Author Topic: How much money are you actually making in RE versus investing in index funds?  (Read 9665 times)

Beric01

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So I've always been intrigued by investing in real estate , but I've run some mock numbers and it just doesn't seem to come out ahead of investing in the market (as I current am). For example, in my area a 1 million dollar single-family home rents for at best $45K a year. This is basically 4.5% return, and then you subtract out property taxes and maintenance, and interest if you have a mortgage, and your return is around 3%-3.5%. This is just awful!

I know my area (SF bay area) is one of the best places in the country to rent rather than buy, but what am I missing here? It is better to buy townhouses? Apartment complexes? Office space? I just don't see long-term returns of even 7-8% like in the market, let alone beating it. And then you have to factor in your own time spent managing the property, which surely accounts for something. So what are you guys making in real estate, when you subtract out all costs of owning property?

waltworks

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Read some of the other threads here, dude. This has been discussed over and over.

Your area sucks for cash flow RE investing but there are places where you can buy a $50k house and rent it for $1000 a month. Those places are fewer and further between now that the crash is in the rear view mirror far enough, of course, but they do exist.

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Beric01

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Read some of the other threads here, dude. This has been discussed over and over.

Your area sucks for cash flow RE investing but there are places where you can buy a $50k house and rent it for $1000 a month. Those places are fewer and further between now that the crash is in the rear view mirror far enough, of course, but they do exist.

-W

I found a couple other threads but none are directly comparing RE to index funds.

Would you recommend that a person buy property in a place they do not live as their first property? And if you do, then you have even less cash available for good return due to having to hire more people to take care of the place, reducing your return still further.

EDIT: Here's a map that seems to track rental returns, but very little is close by...
« Last Edit: September 22, 2014, 01:02:25 PM by Beric01 »

Bobberth

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Index funds are an investment while real estate is a business so you're comparing apples to oranges.  Some find that one is better suited than the other for them personally or that they absolutely don't want to do one so go toward the other.  Yes there are more direct expenses to REI but those should be factored in your due diligence before a purchase, just like the costs of index investing. 

So to answer your question of whether Index or Real Estate is better:  The answer is a definite YES!

AJ

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Would you recommend that a person buy property in a place they do not live as their first property?

It's not ideal, but if you're not willing to move it's still possible. Ideally, I would say your first property shouldn't be a rental either, but your personal residence. You'll learn a lot on the first one, but professionals will hold your hand (and give you better rates) on your first owner-occupied property purchase.

And if you do, then you have even less cash available for good return due to having to hire more people to take care of the place, reducing your return still further.

Nope. Property management and repair expenses should be factored into any investment property buy, even if you buy close to home and intend to self-manage. If the numbers don't work with PM in place (even if you pay yourself to do it), then the numbers don't work period.

If you are interested in real estate, I would suggest biggerpockets.com forums.


Beric01

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It's not ideal, but if you're not willing to move it's still possible. Ideally, I would say your first property shouldn't be a rental either, but your personal residence. You'll learn a lot on the first one, but professionals will hold your hand (and give you better rates) on your first owner-occupied property purchase.

I plan to rent for life (particularly in my area), so I would only be interested in property as an investment. I have no desire to own unless I'm living in an area where it actually makes sense.

My current living location is close to ideal - I get the higher income associated with an expensive area, while living in a cheap studio apartment. If I moved to a cheaper area, my income would drop drastically whereas my living expenses would drop a small amount (and perhaps even rise if I needed to purchase a car - I'm currently carless).

If you are interested in real estate, I would suggest biggerpockets.com forums.

Thanks fir the recommendation. As stated, my current default is index investing, but if I can make better returns with real estate I don't want to rule out that option.

AJ

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Thanks fir the recommendation. As stated, my current default is index investing, but if I can make better returns with real estate I don't want to rule out that option.

I think if you're not drawn to real estate, or if you're expecting it to be like index investing, you will be disappointed. My last investment RE purchase had a cash-on-cash return of 19.9% (which doesn't count principal pay-down on the mortgage, appreciation, or tax benefits). My ROI on the funds I invested will be well north of 30% in the first year. But I LOVE real estate, so doing all the required due diligence and research was genuinely fun for me. It's not really that it took a lot of time per se, but I'm not sure how I would have felt about it if I was only doing it for the money. Nothing goes exactly as you plan.

Like Bobberth said, it's rather like apples and oranges.

thedayisbrave

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Honestly, I don't know many people in RE who are only in it because they didn't want to "rule out the option."  Oh yes... real estate can be fun.  But it can also make you pull out your hair sometimes.  It takes blood, sweat, and tears.  You have to really love it.

