Author Topic: Is there a 4% rule to retire on Real Estate?  (Read 8671 times)

andysandp

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Is there a 4% rule to retire on Real Estate?
« on: January 14, 2017, 08:57:21 PM »
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, do you simply live off the Rent minus Expenses?

Or do you only use 4% and live off $40,000 each year?  (This is assuming the Rent minus expenses is MORE then 4%)  What do you do with the excess Rent?

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?
Don't you need to prepare a separate Fund for Repairs?

I know there has been the Trinity Study to back up the 4% rule during bad markets, but has there been any studies for Real Estate to back up a safe withdrawal from Rent rate?

Thanks!
« Last Edit: January 14, 2017, 09:01:08 PM by andysandp »

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #1 on: January 14, 2017, 11:23:07 PM »
No. You would retire using RE when your net rents cover all of your living costs. So when you're banking $40K a year above expenses, regardless of the nw of the properties.

Playing with Fire UK

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #2 on: January 15, 2017, 01:14:09 AM »
No. You would retire using RE when your net rents cover all of your living costs. So when you're banking $40K a year above expenses, regardless of the nw of the properties.

With the caveat that you either have enough units that the net rent has an average amount of repairs or you have a sinking fund.

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #3 on: January 15, 2017, 01:30:45 AM »
No. You would retire using RE when your net rents cover all of your living costs. So when you're banking $40K a year above expenses, regardless of the nw of the properties.

With the caveat that you either have enough units that the net rent has an average amount of repairs or you have a sinking fund.

Implied above by 'net rents' and 'above expenses.' Clearly a successful FIRE would imply that these are calculated properly.

gerardc

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #4 on: January 15, 2017, 01:33:29 AM »
Uh, living on full rent seems a lot riskier than the stock alternative. I think RE income is more around 8% after expenses, so you need to only spend 4% and re-invest the rest. Otherwise if you spend it all, in a bad year where RE crashes or vacancies are high, you won't be able to survive and will need to sell, resulting in a dramatic loss and a failure rate much higher than 95% for a stock portfolio.

That's just as bad as spending all your gains/dividends of stock in a given year, instead of using the 4% rule to amortize the good and bad years.

Playing with Fire UK

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #5 on: January 15, 2017, 01:58:04 AM »
Implied above by 'net rents' and 'above expenses.' Clearly a successful FIRE would imply that these are calculated properly.

MM, wasn't trying to suggest that you would have ignored this. I've seen calcs elsewhere that forget about big maintenance expenses and wouldn't want a novice make the same mistake.

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #6 on: January 15, 2017, 08:54:13 AM »
OK to clarify,

Let's assume I need $40,000 a year to retire.

I can either have $1 million dollars in Stock/Bond Portfolio and use the 4% rule to Retire on $40,000 for the next 30-60 years, or...

How much do I need in Real Estate with No Mortgage to retire on $40,000 a year for the next 30-60 years?

One has to assume the Rental Market Rents will come down during certain periods and one also has to consider Repairs within the next 30-60 years.  Is it as simple as living off the Rents minus all Expenses each year? 

How much do you have to save each year for the Repair funds?  What do you do with the excess Rent if you have any left over?


« Last Edit: January 15, 2017, 08:59:34 AM by andysandp »

pxpaulx

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #7 on: January 15, 2017, 09:02:27 AM »
...Seems like that is pretty much what gerardc said above.

I'm not into the whole rental property thing, but it seems to me the property value wouldn't have anything to do with whether or not you can retire. It would be based on the renal income covering your expenses, property upkeep, the rental market itself and other potential market challenges.

tralfamadorian

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #8 on: January 15, 2017, 09:05:30 AM »
It can't be as simple as living off the Rents minus all Expenses each year?  Don't you have to save for a repair fund?

Expenses = Mortgage/Taxes/Insurance + Other Ongoing Monthly Expenses + 10% Vacancy + 10% CapEx

Yes, in general 20% of your monthly rents should be going to a dedicated fund to cover repair costs, CapEx, lost rent due to vacancy, eviction costs and other misc. 

tallen

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #9 on: January 15, 2017, 09:10:44 AM »
OK to clarify,

Let's assume I need $40,000 a year to retire.

I can either have $1 million dollars in Stock/Bond Portfolio and use the 4% rule to Retire on $40,000 for the next 30-60 years, or...

