Author Topic: Is there a 4% rule for Real Estate Retirement like there is for Stocks?  (Read 5266 times)

andysandp

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I understand the 4% Withdrawal Rule to retire on your total portfolio in Stocks. 

How about Real Estate?  Is there a 4% rule for your total Real Estate Net Worth?

For example, if you have $1 million worth of Real Estate and assuming you have no Mortgage, do you simply live off the Rent minus all Expenses for the next 30-60 years? 

Or do you only use 4% rule and use only $40,000 of your rent each year?  (I'm assuming your Rent minus Expenses is MORE then $40,000)  What do you do with the excess Rent?  Also don't you also need a separate fund for Repairs or separate fund to support $40,000 when the Rental Markets go down?

I know the Trinity Study was used to back up the 4% rule because you have to assume the markets crash at some point, but has there been any studies for Real Estate to back up a safe withdrawal from Rent Rate?
« Last Edit: January 15, 2017, 09:13:40 AM by andysandp »

radram

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #1 on: January 15, 2017, 09:28:49 AM »
I understand the 4% Withdrawal Rule to retire on your total portfolio in Stocks. 

How about Real Estate?  Is there a 4% rule for your total Real Estate Net Worth?

For example, if you have $1 million worth of Real Estate and assuming you have no Mortgage, do you simply live off the Rent minus all Expenses for the next 30-60 years?

Or do you only use 4% and live off $40,000 each year?  (This is assuming your Rent minus expenses is MORE then 4%)  What do you do with the excess Rent?  Don't you also need a separate fund for Repairs?

Then the following year do you live off $40,000 but add 3 percent for Inflation?  And then each following year keep adding 3% for Inflation?

I know the Trinity Study was used to back up the 4% rule because you have to assume the markets crash at some point, but has there been any studies for Real Estate to back up a safe withdrawal from Rent Rate?

Great question. The answer would really be location specific, and would be completely dependant on expected average annual returns. In that way, you could apply the 4% rule in the exact same way, increasing or decreasing that SWR based on your expected return. If the real estate is owned and managed by you, verses a REIT for example, you could potentially expect a higher return than the stock market in exchange for active management of your real estate. That would allow a SWR higher than 4%.

Here is one article that shows some expected annual returns, YMMV
http://www.investopedia.com/ask/answers/060415/what-average-annual-return-typical-long-term-investment-real-estate-sector.asp

I do not really consider real estate investors FIRE. They simply exchanged 1 career for another, unless they hire out the management of the properties. If they do, it is then simply a cost, and comes off the expected annual returns. With enough properties you pay to have managed, you become your own REIT. As you add more property, you decrease the harm a major repair impacts your bottom line.

Where I live, $1 million in rental property would generate about $100,000 in income and $45,000 in expenses if I self managed. Taxable income would be about $30,000 - $40,000 (thank you depreciation). Real estate would appreciate an additional $30,000 annually.  I would need nothing else and I would "FIRE" today (but I already AM FIRE :) )

Good luck.

andysandp

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #2 on: January 15, 2017, 11:20:21 AM »
Thanks for the tips!

In your case, when you deduct for Expenses, do you save for future repairs (not just immediate repairs)?  For early retirement, in 30-60 years you will have lots of repairs like new kitchen, heating system, roof, bathrooms, floors etc.

What percentage of your rent do you save for Future Repairs?  Do you keep the Future Repair Fund in a Savings account? Or put it into stocks?

You said where you live the taxable income would be around $30,000-$40,000 after Expenses.  Let's say we live off $30,000 the first year.  Then in 10 years the market crashes and your Rental income is cut 30%.  Where do you get the money to replace the loss of 30% of the Rental Income?

Thanks!





radram

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #3 on: January 15, 2017, 12:10:45 PM »
Thanks for the tips!

In your case, when you deduct for Expenses, do you save for future repairs (not just immediate repairs)?  For early retirement, in 30-60 years you will have lots of repairs like new kitchen, heating system, roof, bathrooms, floors etc.

What percentage of your rent do you save for Future Repairs?  Do you keep the Future Repair Fund in a Savings account? Or put it into stocks?

You said where you live the taxable income would be around $30,000-$40,000 after Expenses.  Let's say we live off $30,000 the first year.  Then in 10 years the market crashes and your Rental income is cut 30%.  Where do you get the money to replace the loss of 30% of the Rental Income?