You should probably stick to indexing.  You can always purchase shares of a REIT which are real estate securities but don't require the direct involvement that (physical property) real estate investing does.

arebelspy

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Right now, I don't bother if it's not double digit cash on cash return.  I will shift that in the future though for a few reasons.

Over the last 5 years, I've averaged a 12% cash on cash return, 15% when you count principal paydown.  That's not counting an extra few percent I earned for managing some myself, as that's not a return on my investment, but a return on labor.  If you counted that, as some people do, add another 3% or so to both those numbers.

That also doesn't count appreciation.  Most of my properties have appreciated between 50% and 80% over the last 3 years (which is a ridiculous return since I'm leveraged 75% LTV).

But I don't count on appreciation, my management doesn't count towards returns, and principal paydown is a nice bonus, but the key factor I look at is cash on cash return.  And I like double digit.

The main benefit though of real estate for early retiring is the stability of returns.  There's not much of a sequence of returns risk, and you don't actually ever draw down on your assets, so while someone in equities may need a 4% SWR, someone with the right real estate could easily be spending 50% more than that (what would be equivalent to a 6% SWR) and need 2/3s as much money, and thus FIRE way earlier, and in a much safer manner.

That's the real benefit to real estate for early retirees, the returns aside.
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Fishingmn

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #10 on: September 28, 2014, 06:55:42 AM »
The main benefit though of real estate for early retiring is the stability of returns.  There's not much of a sequence of returns risk, and you don't actually ever draw down on your assets, so while someone in equities may need a 4% SWR, someone with the right real estate could easily be spending 50% more than that (what would be equivalent to a 6% SWR) and need 2/3s as much money, and thus FIRE way earlier, and in a much safer manner.

That's the real benefit to real estate for early retirees, the returns aside.

This is right - but the other key issue is that rents should, in general, stay level with inflation

tracylayton

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #11 on: September 28, 2014, 08:01:22 AM »
Of the 4 rentals I own, about 15.2% ROI. If you factor in the amount of principal paid down ($9,600/yr.) then 20.1%. Then, I have some added tax benefits like depreciation. However I bought mine as foreclosures during the housing crash, and I don't think I could duplicate that right now. Most of the homes have appreciated about 40%, and I didn't factor that in. Also, when the all of the mortgages are paid off I will have a steady income of $4000/month after taxes and insurance. I can definitely live off of that. I have my real estate broker's license, so I collect a 3% commission when I buy, and I do all of my own property management. All of the homes were built in 2003 or after, so I have very few repairs. It is not for the faint of heart! I sold the only older rental I owned this year. The tenant had been there for 5 years, and became a hoarder after losing her job. Once her unemployment stopped, she couldn't pay rent. I let her stay rent free while it was on the market and then paid a mover to put all of her things in storage. I hauled off 3000 lbs of junk to the dump and had to replace the carpet. In 5 years, that's the only bad experience I've had. The tenant wrote me a very sincere letter thanking me for helping her when no one else would. Even with that house, I paid $45,000 cash and collected $33,000 in rental income (after taxes and insurance) over 5 years. Then I sold it for $55,000. I almost doubled my initial investment.

arebelspy

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #12 on: September 28, 2014, 08:09:05 AM »
The main benefit though of real estate for early retiring is the stability of returns.  There's not much of a sequence of returns risk, and you don't actually ever draw down on your assets, so while someone in equities may need a 4% SWR, someone with the right real estate could easily be spending 50% more than that (what would be equivalent to a 6% SWR) and need 2/3s as much money, and thus FIRE way earlier, and in a much safer manner.

That's the real benefit to real estate for early retirees, the returns aside.

This is right - but the other key issue is that rents should, in general, stay level with inflation

Absolutely.  So one's returns are real returns, not nominal.  Of course that means their appreciation will be about 0% real, but it's basically like a giant I Bond.  I'm okay with that.
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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #13 on: September 28, 2014, 10:09:18 AM »
I don't know if I'm just rehashing the same ideas but I personally prefer stocks over real estate at this stage of my life.

Here's a biggerpockets link http://www.biggerpockets.com/renewsblog/2013/07/17/real-estate-vs-stocks/ that kind of says how I feel. I'm not experienced in investing yet (only started in 2011) when I got out of school >.> But because of this short time frame, I've found stocks to be more of my taste.