How much do I need in Real Estate with No Mortgage to retire on $40,000 a year for the next 30-60 years?

One has to assume the Rental Market Rents will come down during certain periods and one also has to consider Repairs within the next 30-60 years.  Is it as simple as living off the Rents minus all Expenses each year? 

How much do you have to save each year for the Repair funds?  What do you do with the excess Rent if you have any left over?

Markets vary and so do individual purchases so there is no way to say X amount of RE will give you X amount of dollars.

Maintenance, repairs, Cap Ex, management costs, and vacancies should all be included in the "expenses" calculation which is also hard to be accurate on because those vary also.

If ALL expenses are accounted for then yes, it is as simple as living off of rents minus expenses. The problem is most people underestimate their true expenses over the long term.

Another Reader

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #10 on: January 15, 2017, 09:15:38 AM »
There is no SWR for real estate.  Paper portfolio SWR's are based on a combination of interest, dividends, and selling the underlying assets over time.  Rebalancing to the desired asset allocation is part of that strategy.

Unless you plan to sell the real estate to generate income, you simply use the net income from the properties, net of ALL expenses, including reserves for replacement.  The 50 percent rule is a good rule of thumb.  So if your real estate portfolio generate $100,000 of gross income, you can figure on having about $50,000 to pay any mortgages (P&I) and yourself.  You do have to have the discipline to put aside those reserves, however.

Your income does not increase by the inflation rate or some set percentage.    It will vary with your net rental income.

Make sense?

Megma

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #11 on: January 15, 2017, 09:16:05 AM »
OK to clarify,

Let's assume I need $40,000 a year to retire.

I can either have $1 million dollars in Stock/Bond Portfolio and use the 4% rule to Retire on $40,000 for the next 30-60 years, or...

How much do I need in Real Estate with No Mortgage to retire on $40,000 a year for the next 30-60 years?

One has to assume the Rental Market Rents will come down during certain periods and one also has to consider Repairs within the next 30-60 years.  Is it as simple as living off the Rents minus all Expenses each year? 

How much do you have to save each year for the Repair funds?  What do you do with the excess Rent if you have any left over?

This isn't simple to answer because there's too much variation in property rents, a 100k house could rent for 800, 1000 or 1200 a month. There's no fixed rule, though there are rules for what is a good investment (hint: a lot of property isn't a good investment).  The value of your RE portfolio is almost irrelevant in determining if you can FIRE from it.  Metric Mouse and Playing with Fire are telling you that you can't look at it the same way and you need to consider the net income from the specific portfolio.

Another factor, is if the properties are paid off or not. You could need much less than 1 million in property if they get good rents and have been paid off to have 40k that you can live off each year.

So there's no simple rule to use, you have to run the numbers on your specific property portfolio.

larmando

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #12 on: January 15, 2017, 10:15:10 AM »
The 50 percent rule is a good rule of thumb.  So if your real estate portfolio generate $100,000 of gross income, you can figure on having about $50,000 to pay any mortgages (P&I) and yourself.  You do have to have the discipline to put aside those reserves, however.

Your income does not increase by the inflation rate or some set percentage.    It will vary with your net rental income.

Make sense?

+1 to this. For properties I consider 50% of rents to be "what I can live on" and the rest to be "repairs, vacancy, etc".

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #13 on: January 15, 2017, 11:30:52 AM »
OK thanks, great information!

Let's assume I have no Mortgage and after all Expenses I have $40,000 of Net Rental Income a year.  Let's assume all I need is $40,000 to live. Let's assume Net Rental Income increases 3% each year with Inflation.

Let's say in year 10 of my retirement, the market crashes, and now I get a 30% decrease in my Net Rental Income.
Where do I get the money to replace this 30% loss of Net Rental Income to live? 

« Last Edit: January 15, 2017, 11:36:13 AM by andysandp »

Another Reader

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #14 on: January 15, 2017, 11:42:14 AM »
The value may go down 30 percent (or more) but rents rarely do.  Vacancy due to higher unemployment might increase, as will collection loss, and rents will erode.  Smart landlords keep cash reserves plus they invest in other asset classes to complement the real estate.

