Author Topic: 4% Withdrawal Rate if Investing in Real Estate?  (Read 9680 times)

Kiwi Mustache

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4% Withdrawal Rate if Investing in Real Estate?
« on: June 19, 2016, 07:05:40 PM »
Hi,

I intend to have my investments in real estate as opposed to the stock market/index funds.

In order to know when I'm FI, I need to have a 4% safe withdrawal rate. However, how does this work with real estate? Is it essentially the after tax income from your rentals being more than your living expenses? So % earned on assets is rather inconsequential for real estate and just use that calculation instead?

Tumbler

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #1 on: June 20, 2016, 09:23:22 AM »
To me, FI from real estate would be when your real estate income, after accounting for future maintenance/capital expenses (new roof, plumbing disaster, etc...) surpasses your living expenses. You might want to add in a cushion to account for changes in rent prices over time - it's possible that rent in one or all of your units could come down for a short or extended period of time.

boarder42

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #2 on: June 20, 2016, 09:28:21 AM »
yes correct the 4% SWR applies only to the stock market investments. 


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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #3 on: June 20, 2016, 09:59:17 AM »
Hi,

I intend to have my investments in real estate as opposed to the stock market/index funds.

In order to know when I'm FI, I need to have a 4% safe withdrawal rate. However, how does this work with real estate? Is it essentially the after tax income from your rentals being more than your living expenses? So % earned on assets is rather inconsequential for real estate and just use that calculation instead?
The cash yield on real estate varies so much with location, condition, and type of property that there's no way to generalize. This actually takes a step OUT of the process. You don't estimate income based on total equity, you just observe it directly. Once it's high enough for you, you quit... xD

clarkfan1979

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #4 on: June 24, 2016, 02:38:46 PM »
more than likely rents will increase with inflation. Your mortgage will stay the same. As a result, I think there is a sustainability cushion already built in.

hucktard

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #5 on: July 01, 2016, 09:45:25 AM »
Yep, the 4% rule does not apply to real estate. For me, once my cashflow from my rentals equals my monthly expenses I will think about quitting my job. However, I probably won't quit my 9-5 until I also have a cash/stock cushion of about $500K in addition to my rentals.

TheGrimSqueaker

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #6 on: July 01, 2016, 09:58:46 AM »
Hi,

I intend to have my investments in real estate as opposed to the stock market/index funds.

In order to know when I'm FI, I need to have a 4% safe withdrawal rate. However, how does this work with real estate? Is it essentially the after tax income from your rentals being more than your living expenses? So % earned on assets is rather inconsequential for real estate and just use that calculation instead?

To be safe, calculate what your after tax income would be WITHOUT depreciation, taking vacancies and major repair expenses into account. Being able to write off depreciation is a tax goodie that can go away with one stroke of a legislator's pen or one change in policy. It happened before in 1986; it can happen again.

To provide you with a reasonable retirement, your investment real estate must be cash flow positive WITHOUT depreciation, even taking repairs and vacancies into account. This is very seldom possible with mortgaged property. Most often, you have what my friends and I call "cash flow to equity" which means that your property is not giving you extra money to live off of, but the mortgage is being paid down and the equity is increasing more than the value of what you're pumping into it.

GrOW

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #7 on: July 01, 2016, 10:07:32 AM »
Will you have any stock market investments? I ask because I have known a few couples that planned on 4% of investments to cover extreme barebones expenses and real estate income for the rest. They all felt it gave them some more comfort on knowing when to retire as well as same basic diversification.

Blindsquirrel

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #8 on: July 02, 2016, 07:36:22 AM »
 Totally dependant on area. If you are in New Zealand I have no clue, in the USA some areas you will crush the 4% rule handley, in HCOL areas, not so much.   

zephyr911

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #9 on: July 07, 2016, 07:17:40 AM »
Totally dependant on area. If you are in New Zealand I have no clue, in the USA some areas you will crush the 4% rule handley, in HCOL areas, not so much.
Exactly.
It is quite possible to cash-flow 10% on equity where I live, with the right financing terms. Totally impossible in many areas.

NoNonsenseLandlord

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #10 on: July 12, 2016, 09:36:00 PM »
I just quit my 6-figure W2 job to be a landlord.

I was saving almost 2x my W2 gross pay.  I was saving ~250% of my gross pay, less taxes.  I was saving ~4x my spending, every year for the past 3+ years.

You should be able to spend what you take in from the rentals.  Make sure you account for vacancy and a 10% maintenance budget.  Never mistake deferred maintenance for profit.  There is no withdrawal percentage that makes sense.  It's all about cash flow.


arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #11 on: July 18, 2016, 05:42:34 AM »
I used to think it was as simple as looking at cash flow, after taking into account vacancies, capital expenses, maintenance, etc. etc. (all expenses basically) and saying that when cash flow > expenses, you're good.

The reason why?  It's what every real estate investor said.  In books, on BiggerPockets, etc.  Even the well-experienced ones.

I'm not so sure, now.  I think there are absolutely cases where you could have your cash flow > your expenses, be saving a significant chunk of your income (over and above the amount set aside for all expenses--we're assuming you project that correctly and set aside for that already) and STILL hit ER failure, simply due to the market you're invested in lagging inflation.