Thanks!

More great questions. Where and how I prepare for inevitable expenses would entirely depend on cash flow and length time between expected repair. For example, I put on a new roof in 2004. It will need another in 2025 or so and will cost about $3500 (today's value) if I do it myself, and it is 8 years away. I am not "saving" for this yet, since cash flow of the property brings in about $500 per month, so I know I can cover that repair with savings and then build it back.

New windows were replaced in 2016. I knew it needed them since 2012 or so the money was saved as cash until I got the price I wanted.

I use my emergency fund to double as the fund for my rental. If both were to exceed normal spending, by a large amount,  it is possible I would be short of cash for a short period. In that case, I still have a $50,000 HELOC I could use and pay back with future earnings.

I think the key is options, and we have several.

As far as a crash is concerned, the one in 2009 caused a large amount of the population to loose their home and look for rentals. For me, I was able to increase rent 8% during that period while being able to be more selective with tenants. I suppose if income decreased 30%, I would either do the same with spending, get a PT job to make up the difference, or increase the SWR if the room was there. So far, it is.

In your example of earning $40,000 and spending $30,000 for 10 years, I now have an additional $100,000+ I should have already put to work in the form of another rental, stocks, or whatever. That 30% decrease in rent would already be covered by the new investments.

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #4 on: January 19, 2017, 07:07:53 PM »
This isn't really an answer to the question you ask, but some of the financial good guys (Burton Malkiel, David Swensen) see real estate is essentially a cross between a bond and a stock... with returns that fall somewhere between those of bonds and stocks.

The idea, BTW, is that the fixed lease or rent payments are like a bond's interest payments and that the future sales price is essentially like an appreciating stock you might sell.

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #5 on: January 19, 2017, 07:14:52 PM »
This isn't really an answer to the question you ask, but some of the financial good guys (Burton Malkiel, David Swensen) see real estate is essentially a cross between a bond and a stock... with returns that fall somewhere between those of bonds and stocks.

The idea, BTW, is that the fixed lease or rent payments are like a bond's interest payments and that the future sales price is essentially like an appreciating stock you might sell.

Your financial "good guys" clearly know nothing about real estate.  As an illiquid asset with significant risk attached, it should produce returns higher than either stocks or bonds.  If between cash flow and appreciation it does not do so, then you have not done your job as an investor.

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #6 on: January 19, 2017, 07:51:54 PM »
This isn't really an answer to the question you ask, but some of the financial good guys (Burton Malkiel, David Swensen) see real estate is essentially a cross between a bond and a stock... with returns that fall somewhere between those of bonds and stocks.

The idea, BTW, is that the fixed lease or rent payments are like a bond's interest payments and that the future sales price is essentially like an appreciating stock you might sell.

Your financial "good guys" clearly know nothing about real estate.  As an illiquid asset with significant risk attached, it should produce returns higher than either stocks or bonds.  If between cash flow and appreciation it does not do so, then you have not done your job as an investor.

The endowment fund that David Swensen manages has about $25 billion and about 25% of it is in real estate and natural resources. So actually he and team know quite a bit about real estate. (His long-run returns are pretty impressive.... and btw his books are really thought provoking.)

http://investments.yale.edu/

I agree with you, BTW, if you're saying that alternative asset classes are less efficient and so can produce really remarkable returns for the top quartile of performers.


SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #7 on: January 19, 2017, 07:55:43 PM »
I should better source my references to Swensen and Malkiel...

For Swensen's discussion of real estate returns for individual investors, "Unconventional Success."

For Malkiel, and I know this isn't very strong, but I'm thinking of the table of returns in his "Random Walk Down Wall Street."

I've said this before, but another really good source to keep an eye out for are Green Street Advisors' white papers on direct real estate investment returns.

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #8 on: January 19, 2017, 08:00:37 PM »
Swenson is probably buying investment grade industrial parks, regional shopping centers,  apartment portfolios and the like.  Cap rates are fairly low and the market is competitive.  Ownership of small residential and commercial properties is management intensive, has significant risk to the income stream attached, and is illiquid.  It has characteristics of a business that paper assets do not have.  Yields are (or should be) higher than the investment grade stuff.

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #9 on: January 19, 2017, 08:49:23 PM »
A handful of comments... and I make these comments not to argue with anybody but to try and throw out some useful ideas and follow-up sources people can use to thoughtfully consider long-run returns from real estate and how real estate might impact an SWR...