In Phoenix from 2008 to 2011, values went down by as much as 60 percent or even more, but rents increased because all those people that went through foreclosure and short sales needed a place to live.

tralfamadorian

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #15 on: January 15, 2017, 02:57:36 PM »
Let's say in year 10 of my retirement, the market crashes, and now I get a 30% decrease in my Net Rental Income.
Where do I get the money to replace this 30% loss of Net Rental Income to live?

As another reader mentioned, market crashes do not decrease rents. Rents stagnant or decrease slightly when money's cheap and everyone and their dog is a buying a house, decreasing your tenant pool. A 30% decrease in rents would be an unlikely scenario- possibly in a town with a single major employer that closes, which would be a place you would avoid investing in for that very reason.

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #16 on: January 15, 2017, 11:05:09 PM »
Let's say in year 10 of my retirement, the market crashes, and now I get a 30% decrease in my Net Rental Income.
Where do I get the money to replace this 30% loss of Net Rental Income to live?

As another reader mentioned, market crashes do not decrease rents. Rents stagnant or decrease slightly when money's cheap and everyone and their dog is a buying a house, decreasing your tenant pool. A 30% decrease in rents would be an unlikely scenario- possibly in a town with a single major employer that closes, which would be a place you would avoid investing in for that very reason.

But could be possible for other reason - property floods or takes other severe damage, extended vacancies, dead beat renter with particularly messy eviction etc.

In this case, one would have to draw on cash reserves or other savings - if none exist, one would have the options to decrease expenses, draw debt, sell a property or get a haircut and a real job.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #17 on: January 24, 2017, 04:00:04 PM »
Previous discussion on this:
http://forum.mrmoneymustache.com/real-estate-and-landlording/4-withdrawal-rate-if-investing-in-real-estate/

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.
« Last Edit: January 24, 2017, 04:06:56 PM by arebelspy »
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 two 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.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #18 on: January 24, 2017, 10:16:37 PM »
Great Link Arebelspy!  That link really helped me with my questions!  Sorry to ask questions that were previously answered, but I'm new to this Board.  I do think Real Estate people tend to simplify things and you really have to look at all expenses and possibilities of how things can go wrong, especially if your going to hold for 40-60 years.

Thanks!

Playing with Fire UK

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #19 on: January 25, 2017, 12:53:27 AM »
That link really helped me with my questions!  Sorry to ask questions that were previously answered, but I'm new to this Board.

The search box is terrible on this otherwise excellent forum, if you use a search engine and type: site:forum.mrmoneymustache.com real estate SWR

then you can get useful results from older posts.


Great link ARS, we don't talk about that enough. I'm also a little concerned when RE people talk about cash out refis as cash flow. I've considered that appreciation is a hedge against living expenses inflation, not an ATM for spending. But each to their own.

The link between income and rents can work both ways if you are FIRE: one of my concerns is that my town becomes a commuter town with higher wages (earned in a bigger city) and our local inflation increases significantly compared to national inflation or growth/rent received. Local inflation could be the local cheap supermarket closing and being replaced by a Whole Foods; services costing more, property tax costing more etc.

rachael talcott

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #20 on: January 25, 2017, 04:42:47 PM »
I waited to FIRE until my rental profits were twice my personal expenses, with enough cash on the side to buy more properties that will nearly double my rental income in the next five years.  That's probably way more conservative than I needed to be, but it would be difficult for me to go back to work, and as ARS says there are risks that rents will not keep pace with inflation and/or property values will go down. 


andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #21 on: February 26, 2017, 09:41:55 AM »
People are saying during Real Estate Crashes, Rents don't go down much.  Even if Rents only go down 10%, that can really hurt you if you have a Mortgage.

For Example:

$14,000 Total Monthly rents which is $168,000 a year.
$9000 Total Monthly Expenses (includes Mortgage) which is $108,000 a year.

So you net $60,000 and you are FIRE expecting $60,000 a year.

Let's say there is a crash and rents go down 10%

Rent is now $151,200, but Expenses are still $108,000.

So now you only net $43,200 which is a big cut! 

Any thoughts about this?
I guess you shouldn't FIRE with a Mortgage?

« Last Edit: February 26, 2017, 10:11:06 AM by andysandp »

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #22 on: February 26, 2017, 10:14:07 AM »
People are saying during Real Estate Crashes, Rents don't go down much.  Even if Rents only go down 10%, that can really hurt you if you have a Mortgage.