The critical assumption one relies on when wanting to FIRE based on cash flow > expenses is this:
more than likely rents will increase with inflation

That may be a dangerous assumption.  Historically rents have risen with income, not inflation (those are sometimes tied together, but not always).  And any particular area may rise less, or more, depending on that local economy.

If rents in the area you're invested in start a slow (or quick) decline while you're living in an area with increasing expenses (or even in that area, but not seeing your expenses go down, because food, travel, etc. still all cost the same), you might quickly run into trouble.

I made some posts recently about when SWR/WR is Less Than ROI.

The background, from this post:
Quote
another big problem is you don't know what the SAFE withdrawal rate is, even if you have a return on investment.

In other words, let's pretend your return is 6%. Your SWR* might be 9% (i.e. you could spend all of the income from the property - the 6% - AND cash out refi equity every few years due to the property value increasing, to give you a total yield of 9%), or it might be 3% (i.e. you can spend half of the 6% income you're getting, and need to reinvest the other half in order to make it the money keep growing and last long term).

*Safe as in - it is sustainable long term

If you're in an area where prices stagnate, rents don't rise much, and inflation outpaces them, your SWR is lower than your yield. That is, you may be earning 6%, but if your expenses and costs rise faster than inflation, you'd better be LBYM, saving a good chunk of that 6%, and plowing some of those proceeds back into more investments to keep pace, or in 20-30 years you'll be hurting really, really bad.

So we use the word "safe withdrawal rate (SWR)" fairly loosly, usually to mean "WR" -- but the actual safe withdrawal rate is the rate that is sustainable long term, and that might be more or less than your ROI. You can't just go "I'm making 6%, I can spend 6% without eating into principal, I'm good" - because of inflation."

"And I almost never see it mentioned. Just because your return is $X, that doesn't mean you can spend it all, even if it's stable. Even if you have accounted for vacancy, repairs, etc. and are dead on accurate such that a disaster never hits and your budget is 100% correct to the penny, you still might not be okay spending the rest, because your SWR could be lower than your return.

For stocks it's lower due to volatility (sequence of returns risk). Real estate has less sequence of returns risk, but other systemic risk in expenses rising higher than income.

But in pretty much every real estate book I've read, including ones on long term buy and hold, this isn't really mentioned, or it's handwaived away with a "rents increases will cover it all" -- but that's not necessarily true.

So it's something a smart individual looking to FIRE and live a long time on real estate proceeds should consider.

This one illustrates it with numbers (using a CD to make the math straightforward, but it absolutely applies to real estate as well) from this post:
I can't use cFIREsim, cause our portfolio is mostly real estate.  But I'd estimate my chances are just north of 50% of not needing more paid work? 

I'm surprised your estimate is that low.  Didn't you say you continue to have a positive savings rate in retirement?  Is it because you expect your expenses to go up (presumably it's not because you expect your rental income to go down)?

Well... it's really hard to get an accurate estimate.  So I fluctuate between "we never have to work for money again!" and "we'll definitely have to go back at some point."  My 50/50 estimate is approximately how much time I spend in each stage.  ;)

I do expect my expenses to go up, but only to the level I projected pre-FIREing. We're way below that right now, and if we stayed at this low level forever, we'd have no problems whatsoever.  But I don't necessarily expect them to rise past what I had projected (aka pulled out of nowhere).

It's more that I think my SWR is lower than my ROI.  So while I think we can get along just fine on cash flow for decades(?), we could still hit ER failure.  With my type of income, over time it could fall in real terms if expenses outpace inflation and/or rents underperform inflation.

So we do have a positive savings rate, for now.  But that's not even enough to guarantee having "enough."

For example, i someone had 1MM and wanted to spend in line with the 4% rule, and had a higher ROI than that 4%, so they had a positive savings rate, and a flat inflation rate, but it was higher than their savings rate, they'd run out of money, even with a positive savings rate.

Hypothetical: Person has 1MM, is invested in a one-year CD that paid 5% (and had access to this investment forever, in this hypothetical), and they spent 4% (40k), and reinvest 1% of it (10k), with a 3% inflation rate, the first year they'd spend 40k, reinvest 10k.  The next year, at 3% inflation, they'd spend 41200 (an extra 1.2k over the year before), but they'd have only generated an extra $500 (5% return on the extra 10k invested).  Their expenses are growing faster than their reinvestments. 

Eventually the amount they withdraw (the initial 40k, but adjusted up for inflation) will be higher than the interest generated, so they won't be reinvesting any anymore.  This happens in year 11.  They then have a negative savings rate, and start eating into principal to maintain their lifestyle.  At the end of year 18, their portfolio has fallen back below it's original 1MM.

After 30 years, they'd have about half their initial starting capital (~500k), and only generating ~30k (with their expenses being ~94k annually at that point).  By year 37, they're out of money.

This is someone with a guaranteed investment return of 5% and a positive savings rate of 20% (1% of their 5% return), and they ran out of money after less than 40 years!

Now, obviously they only had a real positive return of ~1.94% (5% nominal, 3% inflation) and were withdrawing 4%, so we can see disaster coming when we understand real return.  But you can easily see why someone who says "I have a withdrawal rate less than my ROI, and a 20% savings rate!" would think they're in good shape, even though they're headed for disaster.