First, here's a source that discusses the relative performance of REITs vs direct real estate ownership...

https://institutional.fidelity.com/app/proxy/content?literatureURL=/9858228.PDF

The paper's conclusions seem to me to echo what you read elsewhere... REITs and direct real estate are pretty similar in terms of their long-run performance.

Second, Swensen's long-run performance is astronomically good. His returns haven't been anything close to average. (An idea: If you want to dig into how they did this, read "Pioneering Portfolio Management"... it's a really excellent book and a real eye opener about investing in alternative asset classes. I think Swensen and his team have been earning a 25%-ish 17%-ish annual return for decades 25 plus years.)

Third, do compare long-run returns in something like Vanguard Total Stock Market index to the Vanguard REIT index... those results seem to me to mesh with what guys like Swensen seem to be saying. Real estate is sort of a hybrid...

Fourth, and final point for tonight, totally agree with hypothesis that says small owner managed properties can produce super-sized returns. This would surely be true for real estate well managed by an owner... just as it's also going to be true of a small business that's well managed by an owner.

Edits: Fix material errors stating Swensen's long-run track record.

« Last Edit: January 26, 2017, 10:41:07 AM by SeattleCPA »

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #10 on: January 19, 2017, 08:54:04 PM »
Okay, I said that was my final comment but something you referenced connects to a point that Swensen makes that's really interesting.

He says the data shows that in the traditional asset classes, the average investor gets maybe 11%, the top quartile gets 12% and the bottom quartile gets 10%. So it's pretty efficient... you don't want to pay fees to try and beat average.

In the alternative asset categories like real estate, there's a massive spread. I don't remember spread for real estate, but for private equity, the average private equity investment delivers something like -1% annually... the top quartile maybe delivers 25% annually, and the bottom quartile delivers maybe -15% annually. (These are long-run annual returns.)

My take-away: You get into these alternative asset classes, and even when you're talking the big boys, the markets are really inefficient.

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #11 on: January 19, 2017, 09:10:35 PM »
You have an academic perspective with apparently no experience in direct real estate investing.  Written material that you cite is not particularly useful in understanding the small investors and their investments.  Suggest that if you want to understand the small real estate investor and the achievable returns in non-investment grade properties that you get to know a few.

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #12 on: January 19, 2017, 10:13:55 PM »
We've gotten off on the wrong foot. I'm not against real estate. And sorry for causing you any personal aggravation...

Here are three blog posts I've written for my many real estate investor clients... you can decide whether it seems like I'm just blowing smoke or not..

http://evergreensmallbusiness.com/real-estate-vs-ira-and-401k-accounts-part-i/

http://evergreensmallbusiness.com/real-estate-investors-net-investment-income-tax/

http://evergreensmallbusiness.com/vacation-homes-as-small-business-tax-shelters/


Metric Mouse

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #13 on: January 20, 2017, 03:31:45 AM »
Is this a duplicate thread?

Bobberth

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #14 on: January 20, 2017, 02:47:34 PM »
The 4% rule assumes investing in equities and bonds. That 4% withdrawal consists of income, capital gains and selling off principal. With real estate in retirement, you generally are living off of the income the property produces so the closest thing to a retirement rule that I can think of is the 50% rule: 50% of the gross rent will, on average and over a long period of time, go to expenses. You then take principal and interest payments out of the remaining half (taxes and insurance are part of the 50% in expenses) to determine your cash flow. Once your cash flow meets your needs, you can retire. Real estate net worth plays an indirect role in that purchase price & mortgage amounts determine your cash flow but the same $1mm real estate net worth invested at a 4% CAP rate or a 10% CAP rate have different results when it comes to retiring because the cash flow is different.



SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #15 on: January 20, 2017, 04:24:59 PM »
The 4% rule assumes investing in equities and bonds. That 4% withdrawal consists of income, capital gains and selling off principal. With real estate in retirement, you generally are living off of the income the property produces so the closest thing to a retirement rule that I can think of is the 50% rule: 50% of the gross rent will, on average and over a long period of time, go to expenses. You then take principal and interest payments out of the remaining half (taxes and insurance are part of the 50% in expenses) to determine your cash flow. Once your cash flow meets your needs, you can retire. Real estate net worth plays an indirect role in that purchase price & mortgage amounts determine your cash flow but the same $1mm real estate net worth invested at a 4% CAP rate or a 10% CAP rate have different results when it comes to retiring because the cash flow is different.