I don't know how accurate the link is but from what I've researched myself, stocks and real estate returns are pretty equal to each other and while I'm accumulating money that's all I really care about. Arebelspy mentioned how someone can spend the entire rental income and not touch the "house" for a 6% swr but a swr is for someone not in their accumulation phase imo. So yes cash flow is nice if you plan to use it but my job is my cash flow for the time being, so I don't "need" a second cash flow, I just need an investment that grows.

That doesn't mean I won't try my hand in rentals later on in life but at this point in time, and I plan to make a career change next spring or later in 2015, I would rather have my money in the stock market than tied up in real estate that is harder to recoop if I needed cash.

Zette

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #14 on: September 28, 2014, 10:49:23 AM »
You could always consider investing in a REIT index, giving you a real estate position in your investment portfolio.  It wouldn't have returns that are much better than your stock index funds, but would give you asset class diversification.

arebelspy

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #15 on: September 28, 2014, 05:03:36 PM »

Arebelspy mentioned how someone can spend the entire rental income and not touch the "house" for a 6% swr but a swr is for someone not in their accumulation phase imo. So yes cash flow is nice if you plan to use it but my job is my cash flow for the time being, so I don't "need" a second cash flow, I just need an investment that grows.

You do realize that you don't HAVE to spend the cash flow, right?  You can reinvest it.

I'm not yet living on my cash flow (though it's more than enough to support me, I'm FINE but not yet ER) either, but that just means I can leverage it to compound my returns.

We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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SwordGuy

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #16 on: September 28, 2014, 06:00:26 PM »
My wife and I are working on getting our first rental property.  Our goal is to diversify our income streams.  Social security, index funds and real estate rents.   As time goes by we'll probably add some bonds.

It would be nice if the rentals make a higher rate of return than the index funds but that's not essential.   Diversity is its own reward.

Left

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #17 on: September 30, 2014, 04:47:27 AM »
You do realize that you don't HAVE to spend the cash flow, right?  You can reinvest it.

I'm not yet living on my cash flow (though it's more than enough to support me, I'm FINE but not yet ER) either, but that just means I can leverage it to compound my returns.
But if you do it this way, aren't all the rental prices taxed like normal income? Or can you filter this into a LLC and pay corporate rates? Or do you hold them in ira to delay taxes?
I wasn't sure if the % you mentioned on return included taxes paid or not which could make a difference on returns.

edit: I understand you can deduct the interest/etc and if the expenses outweigh the income you can subtract that out of your job income but in this case you are operating a business on a loss and only gains would be in house price appreciating through the years?
« Last Edit: September 30, 2014, 05:02:29 AM by eyem »

arebelspy

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #18 on: September 30, 2014, 06:55:28 AM »
Read up on depreciation, a paper loss to offset the taxes. It's recaptured on sale, but there are ways to defer it further (1031 being the primary one).
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tracylayton

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #19 on: September 30, 2014, 07:29:23 AM »
Read up on depreciation, a paper loss to offset the taxes. It's recaptured on sale, but there are ways to defer it further (1031 being the primary one).
I was wondering if I could avoid the capital gains tax and recapturing the depreciation by moving into each rental for 2 years prior to selling them? Do you know arebelspy? I doubt if I will sell any of them for 15 to 20 years.

arebelspy

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #20 on: September 30, 2014, 08:34:10 AM »

Read up on depreciation, a paper loss to offset the taxes. It's recaptured on sale, but there are ways to defer it further (1031 being the primary one).
I was wondering if I could avoid the capital gains tax and recapturing the depreciation by moving into each rental for 2 years prior to selling them? Do you know arebelspy? I doubt if I will sell any of them for 15 to 20 years.

No, that no longer works. It will be prorated based on the amount of time it was a rental. So if you owned it 20 years and lived in it two, you could save on 10% of the capital gains taxes.

That is my understanding of the current tax law, but of course check with your CPA (and it's actually a bit more complicated if you owned it before the early 2000's, because then you can save on some of that, but I was assuming you were talking for any future purchases). And of course it could change in 20 years.
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Beric01

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Re: How much money are you actually making in RE versus investing in index funds?
« Reply #21 on: September 30, 2014, 05:28:12 PM »
I don't know if I'm just rehashing the same ideas but I personally prefer stocks over real estate at this stage of my life.

Here's a biggerpockets link http://www.biggerpockets.com/renewsblog/2013/07/17/real-estate-vs-stocks/ that kind of says how I feel. I'm not experienced in investing yet (only started in 2011) when I got out of school >.> But because of this short time frame, I've found stocks to be more of my taste.