For Example:

$14,000 Total Monthly rents which is $168,000 a year.
$9000 Total Monthly Expenses (includes Mortgage) which is $108,000 a year.

So you net $60,000 and you are FIRE expecting $60,000 a year.

Let's say there is a crash and rents go down 10%

Rent is now $151,200, but Expenses are still $108,000.

So now you only net $43,200 which is a big cut! 

Any thoughts about this?
I guess you shouldn't FIRE with a Mortgage?
Buy two more properties in the crashed market and increase your income?

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #23 on: February 26, 2017, 10:27:52 AM »
People are saying during Real Estate Crashes, Rents don't go down much.  Even if Rents only go down 10%, that can really hurt you if you have a Mortgage.

For Example:

$14,000 Total Monthly rents which is $168,000 a year.
$9000 Total Monthly Expenses (includes Mortgage) which is $108,000 a year.

So you net $60,000 and you are FIRE expecting $60,000 a year.

Let's say there is a crash and rents go down 10%

Rent is now $151,200, but Expenses are still $108,000.

So now you only net $43,200 which is a big cut! 

Any thoughts about this?
I guess you shouldn't FIRE with a Mortgage?
Buy two more properties in the crashed market and increase your income?

Well if you are Fire (Retired) you don't have Income to buy more units.

tallen

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #24 on: February 26, 2017, 01:19:00 PM »
Previous discussion on this:
http://forum.mrmoneymustache.com/real-estate-and-landlording/4-withdrawal-rate-if-investing-in-real-estate/

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.

Link isn't working. Would live to read it though if it ever gets fixed.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #25 on: February 26, 2017, 02:08:08 PM »
No forum links are working right now. We're aware of the issue and are working on a fix.  Keep the tab open and check back in a day or two. :)

Edit: here is a temporary link, for the moment, to the same post, until the above one is working again:
http://forum.mrmoneymustache.com/index.php?topic=57661.msg1156130#msg1156130
« Last Edit: February 26, 2017, 02:22:32 PM by arebelspy »
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 two 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.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #26 on: February 26, 2017, 02:16:56 PM »
People are saying during Real Estate Crashes, Rents don't go down much.  Even if Rents only go down 10%, that can really hurt you if you have a Mortgage.

For Example:

$14,000 Total Monthly rents which is $168,000 a year.
$9000 Total Monthly Expenses (includes Mortgage) which is $108,000 a year.

So you net $60,000 and you are FIRE expecting $60,000 a year.

Let's say there is a crash and rents go down 10%

Rent is now $151,200, but Expenses are still $108,000.

So now you only net $43,200 which is a big cut! 

Any thoughts about this?
I guess you shouldn't FIRE with a Mortgage?

More leverage = more risk. Your expenses are almost double your net.

My gross rents are >13k/mo and mortgages <2k (though obviously there are other expenses). I sleep fine.

But your example is much more dangerous, if the individual isn't flexible with spending.

We can create even more dangerous scenarios.

Crank that up to 1MM rents, 950k expenses.

Sweet, can ER on 50k/yr!  If you only spend 30k annually, you're sitting pretty!

Now rents drop 10%. 900k rents, 950k expenses. Now you're LOSING 50k per year.  If you're spending 30k personal and losing 50k on the properties, you're in trouble (though you are paying down a fair amount of principal, so probably still net worth even).

The lesson is to model bad scenarios and make sure your portfolio can survive them.  If a 10% rent drop causes major problems, your plan probably isn't robust.  :)

I'd model both for short term pain (20% rent drops and 20% vacancy) and long term slide where you don't keep up with inflation (as in the thread I linked to above), and make sure you can handle either of those scenarios.
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 two 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.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #27 on: February 26, 2017, 02:51:32 PM »
Thanks Arebelspy!  Great points!

I was modeling after an ideal 1 million dollars worth of Real Estate.  This is not just one unit, could be a total of 4-10 that totals 1 million.  This model is just to simplify, I tried to give an estimate of costs.

Real Estate- 1 million

Rent 2% rule- $240,000 a year
All Expenses 50% rule- $120,000 a year
Mortgage- $48,300 a year (assuming 25% down, 5% rate)

So you would net $71,700.  If you decide to Fire now, expecting $71,700, or even $61,700, it could be dangerous.

