematically unjustifiable prices.

Buffaloski Boris

  • Pencil Stache
  • ****
  • Posts: 973
  • A Very Stupid Person®️ Authentic Russian Bot
Re: Does Real Estate support higher withdrawal rates?
« Reply #19 on: July 26, 2019, 02:53:23 PM »
I like the idea BUT I gotta wonder how this works out in economic downturns?  Less people employed means less people seeking to live on their own.

I do find RE a heck of a lot more appealing than equities and bonds these days. CAPE ratios north of 30? 10 year Treasuries around 2%?  Pffffffffft!