I don't know how accurate the link is but from what I've researched myself, stocks and real estate returns are pretty equal to each other and while I'm accumulating money that's all I really care about. Arebelspy mentioned how someone can spend the entire rental income and not touch the "house" for a 6% swr but a swr is for someone not in their accumulation phase imo. So yes cash flow is nice if you plan to use it but my job is my cash flow for the time being, so I don't "need" a second cash flow, I just need an investment that grows.

That doesn't mean I won't try my hand in rentals later on in life but at this point in time, and I plan to make a career change next spring or later in 2015, I would rather have my money in the stock market than tied up in real estate that is harder to recoop if I needed cash.

Thanks for posting this link. Interesting read.

But ARS's 12% returns do look nice. I'll have to do some investigation into what's required for investing outside of one's home market. There is leverage you're talking about though...

arebelspy

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Thanks for posting this link. Interesting read.

But ARS's 12% returns do look nice. I'll have to do some investigation into what's required for investing outside of one's home market. There is leverage you're talking about though...

Not necessarily. Most of my out-of-state ones were purchased in cash.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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b1gm1ke11

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It's true, an index fund is pretty damn efficient in getting nearly market return and you don't have to do anything except put money into it.   I own Vanguard funds and I highly enjoy the sit back and relax for the long term approach.   

However, I'd be pressed to find a stock market investment that paid me a 10% cash on cash return consistently in the stock market.  Most reputable stocks don't pay dividends anywhere near that.  You could buy some risky stocks I suppose that pay 10% dividends but why do that when you can have a single family home do the same thing as well as have good potential for appreciation in the right market.  And you get to write off the real estate "loss" at the end of the year because the depreciation expense offsets your income.

arebelspy

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It's true, an index fund is pretty damn efficient in getting nearly market return and you don't have to do anything except put money into it.   I own Vanguard funds and I highly enjoy the sit back and relax for the long term approach.   

However, I'd be pressed to find a stock market investment that paid me a 10% cash on cash return consistently in the stock market.  Most reputable stocks don't pay dividends anywhere near that.  You could buy some risky stocks I suppose that pay 10% dividends but why do that when you can have a single family home do the same thing as well as have good potential for appreciation in the right market.  And you get to write off the real estate "loss" at the end of the year because the depreciation expense offsets your income.

It's true you won't find a stock that gives you that cash in cash return (via dividends), but stocks should grow more relative to inflation (RE should appreciate at the rate of inflation).

Total return is more what matters, so comparing cash on cash of RE vs. Dividends sells stocks short, IMO.
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aschmidt2930

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Arebelspy mentioned how someone can spend the entire rental income and not touch the "house" for a 6% swr but a swr is for someone not in their accumulation phase imo. So yes cash flow is nice if you plan to use it but my job is my cash flow for the time being, so I don't "need" a second cash flow, I just need an investment that grows.

You do realize that you don't HAVE to spend the cash flow, right?  You can reinvest it.

I'm not yet living on my cash flow (though it's more than enough to support me, I'm FINE but not yet ER) either, but that just means I can leverage it to compound my returns.

My thoughts exactly.  One positive of renting real estate is once you pay off the property, 100 percent of returns can be put into Index funds if desired. 


arebelspy

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Or even before you pay off the property. I plan on keeping a number of mortgages for the long term, low rate inflation hedge. But excess cash flow is going to be redirected into Vanguard.

No one said they're mutually exclusive investments, or that if you have cash flow you have to spend it or use it to pay down a mortgage. Do whatever makes sense for your situation.
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Roland of Gilead

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Several of the people in this thread back up their RE investment return by saying they bought during the market crash and so have a really nice ROI.

If you bought Apple during the market crash of 2009 for $100 (pre split) you have a dividend yield now of about 14% on your original investment.

Although this is a better comparison to RE investing than an index (because nobody buys an index of houses and thus takes on diversity risk), if you bought SPY in 2009 for $70 you still have a quite respectable 5% yield.

arebelspy

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We're not talking about buying at an absolute bottom though, just in the span of several years where it was low.

Plus I can find RE now that yields double digit returns.  Not just based on "if you bought at a low three years ago". I can't (personally) confidently choose a stock that will return that due to finding a "deal" the way I can in RE.
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Roland of Gilead

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We're not talking about buying at an absolute bottom though, just in the span of several years where it was low.

Plus I can find RE now that yields double digit returns.  Not just based on "if you bought at a low three years ago". I can't (personally) confidently choose a stock that will return that due to finding a "deal" the way I can in RE.

Maybe Seadrill.  As of Friday you could buy it at $22 and it pays a buck a quarter, or a yield of 18%.  They claim the dividend is safe at least until 2016.