If Rent goes down 10%, you will only net $47,700.

What is the historical worse case scenario for Rent % drops?





maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #28 on: February 26, 2017, 02:58:09 PM »
No forum links are working right now. We're aware of the issue and are working on a fix.  Keep the tab open and check back in a day or two. :)

Edit: here is a temporary link, for the moment, to the same post, until the above one is working again:
http://forum.mrmoneymustache.com/index.php?topic=57661.msg1156130#msg1156130

Thanks for the fixed link. I've pulled out one line from your post over there which is a very important point I hadn't thought about previously WRT real estate.

Quote
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.

Emphasis mine. Never thought about that before.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #29 on: February 26, 2017, 03:03:05 PM »
I'm pretty sure the "historical worst case scenario" for rent is zero, or negative 100%, however you want to look at it, at least for certain areas.

There are plenty of places in Detroit, for example, that can be had for free, and there are no takers. 50 years ago those were decent neighborhoods.

If you mean nationwide, I'm guessing the great depression would be your worst case scenario, but the housing market was so different (very few mortgages for homes, no fannie/freddie, much more rural nation, etc) that it probably doesn't make much sense to try to use that to war game a worst case scenario.

If you're bored, though: http://www.people.hbs.edu/tnicholas/anna_tom.pdf

Money quote: "According to our estimates, net rental income provided an
additional return of 2.5% up until 1929. Since rental revenues did not fall
drastically, but rather declined gradually following the 1929 drop in real estate
prices, net rental revenues rose to almost 6% of the market value of a property
in the early 1930s but eventually fell to a −1.3% in 1935. The reason why
net income declined to a negative number is because gross rental revenues fell
dramatically starting in 1930 but taxes and operating expenses remained steady."

That would be pretty bad for your revenue stream!

-W

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #30 on: February 26, 2017, 03:04:22 PM »
House prices, too, are tied to income.

Income and inflation have been pretty similar for the last 40 years (thus why you hear about wages stagnating since the 70s--stagnating=flat in real terms), so people treat it as the same, and functionally they have been for a bit, but there can be a difference.

Rents are even more closely tied to income though, because they aren't artificially pushed up by foreign investors, for example, or home buying incentives.
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arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #31 on: February 26, 2017, 03:06:33 PM »
Thanks Arebelspy!  Great points!

I was modeling after an ideal 1 million dollars worth of Real Estate.  This is not just one unit, could be a total of 4-10 that totals 1 million.  This model is just to simplify, I tried to give an estimate of costs.

Real Estate- 1 million

Rent 2% rule- $240,000 a year
All Expenses 50% rule- $120,000 a year
Mortgage- $48,300 a year (assuming 25% down, 5% rate)

So you would net $71,700.  If you decide to Fire now, expecting $71,700, or even $61,700, it could be dangerous.

If Rent goes down 10%, you will only net $47,700.

What is the historical worse case scenario for Rent % drops?

I'd either be assuming closer to a 1% rule on a hypothetical portfolio, or assume higher expenses (above the 50% rule) for a 2% rule property (likely multiplex or bad area or old or all of the above).

Of course, ideally one is running specific numbers on their properties, but for a hypothetical, that's what I'd do.
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maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #32 on: February 26, 2017, 03:09:58 PM »
Thanks Arebelspy!  Great points!

I was modeling after an ideal 1 million dollars worth of Real Estate.  This is not just one unit, could be a total of 4-10 that totals 1 million.  This model is just to simplify, I tried to give an estimate of costs.

Real Estate- 1 million

Rent 2% rule- $240,000 a year
All Expenses 50% rule- $120,000 a year
Mortgage- $48,300 a year (assuming 25% down, 5% rate)

So you would net $71,700.  If you decide to Fire now, expecting $71,700, or even $61,700, it could be dangerous.

If Rent goes down 10%, you will only net $47,700.

What is the historical worse case scenario for Rent % drops?

For small towns? Close to 100% if the only employer in town pulls up and leaves.

For bigger cities? Probably Detroit would be the best example to dig into for a worst case scenario of what can happen to rental income and property values, but looking at historical data on property values in a lot of the old "rust belt" cities in the northeast will give you some sense of what a bad outcome looks like for real estate. (Edit, Waltworks beat me to the Detroit example)

The problem is we don't have the same sort of detailed historical data on rental prices over the past century or more as we do for stock market indexes.