Based on tax returns I have seen over the years, I would think many real estate investors in effect use "withdrawal rates" that are below 4%.

As noted in Bobberth's comment, you've got an illiquid asset... and you're making principal payments which use up some of the income.

okobrien

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #16 on: January 20, 2017, 10:10:31 PM »
SeattleCPA, as a real estate investor with an academic background, I appreciate your info and links in this thread.  I have added the Swensen book to my library reading list.

SeattleCPA

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #17 on: January 21, 2017, 07:12:19 AM »
SeattleCPA, as a real estate investor with an academic background, I appreciate your info and links in this thread.  I have added the Swensen book to my library reading list.

Thanks OKObrien.

We don't all agree about this, but I think there's lots of wisdom to be gleaned from guys who come at this from an academic perspective. Their insights often flow from hard data. And their analyses are often tempered by criticisms and commentary from other smart peers. In the case of Swensen, he also has decades of experience and a track record to die for.

BTW, you maybe know about this resource, but my favorite small real estate investor book is Marc Anderson's Retire Rich from Real Estate. The title makes the book sound like just another "get rich quick" formula. But it's not.

http://www.retirerichfromrealestate.com/

Ryland

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #18 on: January 21, 2017, 09:47:14 AM »
Epic question.

There kind of is... here's some basic knowledge. They come with the same gives & takes of the 4% rule:

Real estate grows at the rate of inflation -- 3%
If you're investing in real estate for cash flow, make sure it produces you 1% of the purchase price per month.
That means 12% per year.
3% goes to fix it (not every year, but over the long term (think roof replacement, etc.))
That leaves you right around 9% per year before inflation. Similar to stocks

Definitely check out Frugal Vagabond's blog and ebook and unreal real estate analysis spreadsheet. He is on his path to FI through long distance real estate. Such insanely helpful information coming out of his site.

http://frugalvagabond.com/

Good luck! Hope this helps!

andysandp

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #19 on: January 21, 2017, 10:01:48 AM »
Thanks for the tips!

So in your example, let's say we have 1 million dollar property and in Retirement.

That means we get

$120,000 for rent for cash flow
$30,00 for repairs

$90,000 left over for Retirement living.

Isn't $90,000 much better then the 4% rule for Stocks/Bonds?  4% for Stock/Bonds would only give you $40,000 a year to retire.

Thanks!
« Last Edit: January 28, 2017, 11:09:55 AM by andysandp »

Another Reader

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #20 on: January 21, 2017, 10:46:17 AM »
Epic question.

There kind of is... here's some basic knowledge. They come with the same gives & takes of the 4% rule:

Real estate grows at the rate of inflation -- 3%
If you're investing in real estate for cash flow, make sure it produces you 1% of the purchase price per month.
That means 12% per year.
3% goes to fix it (not every year, but over the long term (think roof replacement, etc.))
That leaves you right around 9% per year before inflation. Similar to stocks

Definitely check out Frugal Vagabond's blog and ebook and unreal real estate analysis spreadsheet. He is on his path to FI through long distance real estate. Such insanely helpful information coming out of his site.

http://frugalvagabond.com/

Good luck! Hope this helps!

ROTFLMAO.  I don't think so.  The one percent rule exists because of the 50 percent rule.  50 percent of your gross income will go to expenses.  On average, you should collect $60,000 net in this scenario.  Some years more, some years less.  Even if the value of real estate grew at a predictable 3 percent (hint: it doesn't) that does not mean your rents grow at 3 percent per year.

Please go to the investment property thread and read how to analyze investment properties.  If you don't, those of us that are experienced investors will buy your property cheap when you lose your shirt.

Metric Mouse

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #21 on: January 21, 2017, 01:01:44 PM »
Epic question.

There kind of is... here's some basic knowledge. They come with the same gives & takes of the 4% rule:

Real estate grows at the rate of inflation -- 3%
If you're investing in real estate for cash flow, make sure it produces you 1% of the purchase price per month.
That means 12% per year.
3% goes to fix it (not every year, but over the long term (think roof replacement, etc.))
That leaves you right around 9% per year before inflation. Similar to stocks

Definitely check out Frugal Vagabond's blog and ebook and unreal real estate analysis spreadsheet. He is on his path to FI through long distance real estate. Such insanely helpful information coming out of his site.

http://frugalvagabond.com/

Good luck! Hope this helps!