Could the price of oil continue to fall and Seadrill need to cut the dividend?  Definitely.   Could the tenants in the house you are renting fail to disclose they adopted 17 cats and only bought one litter box, leaving you with a disaster of pee soaked floors unrentable for months?  Possibly.

arebelspy

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We're not talking about buying at an absolute bottom though, just in the span of several years where it was low.

Plus I can find RE now that yields double digit returns.  Not just based on "if you bought at a low three years ago". I can't (personally) confidently choose a stock that will return that due to finding a "deal" the way I can in RE.

Maybe Seadrill.  As of Friday you could buy it at $22 and it pays a buck a quarter, or a yield of 18%.  They claim the dividend is safe at least until 2016.

Could the price of oil continue to fall and Seadrill need to cut the dividend?  Definitely.   Could the tenants in the house you are renting fail to disclose they adopted 17 cats and only bought one litter box, leaving you with a disaster of pee soaked floors unrentable for months?  Possibly.

If my rentals were only projected to make its rents for a year and 1/2, and then who knows, I wouldn't be buying them, personally.

I want FIRE income for 30+ years. Not two.

:)
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Roland of Gilead

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If my rentals were only projected to make its rents for a year and 1/2, and then who knows, I wouldn't be buying them, personally.

I want FIRE income for 30+ years. Not two.

:)

I am just saying I am not 100% convinced that the rents are as secure as people make them out to be.  We could get in an economic situation where real estate taxes go up but rents go down.

arebelspy

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If my rentals were only projected to make its rents for a year and 1/2, and then who knows, I wouldn't be buying them, personally.

I want FIRE income for 30+ years. Not two.

:)

I am just saying I am not 100% convinced that the rents are as secure as people make them out to be.  We could get in an economic situation where real estate taxes go up but rents go down.

No doubt that could happen, I just think that:
a) It's unlikely, and
b) Even if it did happen, it wouldn't be that bad.

And you should always be prepared and have reserves and a buffer in your cash flow anyways.

See what John and I wrote about a buffer over in this thread:

http://forum.mrmoneymustache.com/index.php?topic=1936
About leverage and negative cash flow....  I'll grant you that the more you are leveraged, the faster you can go cash flow negative if you can't find a tenant.  And believe me, I worried about that when I was first getting started.  But if you are running a place that is extremely cash flow positive (i.e. well over 1%), it would take months of vacancy each year (or a much reduced rent) to generate negative cash flow over an annual period.  One metric I like to calculate for each deal I pursue is "breakeven occupancy" along with it's counterpart, "breakeven rent", where cash flow is concerned.  This gives me an idea of how bad things would need to get before I'd actually be cash-flow negative. 

Well said.

I could have about a 75% vacancy rate right now and break even after PITI, though any maintenance occurring on those other 25% would put me cash flow negative. If I use standard assumptions for that, I could have around 30% occupancy and cover everything, but have no cash flow for myself to live on.

Given I don't ever expect more than a 20% or so vacancy rate as a worst case scenario, I'm not too worried about being cash flow negative.

Even when multiple properties go vacant at once, which happens (due to variance and the law of large numbers), you want to be fine in that circumstance by having your other properties cover that (AND have large reserves on top of that).

Be smart, play it safe, but don't worry or lose sleep about it, just plan and prepare.

If instead of the vacancy, my rents could drop 75% (the numbers work out the same... Basically I'm losing 75% of my rents) and I'd still be fine. Do you see rents dropping from 1000 (my current average) to 250?

How bad of a scenario are we talking

I can't see it. Dropping to 900, sure. 800, possible. 700, pretty unlikely. 250?  Heh. I think we'd have bigger issues to worry about.

Example: Vegas in the housing crash lost 60% of its value from the peak while rents dropped 5%.

So, sure, rents can drop in certain circumstances, but they're one of the things that tend to hold steady or go up over time (like food).

You just don't see a 30% decrease in rent overnight.

Historically, it's quite rare for rents to decrease. How often have you lived somewhere and the landlord decreased your rent instead of increasing it?  (If they do, it's usually to keep a good tenant, and it's raised up after they move.)

AND, if we were in some sort of situation where rents decreased, it'd also probably be a situation where your FIRE expenses would be decreasing as well due to that economic climate (some sort of deflation) decreasing your expenses, so your decreased expenses likely would match the decreased rent.

Just as how if your expenses go up, your rents are likely to go up, the same economic factors should help protect you in this scenario.

to;dr: it's unlikely, but even if it did happen it probably wouldn't be that bad, and even if it did, and was, your decreased expenses should offset that and you'll be fine anyways. End of the world scenarios aside.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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