My sense though is that, while the stock market is more likely to have sudden sharp corrections, a worst case scenario for real estate comes on more slowly: longer and longer waits to find new tenants, rent starts getting paid later and requiring more effort to collect, low demand means you're unable to raise prices for one year, then, two years, then a decade.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #33 on: February 26, 2017, 03:21:32 PM »
My sense though is that, while the stock market is more likely to have sudden sharp corrections, a worst case scenario for real estate comes on more slowly: longer and longer waits to find new tenants, rent starts getting paid later and requiring more effort to collect, low demand means you're unable to raise prices for one year, then, two years, then a decade.

This is the long, slow decline I was talking about in the linked thread, and why the idea that "cash flow > expenses" is invalid, because it relies on an underlying premise of rents keeping pace with expenses/inflation, which may not be the case.

Thus why I think having excess cash flow, which you reinvest, is prudent.  It means you SWR (or more like "spending rate") needs to be < your ROI, and you invest the difference.
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Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #34 on: February 26, 2017, 05:17:24 PM »
People are saying during Real Estate Crashes, Rents don't go down much.  Even if Rents only go down 10%, that can really hurt you if you have a Mortgage.

For Example:

$14,000 Total Monthly rents which is $168,000 a year.
$9000 Total Monthly Expenses (includes Mortgage) which is $108,000 a year.

So you net $60,000 and you are FIRE expecting $60,000 a year.

Let's say there is a crash and rents go down 10%

Rent is now $151,200, but Expenses are still $108,000.

So now you only net $43,200 which is a big cut! 

Any thoughts about this?
I guess you shouldn't FIRE with a Mortgage?
Buy two more properties in the crashed market and increase your income?

Well if you are Fire (Retired) you don't have Income to buy more units.
Ah yes. The firee who has zero cash on hand and spends exactly every dollar they earn from rent. This would be a pickle. Guess they would have to cut their budget for a year. Poor person.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #35 on: February 26, 2017, 06:56:43 PM »
I'm not sure what you're suggesting, MM.

Do you instead picture the ER'd with real estate individual:
A) Having massive cash piles (I.e. not being invested with excess cash) that is on top of their necessary cash reserves to buy more in a downturn, or
B) Dipping into their cash reserves to buy more during a downturn (the exact moment when they may need the reserves due to decreased rents, higher vacancy, etc.)?

Neither of those seem realistic, to me. I know I have excess cash flow, but reinvest that constantly. I'd have to sell investments to buy more in a downturn.
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 two 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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Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #36 on: February 26, 2017, 07:14:54 PM »
I don't see it as wrong to sell investments to buy more properties when real estate markets are in a slump.

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #37 on: February 26, 2017, 07:22:22 PM »
I don't see it as wrong to sell investments to buy more properties when real estate markets are in a slump.

So is the assumption here that the excess cash from the retiree spending less than their real estate cash flow gets invested in the stock market? If it is getting investing in additional properties, there would be nothing to sell during the slump.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #38 on: February 26, 2017, 07:34:14 PM »
I don't see it as wrong to sell investments to buy more properties when real estate markets are in a slump.

So is the assumption here that the excess cash from the retiree spending less than their real estate cash flow gets invested in the stock market? If it is getting investing in additional properties, there would be nothing to sell during the slump.
Well i guess i wouldn't find it a very robust plan for a person to do bare bones fire on only their investment property cash flow that just met their needs, with no way to reduce spending, no diversity in their portfolio and no cash stash to see them through and zero ability to get a side job. I'm sure people have done it, but that would be like investing in Apple, making it rich, and then only buying and selling Apple stocks to fund retirement.  It could work, but I don't think many people do it, nor would I recommend such things.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #39 on: February 26, 2017, 07:34:45 PM »
I don't see it as wrong to sell investments to buy more properties when real estate markets are in a slump.

The problem is that (at least recently) those slumps tend to coincide.

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #40 on: February 26, 2017, 07:39:40 PM »
Yes, yes they have. Hard on any retiree when that happens.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #41 on: February 26, 2017, 07:50:54 PM »
Yes, yes they have. Hard on any retiree when that happens.