This is the situation I'm in.  My ROI on my rentals (just my cash on cash return, not counting appreciation and principal paydown) is much higher than my "WR" (aka spending amount).  Due to this, I have a positive savings rate.

Yet my "WR" may still be too high, and I may still be heading for portfolio failure.  I don't know.  But it is an added risk, if expenses outpace inflation or rents underperform inflation.  Then I could have a real return, like our doomed investor, of less than my spending rate, all while having a positive savings rate, and not even know it.

That is my bigger worry.  Not my expenses increasing, or my portfolio not putting out enough cash flow to support me over the next decade or two.  It's multiple decades down the line--will I have reinvested enough, along the way, to avoid that scenario?

I think this is something almost no one in real estate realizes.  If your income goes up in line with inflation, as it likely will the majority of the time, sure.. your SWR may be the ROI.  Or higher!  You might be able to spend MORE than your cash flow (deficit spending and selling a property every once in awhile to cover that) and still be fine, if your income is increasing much faster than inflation.  You could have an ROI of 6% and SWR of 9%. 

But typically, it'll keep in line with inflation, and an ROI of 6% may equal a SWR of 6%, and you'll be just fine (again, assuming proper set asides for CapEx, vacancy, etc.).

But just because this is the case the majority of the time doesn't mean it always will be. And that possibility, of rents declining in real terms (even if they are rising overall, if they aren't rising as fast as inflation--and you can only push rents to what the local market will bear), you may be in trouble.  Even if you're not only not spending all your cash flow aside from set asides, but reinvesting some of it!  It may not be enough.

It's a risk to be aware of, and hedge against, IMO.

As you can tell, I've put some thought into this lately, as I FIRE'd on real estate a year ago, and I'm trying to account for any risks that I can.  And this is, from what I've seen of the real estate field, and people telling you how to retire on passive income "an unknown unknown"--I'd rather turn it into a known unknown, at the very least.

Hope that helps give you (and others, who have posted here and who haven't) something new to consider. :)
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FiveSigmas

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #12 on: July 18, 2016, 10:01:21 AM »
I used to think it was as simple as looking at cash flow, after taking into account vacancies, capital expenses, maintenance, etc. etc. (all expenses basically) and saying that when cash flow > expenses, you're good.

ARS, thanks for your thought-provoking post. I really appreciate the insight from someone who's putting his money where his mouth is.

Bicycle_B

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #13 on: July 22, 2016, 04:50:02 PM »
I used to think it was as simple as looking at cash flow, after taking into account vacancies, capital expenses, maintenance, etc. etc. (all expenses basically) and saying that when cash flow > expenses, you're good.

ARS, thanks for your thought-provoking post. I really appreciate the insight from someone who's putting his money where his mouth is.

+1

Another Reader

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #14 on: July 22, 2016, 06:46:11 PM »
This is actually what happened in Phoenix over the last 20 years.  Rents grew very slowly or even declined in some periods, except for a couple of spurts in 1995-96 and in the last three or four years.  Expenses grew dramatically over the same period, doubling or in some cases tripling.  It is now substantially LESS profitable to own rentals today than 20 years ago.  I expect this trend to continue.  Were I starting out today, I would probably avoid the Phoenix market. 

What has happened is that prices have gone up substantially over the same 20 years.  Plus there were some great buying opportunities from 2009 to early 2012.  There is profit to be made, but right now the larger yield in many cases is harvesting the appreciation.  I recently remodeled and sold an older property for a nice profit because the maintenance and capital improvement costs had skyrocketed.  I may sell a couple of others to pay off most of the remaining mortgages.  The returns on the other properties are not terrible, but I would be loathe to rely on even a free and clear portfolio for a 40 year retirement.  With operating expenses eating more of the profits and increasing government interference in rental operation, especially the loss of control over who can rent your property, diversification becomes a lot more attractive, if not necessary. 

mathjak107

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #15 on: July 23, 2016, 07:37:02 AM »
while the original study's were only stocks and bonds the math that was determined to be needed to pass the worst time frames in history stay true for any investments .

work by michael kitces has shown that the failure for 4% to hold up in every time frame was not because of poor 30 year sequencing . it was caused by real returns over the first 15 years  falling below 1% as an average .

so no matter what you are utilizing for investments to have 4% inflation adjusted hold up you need to maintain about a 2% real return over the first 15 years of your retirement .

in all cases even though things improved over the 30 year period it was to little to late . the outcome was already decided the first 15 years .

so just monitor things . if you are 6 or 7 years in and are below a 2% real return average start to cut back a bit .

what investments you use to maintain that average is irrelevant , the math is the math .

this is one of the useful facts that modern day research on retirement portfolio study  has given us . it has quantified what it takes for the 4% safe withdrawal rate to fail in to an actual useful  number  that is not time frame , event or investment sensitive ..

« Last Edit: July 23, 2016, 07:41:00 AM by mathjak107 »

ender

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #16 on: July 23, 2016, 09:45:03 AM »
This is actually what happened in Phoenix over the last 20 years.  Rents grew very slowly or even declined in some periods, except for a couple of spurts in 1995-96 and in the last three or four years.  Expenses grew dramatically over the same period, doubling or in some cases tripling.  It is now substantially LESS profitable to own rentals today than 20 years ago.  I expect this trend to continue.  Were I starting out today, I would probably avoid the Phoenix market. 