ROTFLMAO.  I don't think so.  The one percent rule exists because of the 50 percent rule.  50 percent of your gross income will go to expenses.  On average, you should collect $60,000 net in this scenario.  Some years more, some years less.  Even if the value of real estate grew at a predictable 3 percent (hint: it doesn't) that does not mean your rents grow at 3 percent per year.

Please go to the investment property thread and read how to analyze investment properties.  If you don't, those of us that are experienced investors will buy your property cheap when you lose your shirt.

Or someone following their advice will buy a property that is not actually cash positive and lose their shirt that way.

FrugalFisherman10

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #22 on: January 26, 2017, 01:36:13 PM »
Thanks for the tips!

So in your example, let's say we have 1 million dollar property and in Retirement.

That means we get

$120,000 for rent for cash flow
$3000 for repairs

$90,000 left over for Retirement living.

Isn't $90,000 much better then the 4% rule for Stocks/Bonds?  4% for Stock/Bonds would only give you $40,000 a year to retire.

Thanks!
$30,000* in repairs (not $3000).

Not sure if that was a typo or a miscalculation but wanted to point it out just in case

...That would be an expensive 0 and comma ($27k)

Sent from my SM-G900V using Tapatalk


Metric Mouse

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #23 on: January 27, 2017, 11:35:38 PM »
Thanks for the tips!

So in your example, let's say we have 1 million dollar property and in Retirement.

That means we get

$120,000 for rent for cash flow
$3000 for repairs

$90,000 left over for Retirement living.

Isn't $90,000 much better then the 4% rule for Stocks/Bonds?  4% for Stock/Bonds would only give you $40,000 a year to retire.

Thanks!
$30,000* in repairs (not $3000).

Not sure if that was a typo or a miscalculation but wanted to point it out just in case

...That would be an expensive 0 and comma ($27k)

Sent from my SM-G900V using Tapatalk
Not as expensive as the next zero...

andysandp

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #24 on: January 28, 2017, 11:12:06 AM »
Sorry that was a typo.  The $3000 repairs should say $30,000 for repairs.  I just fixed it!

arebelspy

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Re: Is there a 4% rule for Real Estate Retirement like there is for Stocks?
« Reply #25 on: January 29, 2017, 12:09:36 AM »
Another one of these threads?

andysandp, please stop starting duplicate threads.

Here is the other thread andy started on this:
http://forum.mrmoneymustache.com/welcome-to-the-forum/is-there-a-4-rule-to-retire-on-real-estate/

And a previous other thread discussing this:
http://forum.mrmoneymustache.com/real-estate-and-landlording/4-withdrawal-rate-if-investing-in-real-estate

As I wrote in Andy's first thread:
I have a post in there I consider very important to anyone wanting to ER on real estate.  Your WR may be less than your cash flow.

In other words, this typical advice:
No. You would retire using RE when your net rents cover all of your living costs.

It would be based on the renal income covering your expenses, property upkeep, the rental market itself and other potential market challenges.

If ALL expenses are accounted for then yes, it is as simple as living off of rents minus expenses.

Is quite dangerous, overly simplified, and in many cases, potentially wrong.  Even if your net rents cover all your initial living expenses after covering their own expenses, and always cover their own expenses, your ER could fail.

It's such a widespread notion that when cashflow > expenses, you're financially free.

That just isn't necessarily the case long term, and I don't see ANYONE else talking about it.  Because I think they just either haven't thought about it, or don't understand it.

That common advice gets repeated and it makes so much simple sense that people just accept it, and then repeat it themselves. 

But it's dangerous, like I said.

Read this:
http://forum.mrmoneymustache.com/real-estate-and-landlording/4-withdrawal-rate-if-investing-in-real-estate/msg1156130/#msg1156130


Long-ish for a forum post (with the quoted parts), but it's well worth reading and considering, IMO, for anyone wanting to ER with real estate.

EDIT: I consider it so important I decided to come back and bold and enlarge it to try and catch someone's eye.
-----------------------------------------------------------

Locking this duplicate thread. Post in one of the two above links if you have more to add.
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