What has happened is that prices have gone up substantially over the same 20 years.  Plus there were some great buying opportunities from 2009 to early 2012.  There is profit to be made, but right now the larger yield in many cases is harvesting the appreciation.  I recently remodeled and sold an older property for a nice profit because the maintenance and capital improvement costs had skyrocketed.  I may sell a couple of others to pay off most of the remaining mortgages.  The returns on the other properties are not terrible, but I would be loathe to rely on even a free and clear portfolio for a 40 year retirement.  With operating expenses eating more of the profits and increasing government interference in rental operation, especially the loss of control over who can rent your property, diversification becomes a lot more attractive, if not necessary.

Something to consider too is the potential impact and feasibility for new developments on longer term rents.

If you live in a land locked area, it is less likely that a megacorp will build a huge apartment complex than if you live in an area with fields nearby. While this might not have an immediate effect on rent, it might affect your longer term rent potential.

Another Reader

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #17 on: July 23, 2016, 01:24:36 PM »

Something to consider too is the potential impact and feasibility for new developments on longer term rents.

If you live in a land locked area, it is less likely that a megacorp will build a huge apartment complex than if you live in an area with fields nearby. While this might not have an immediate effect on rent, it might affect your longer term rent potential.

Traffic has turned Phoenix into Los Angeles over the last few years.  The "drive until you can buy (i.e. afford the payment)" mentality has changed.  Want a new build?  San Tan Valley, Florence, Casa Grande, Maricopa, and Buckeye are where the builders are.  Indian reservation land south of Chandler and Ahwatukee.  The inner East Valley is almost completely built out.  My rentals are close in, near amenities, employers, and the freeway system.  No fields within at least 10 miles.  The only new multi-family locally is infill. 

Employment is high now, so rents have been going up.  The economy is more diversified than 15 or 20 years ago.  However, the influx of Californians means labor costs have been increasing, so the increasing cost of repairs and capital improvements has outpaced inflation.   More government regulations and costs - higher taxes.  When the economy turns, rents will stagnate and even go down if the employment drops significantly.  Cap rates need to be higher to take this on.

arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #18 on: July 23, 2016, 03:44:58 PM »
while the original study's were only stocks and bonds the math that was determined to be needed to pass the worst time frames in history stay true for any investments .

work by michael kitces has shown that the failure for 4% to hold up in every time frame was not because of poor 30 year sequencing . it was caused by real returns over the first 15 years  falling below 1% as an average .

so no matter what you are utilizing for investments to have 4% inflation adjusted hold up you need to maintain about a 2% real return over the first 15 years of your retirement .

in all cases even though things improved over the 30 year period it was to little to late . the outcome was already decided the first 15 years .

so just monitor things . if you are 6 or 7 years in and are below a 2% real return average start to cut back a bit .

what investments you use to maintain that average is irrelevant , the math is the math .

this is one of the useful facts that modern day research on retirement portfolio study  has given us . it has quantified what it takes for the 4% safe withdrawal rate to fail in to an actual useful  number  that is not time frame , event or investment sensitive ..

90% not relevant for real estate investing.

The thing that causes portfolio failure in a traditional WR, like you mention, is the early returns, and if they're bad (e.g. market crash, super high inflation, etc.).  Rental real estate income is much more stable.  You won't have that, so it's not something to worry as much about.  What I posted, however, is a risk that RE has that equities typically don't.

And Kitces' is for a 30-year time period, because it's targeted at traditional retirees at age 65 (to 95), like the original Trinity study.  Less relevant for many of us here due to that, as well.

We need to protect over multiple decades against long slides in purchasing power, something equities do a great job with, and real estate can, if the area keeps up with/passes inflation.  But if it doesn't, be wary.  That's the point of my post, above. 

Kitces research, while useful if you're doing a traditional 60/40 portfolio and are at a normal retirement age, is much less relevant to this thread, the SWR for real estate.
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Dicey

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #19 on: July 23, 2016, 04:12:16 PM »
This is actually what happened in Phoenix over the last 20 years.  Rents grew very slowly or even declined in some periods, except for a couple of spurts in 1995-96 and in the last three or four years.  Expenses grew dramatically over the same period, doubling or in some cases tripling.  It is now substantially LESS profitable to own rentals today than 20 years ago.  I expect this trend to continue.  Were I starting out today, I would probably avoid the Phoenix market. 

I own a lot of rentals in the Phoenix market.  The values went to hell in 2008-2013, but the rents went up and tenant quality improved because of all the foreclosures and short sales.  If you take the long (multi-generational) view, concentrated real estate investing is one of the best ways to build assets and a solid income stream.

The second quote is from an earlier thread. For those of us who respect and value your opinion, AR, particularly on this topic, would you mind clarifying, please?

mathjak107

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #20 on: July 23, 2016, 04:24:04 PM »
while the original study's were only stocks and bonds the math that was determined to be needed to pass the worst time frames in history stay true for any investments .

work by michael kitces has shown that the failure for 4% to hold up in every time frame was not because of poor 30 year sequencing . it was caused by real returns over the first 15 years  falling below 1% as an average .

so no matter what you are utilizing for investments to have 4% inflation adjusted hold up you need to maintain about a 2% real return over the first 15 years of your retirement .

in all cases even though things improved over the 30 year period it was to little to late . the outcome was already decided the first 15 years .

so just monitor things . if you are 6 or 7 years in and are below a 2% real return average start to cut back a bit .

what investments you use to maintain that average is irrelevant , the math is the math .

this is one of the useful facts that modern day research on retirement portfolio study  has given us . it has quantified what it takes for the 4% safe withdrawal rate to fail in to an actual useful  number  that is not time frame , event or investment sensitive ..

90% not relevant for real estate investing.

The thing that causes portfolio failure in a traditional WR, like you mention, is the early returns, and if they're bad (e.g. market crash, super high inflation, etc.).  Rental real estate income is much more stable.  You won't have that, so it's not something to worry as much about.  What I posted, however, is a risk that RE has that equities typically don't.

And Kitces' is for a 30-year time period, because it's targeted at traditional retirees at age 65 (to 95), like the original Trinity study.  Less relevant for many of us here due to that, as well.

We need to protect over multiple decades against long slides in purchasing power, something equities do a great job with, and real estate can, if the area keeps up with/passes inflation.  But if it doesn't, be wary.  That's the point of my post, above. 

Kitces research, while useful if you're doing a traditional 60/40 portfolio and are at a normal retirement age, is much less relevant to this thread, the SWR for real estate.

i would disagree  to the point the calculation is a bit different .

 so with our real estate , if it spins off 20k a year then 20k is subtracted off what we need like ss or pension would be treated  and then the rest of the portfolio has to maintain 2% real return  over the first 15 years . so in reality , yes the 4% safe withdrawal rate still apply's .

the change is just how you account for the income .


« Last Edit: July 23, 2016, 04:33:39 PM by mathjak107 »

arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #21 on: July 23, 2016, 04:58:44 PM »
This is actually what happened in Phoenix over the last 20 years.  Rents grew very slowly or even declined in some periods, except for a couple of spurts in 1995-96 and in the last three or four years.  Expenses grew dramatically over the same period, doubling or in some cases tripling.  It is now substantially LESS profitable to own rentals today than 20 years ago.  I expect this trend to continue.  Were I starting out today, I would probably avoid the Phoenix market. 

I own a lot of rentals in the Phoenix market.  The values went to hell in 2008-2013, but the rents went up and tenant quality improved because of all the foreclosures and short sales.  If you take the long (multi-generational) view, concentrated real estate investing is one of the best ways to build assets and a solid income stream.

The second quote is from an earlier thread. For those of us who respect and value your opinion, AR, particularly on this topic, would you mind clarifying, please?

Those quotes match.  Added bolding.
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arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #22 on: July 23, 2016, 04:59:52 PM »
so with our real estate , if it spins off 20k a year then 20k is subtracted off what we need like ss or pension would be treated  and then the rest of the portfolio has to maintain 2% real return  over the first 15 years . so in reality , yes the 4% safe withdrawal rate still apply's .

Um, no.  That's exactly what I'm saying you CAN'T do.  That's what everyone says to do, but I'm arguing that there's a big risk in that, many times.  Read my first post in this thread.
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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #23 on: July 23, 2016, 05:02:45 PM »
No contradiction really, except maybe in the years cited.  Rents never really went down in that time frame, and they started increasing sometime around early 2013 IIRC.  In the last two years or so, the demand for single family homes to rent has been very high, because the jobs are there.  I would not pick Phoenix today as a place to invest.  I would invest in real estate for the long term, but not there, and maybe nowhere today because the numbers I see don't make sense.  However, if another buying opportunity in the Phoenix market presented itself, I would not hesitate to buy a few more properties. 

As I said, expenses have increased at a much faster rate than rents.  It shows up more in capital improvements such as roofs that are occasional and not monthly or annual expenses.  Cash flow depends on a lot of factors, but the effect of increased expenses is noticeable.  I think rental increases will slow with the economy.  I'm not hopeful about expenses, and there are troubling trends from HUD and other regulators plus the local government agencies that will make landlording more difficult in the future. 

I have done very well with real estate, as have many others that participate in the forums.  The cash flow is still good, but the appreciation and the equity gains by principal reduction are a significant part of the total profit.  My crystal ball is as cloudy as everyone else's, but I'm just not confident enough in the future of rental real estate to put all my money there.  Hedging by diversifying into some paper assets, and for those that have the time and energy, other businesses, will likely guarantee a successful 40 year retirement.  Make sense?
« Last Edit: July 23, 2016, 05:11:39 PM by Another Reader »

mathjak107

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #24 on: July 23, 2016, 05:11:06 PM »
so with our real estate , if it spins off 20k a year then 20k is subtracted off what we need like ss or pension would be treated  and then the rest of the portfolio has to maintain 2% real return  over the first 15 years . so in reality , yes the 4% safe withdrawal rate still apply's .

Um, no.  That's exactly what I'm saying you CAN'T do.  That's what everyone says to do, but I'm arguing that there's a big risk in that, many times.  Read my first post in this thread.

that rent is still  separate from the 4% swr on your other assets .

so lets say you have 20k ss , 20k pension and 20k  rental income . that is 60k in income  separate from  the portfolio draw .

lf you need 100k  to live on you need to draw 40k a year inflation adjusted from the portfolio . if you have 1 million you are good to go in theory .

but lets say your tenant stopped paying rent and you had to go though eviction . so you lost 6 months rent .

now you need 50k from your portfolio.

well that does not change the fact that 4% is still safe from your 1 million dollar portfolio  , it certainly is , that never changed . but now you are looking at a 5% draw which is not so safe 
« Last Edit: July 23, 2016, 05:14:02 PM by mathjak107 »

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #25 on: July 23, 2016, 05:20:05 PM »
Sure. I just don't see the relevancy to this thread.  But okay, yes, if your living expenses are partially covered by rent, you need to worry about the risks I posted above (and not just treat it like a guaranteed income flow into perpetuity).  And if the other part of your expenses are covered by a traditional portfolio and you're following the 4% rule, you should go read those 4% rule threads that are relevant to that type of portfolio.
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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #26 on: July 23, 2016, 05:21:47 PM »
agreed .

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #27 on: July 23, 2016, 06:36:56 PM »
following

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #28 on: July 24, 2016, 12:31:26 AM »
    As always, it is your spending that determines your success/failure for any asset allocation. I error on the conservative side but use RE instead of bonds for the most part. Interest rates are very, very low right now and that is a distortion that will correct itself eventually, though it may not be in my lifetime. Currently there are in excess of $10,000,000,000,000 in bonds that are negative yield. (Yes, that is trillion with a T). When interest rates rise, the value of those bonds, esp the longer term ones at >5-10 years duration will crater in a manner that will be shocking. When RE crashed in SW Oh,the values dropped but rents and renter quality improved as banks were not writing loans to those who could fog a mirror. Now the rental market is fireball hot but that will also change. Reversion to the mean happens in RE just as it does in the S&P500. The 4% SWR is reasonable for the most part but as ARS wisely noted, you have to watch it. Dividend yield of the S&P500 is now at 2.02% so at 4% you are only looking at limited need for capital appreciation, i.e.  the 15 years of 1% growth.  If you keep your expenses low, you should be fine in a good rental market. If property taxes go up at a wicked rate, sell that dog on a 1031 and buy someplace with lower taxes. We own RE in 5 counties to spread the risk but also invest in paper assets to an almost equal tune. However, you do need to pay attention as ARS said. If you are a rehabber, all you need to do is flip a house or two every year or 3 years to insulate yourself from a heck of a lot and in a LCOL area, you can do that in a fashion that will jack your ROI up considerably without you swinging a hammer or paint brush. Just my 2 cents.

mathjak107

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #29 on: July 24, 2016, 02:47:51 AM »
we found our key to success was investing in real estate in high cost area's but sticking to special situation stuff .

a  million dollar property that goes up 3% is a whole lot more then a 150k property going up 3% .

so  our family partnership bought up co-op apartments in manhattan in a prestigious building over looking central park . these apartments had rent stabilized original tenants in them at a pretty low rent .

cash flow sucked but values were high once they were out .

so we bought up a bunch on the cheap since cash flow was low , offered 100k to buy out the leases since we knew many were baby boomers who would be retiring and over the last 13 years sold off 7 out of 9 at more then  7 figures each .

we also held the commercial lease rights to the stores in the building which our partnership  sold to another investor group  for an incredible amount of money which made real estate news all over the web .

so at this point all the real estate is gone except 2 remaining apartments who may never leave but the over all investment turned out to be golden .

at this point the rent is close to break even so i don't even bother calculating that in to our draw and the investor group still has 2 years  left to pay us off in full for the lease rights but they owe us only a tiny part of the lease right sale  so that we count  for now .

but as i mentioned all real estate income is figured like ss or pension income . it is combined and subtracted off what the portfolio needs to produce to meet our spending .



« Last Edit: July 24, 2016, 03:34:05 AM by mathjak107 »

Another Reader

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #30 on: July 24, 2016, 07:44:53 AM »
we found our key to success was investing in real estate in high cost area's but sticking to special situation stuff .

a  million dollar property that goes up 3% is a whole lot more then a 150k property going up 3% .

so  our family partnership bought up co-op apartments in manhattan in a prestigious building over looking central park . these apartments had rent stabilized original tenants in them at a pretty low rent .

cash flow sucked but values were high once they were out .

so we bought up a bunch on the cheap since cash flow was low , offered 100k to buy out the leases since we knew many were baby boomers who would be retiring and over the last 13 years sold off 7 out of 9 at more then  7 figures each .

we also held the commercial lease rights to the stores in the building which our partnership  sold to another investor group  for an incredible amount of money which made real estate news all over the web .

so at this point all the real estate is gone except 2 remaining apartments who may never leave but the over all investment turned out to be golden .

at this point the rent is close to break even so i don't even bother calculating that in to our draw and the investor group still has 2 years  left to pay us off in full for the lease rights but they owe us only a tiny part of the lease right sale  so that we count  for now .

but as i mentioned all real estate income is figured like ss or pension income . it is combined and subtracted off what the portfolio needs to produce to meet our spending .

Your example shows an investment that was not an income investment but a speculative investment for appreciation.  You purchased at a low point in Manhattan real estate, not too long after 9/11.  Rent control is a sensitive issue there, and you could not predict who would move out and when or what the rent control rules would be when they did.  In other words, you took a lot of risk, and you won.  Yes, you received the sales price for the commercial lease rights over time.  But this investment did nothing to increase your income long term.  What you accomplished was the generation of a large profit that has to be redeployed to produce the income you need. 

My guess is you do not directly own and manage income properties.  If you did, you might conclude what most of the long-term landlords I know have.  Real estate income is variable and there are disturbing trends that may decrease the income or at least drag down the growth of the income stream.  Yes, you need less from your paper portfolio, but it's not as simple as taking your current net rental income and growing it by some rate every year in your calculation.
« Last Edit: July 24, 2016, 08:01:50 AM by Another Reader »

mathjak107

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #31 on: July 24, 2016, 08:01:29 AM »
you are correct on a few points . we did own rentals outside of the partnership since 1987  in queens ny , not manhattan . those were bought for income and eventually sold because we wanted  no real estate in retirement . after decades of dealing with tenants i want nothing but passive , liquid investing in retirement .

the partnership was a bit of a risk . we knew that some tenants would take buyouts , we just did not expect so many .

the lease right sale was something i hated to see sold but our senior  partner was real estate mogul bernard spitzer and basically we had no say in the sale .

the lease rights spun off 25k- 30k  a year in income  as our share and we held only a small percentage of that part of the business .  . now  i basically have what was left after taxes and it is tough to get any where near that in return the last 2 years .

but the good thing is the numbers are working for us as is .
« Last Edit: July 24, 2016, 08:07:06 AM by mathjak107 »

Jim2001

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #32 on: July 24, 2016, 12:09:52 PM »
Kiwi, GREAT question to open the thread.
ARS, GREAT analysis on the cash flow / expense, ultimate savings rate question.

I've got to take a deeper look at my projected 12/31/17 FIRE date with this overlay.

matchewed

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #33 on: July 25, 2016, 07:25:16 AM »
So this is a question for you veteran landlords; how much do you adjust your on paper cash flow for modeling/prediction purposes? I know that each circumstance will be wildly different but is there a rough rule of thumb you'd use or a flat percentage cut that you'd use to simulate the inevitable valleys of cash flow?

arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #34 on: July 25, 2016, 06:33:04 PM »
So this is a question for you veteran landlords; how much do you adjust your on paper cash flow for modeling/prediction purposes? I know that each circumstance will be wildly different but is there a rough rule of thumb you'd use or a flat percentage cut that you'd use to simulate the inevitable valleys of cash flow?

This is a great question.  I have some thoughts (and questions of my own) around it--maybe we should start a new topic?  :)
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Fuzz

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #36 on: July 26, 2016, 03:00:44 PM »
Hey Arebelspy -

I think you raise an interesting point: if the rate of growth in expenses exceeds the rate of growth in rents, then your SWR number isn't meaningful. But I think you generalize this insight too far. Essentially, you're saying that if the inflation in expenses exceeds inflation in general, that's bad.

Well, sort of. I think inflation in general is not an especially useful concept for early retirement. Inflation is defined as the increase in the price level. In the US, we measure the CPI, or inflation in a particular basket of goods as tracked by the DOL. For ER, we worry about inflation because it erodes the value of our savings.

My issue is that the whole idea that we should expect 2 percent inflation a year, or whatever the Fed targets, is that it gives us a false sense of precision.

Armchair guesses here:

Education - prices up 5-7 percent/year over last 30 years. Huge increase, cumulatively.
Healthcare - prices up  7-9 percent/year over last 30 years. Number one cause of bankruptcy. Quality up? Idk.
Electronics - prices exponentially down, function exponentially up, over last 30 years. Imagine buying cloud computing cycles in the 90s - you can't.
Housing - prices up 10 percent/year in Coast cities over last 30 year, down or flat in South and Midwest.
Food - prices down or flat.
Clothes - prices down or flat.
Movies - who even goes to those.
Transportation - probably down if you buy beater Hondas. Maybe up.

What are you going to buy in ER? Probably not education--MOOCs and library cards take care of that. Maybe healthcare, but those costs are set by the government through exchanges. If you get the wrong kind of cancer and want specialized care/treatments, you may go bankrupt regardless of insurance or treatment. This is hard to protect against. Probably housing--but you can control that by owning, or moving. Food and electronics are negligible.

Anyway, my point is that ER folk don't consume the typical basket of goods; that no one consumes the typical basket of goods; and that it's not really relevant for ER folk, because ER folk typically have control over their expenses and can react.

As it relates to rental properties, the idea that (a) you could cash flow, but (b) still have inflation slowly erode the value of your investment is interesting. But I think how that would look in practice is you diligently make 8% a year on your rentals and get clobbered by 20%/year increases in healthcare in your particular kind of disease.

Hope this isn't thread hijacking.


matchewed

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #37 on: July 26, 2016, 03:21:36 PM »
Hey Arebelspy -

I think you raise an interesting point: if the rate of growth in expenses exceeds the rate of growth in rents, then your SWR number isn't meaningful. But I think you generalize this insight too far. Essentially, you're saying that if the inflation in expenses exceeds inflation in general, that's bad.

Well, sort of. I think inflation in general is not an especially useful concept for early retirement. Inflation is defined as the increase in the price level. In the US, we measure the CPI, or inflation in a particular basket of goods as tracked by the DOL. For ER, we worry about inflation because it erodes the value of our savings.

My issue is that the whole idea that we should expect 2 percent inflation a year, or whatever the Fed targets, is that it gives us a false sense of precision.

Armchair guesses here:

Education - prices up 5-7 percent/year over last 30 years. Huge increase, cumulatively.
Healthcare - prices up  7-9 percent/year over last 30 years. Number one cause of bankruptcy. Quality up? Idk.
Electronics - prices exponentially down, function exponentially up, over last 30 years. Imagine buying cloud computing cycles in the 90s - you can't.
Housing - prices up 10 percent/year in Coast cities over last 30 year, down or flat in South and Midwest.
Food - prices down or flat.
Clothes - prices down or flat.
Movies - who even goes to those.
Transportation - probably down if you buy beater Hondas. Maybe up.

What are you going to buy in ER? Probably not education--MOOCs and library cards take care of that. Maybe healthcare, but those costs are set by the government through exchanges. If you get the wrong kind of cancer and want specialized care/treatments, you may go bankrupt regardless of insurance or treatment. This is hard to protect against. Probably housing--but you can control that by owning, or moving. Food and electronics are negligible.

Anyway, my point is that ER folk don't consume the typical basket of goods; that no one consumes the typical basket of goods; and that it's not really relevant for ER folk, because ER folk typically have control over their expenses and can react.

As it relates to rental properties, the idea that (a) you could cash flow, but (b) still have inflation slowly erode the value of your investment is interesting. But I think how that would look in practice is you diligently make 8% a year on your rentals and get clobbered by 20%/year increases in healthcare in your particular kind of disease.

Hope this isn't thread hijacking.

It's slightly (*cough very*) OT but inflation still affects your basket of goods if your basket of goods are smaller. The inflation of the price for any one thing is not some constant factor and may go up or down. In fact a person who only buys three things every year for their necessities is technically less flexible and more at risk to inflation than someone who buys hundreds of things which are necessities and more. The former has nothing to cut out while the latter does.

arebelspy

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #38 on: July 26, 2016, 04:21:41 PM »
Fuzz: I agree with you that your inflation won't match CPI exactly. I essentially agree with everything you posted.  But I'll still posit that it's irrelevant to my point, and post, above.  Whatever inflation you do experience (even if it's different in ways than the "consumer basket" the Bureau of Labor Statistics calculates) will happen (I know of very few ways to become immune to inflation--and lowering expenses isn't one of them..especially with real estate, where your expenses are driven by labor costs, material costs, etc.), and putting it against the risk of rents stagnating is very real.

In other words, you're right that one will experience their own unique brand of inflation, in various categories.  I wouldn't begin to try and guess which, though your healthcare one doesn't seem like a bad guess.  If one is counting on cash flow > expenses in perpetuity that's a risk if their cash flow DOESN'T increase with inflation (or increases, but underperforms their personal amount of inflation), while their expenses do increase.

This is the risk I was referring to, and it doesn't matter so much how much your personal inflation differs from the "average," as long as your rent increases underperform that, which is a potential risk.  Make more sense?  :)
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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #39 on: July 31, 2016, 10:50:14 PM »
I also think it depends how many "doors" are in your rental portfolio.

It is of course riskier to have one luxury home rented that coveres your expenses versus one home with basement suite, 2 condos, and a duplex.

Ideally, you are a bit diversified in location as well.

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #40 on: July 31, 2016, 11:09:41 PM »
I also think it depends how many "doors" are in your rental portfolio.

It is of course riskier to have one luxury home rented that coveres your expenses versus one home with basement suite, 2 condos, and a duplex.

That's relevant for potential sequence of returns problems in that a bunch of bad things could hit at once with less places, but with more it'll smooth out the spikes.  But it's not relevant to a slow slide/real decline.

Quote
Ideally, you are a bit diversified in location as well.

Yes, this would help, if you are in a dozen different locations, even if a few underperform, hopefully a few will overperform, and it'll even out.  Difficult to do, and people who are in one or two geographic areas (as most of us that invest in RE are) are the ones susceptible to the problem I mentioned, as that area could be in slow decline over decades.
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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #41 on: August 03, 2016, 02:22:39 PM »
FOLLOWING

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #42 on: February 27, 2017, 07:55:07 PM »
Quote
Ideally, you are a bit diversified in location as well.

Yes, this would help, if you are in a dozen different locations, even if a few underperform, hopefully a few will overperform, and it'll even out.  Difficult to do, and people who are in one or two geographic areas (as most of us that invest in RE are) are the ones susceptible to the problem I mentioned, as that area could be in slow decline over decades.

I cringe at the thought of having purchased a Detroit based rental property "empire" before Detroit shrank in size like it has.    I imagine quite a few people might have gone bankrupt over that.

Metric Mouse

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Re: 4% Withdrawal Rate if Investing in Real Estate?
« Reply #43 on: February 27, 2017, 08:55:19 PM »
Quote
Ideally, you are a bit diversified in location as well.

Yes, this would help, if you are in a dozen different locations, even if a few underperform, hopefully a few will overperform, and it'll even out.  Difficult to do, and people who are in one or two geographic areas (as most of us that invest in RE are) are the ones susceptible to the problem I mentioned, as that area could be in slow decline over decades.

I cringe at the thought of having purchased a Detroit based rental property "empire" before Detroit shrank in size like it has.    I imagine quite a few people might have gone bankrupt over that.
Guess they should have bet on Toronto or London or San Francisco