I'm trying to figure out what you're trying to say. The debate here is about whether there is a 4% rule equivalent for rental RE. Various folks with experience have discussed the problems that you could run into if rents decline (or fail to keep up with inflation in other costs). It's not clear to me that we have the data to formulate something exactly equivalent, but it's at least an interesting question. We've demonstrated that for certain RE portfolios, even a 10% drop in real rents would be pretty bad.

If you want to retire with WAY more money than you need, then the 4% rule isn't relevant to you, and "just use all your extra money to buy more" (whether stocks or RE) isn't very useful advice.

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #42 on: February 26, 2017, 07:52:06 PM »
Yes, yes they have. Hard on any retiree when that happens.

Well, not exactly.  In the last downturn, we initially experienced some higher vacancy as people lost jobs.  However, the folks that lost their homes needed places to live, so occupancy improved and  rents went UP from 2010 on.  We bought four houses with cash we scraped together that cash flowed from Day One and have each appreciated $100k. 

The key is to look at a rental property or a portfolio of rental properties like an operating business that produces income.  Apply Warren Buffett's approach to business.  How the business assets are valued by the market on any given day is irrelevant.  As long as your business throws off enough income, the only time to think about the value is when you can use excess capital to pick up properties cheap or the assets are so overvalued you would be better off selling and putting the capital to work more efficiently elsewhere.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #43 on: February 26, 2017, 07:57:07 PM »
Yes, yes they have. Hard on any retiree when that happens.

Well, not exactly.  In the last downturn, we initially experienced some higher vacancy as people lost jobs.  However, the folks that lost their homes needed places to live, so occupancy improved and  rents went UP from 2010 on.  We bought four houses with cash we scraped together that cash flowed from Day One and have each appreciated $100k. 

The key is to look at a rental property or a portfolio of rental properties like an operating business that produces income.  Apply Warren Buffett's approach to business.  How the business assets are valued by the market on any given day is irrelevant.  As long as your business throws off enough income, the only time to think about the value is when you can use excess capital to pick up properties cheap or the assets are so overvalued you would be better off selling and putting the capital to work more efficiently elsewhere.

This is all true but it's not relevant to the question of *how much rental income relative to expenses* you need to support yourself. Again, this is supposed to be a "is there a 4% rule equivalent for rentals" thread.

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #44 on: February 26, 2017, 08:11:56 PM »
My point is income may not correlate to value and you need to focus on the income if and when values go south.  If the income is not deteriorating, it might be time to sit tight.  If you have another Detroit on your hands, you may need to rethink your investments, probably before the values drop significantly.

Diversification among asset classes and some income flexibility help as well.  Income tied to business performance, such as dividends, is more resistant to market value shifts, as is contractually promised income, such as pensions and Social Security.  I would be reluctant to rely exclusively on rental income, but I'm older and have zero interest in returning to work. 

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #45 on: February 26, 2017, 08:58:25 PM »
I agree with everything you said, but as an intellectual exercise, care to tackle the OP's question?

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #46 on: February 27, 2017, 12:36:16 AM »
How about: net rents = spending rate + 10% (spending rate)
This would give one cash to invest in good years to combat gradual decline and a buffer for sharp decline.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #47 on: February 27, 2017, 01:01:16 AM »
So 0.9*ROI = WR?
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Re: Is there a 4% rule to retire on Real Estate?
« Reply #48 on: February 27, 2017, 03:19:14 AM »
I agree with everything you said, but as an intellectual exercise, care to tackle the OP's question?

-W

OK. I'll put up something we can poke a stick at.

Baseline: a $1 million 'stach invested in your standard FIRE AA and you take the 4% WR, thus $40k in year 1

Taking that $1 million in cash and investing in real estate, wow, I'm pretty sure you can exceed $40k (just ask ARS). Let's see.

So I take my million and get a property portfolio. Lets assume 5 properties at 200k each, rented out at 1% 'rule' so $2000/mnth each
Assuming 50% 'rule' for vacancies, taxes maintenance and prop management fees

Monthly cashflow
In- $10,000
out- $5000 (prop taxes, repairs, insurance, vacancies, fees etc)
net $5000 = $60,000/yr*

*this will be tax free cos' you can deduct the expenses and depreciation (just depreciation probably over 25k/yr).

so from our $1 million we're pulling a tax free 6% WR. So, by ratio, you'd need 33% less 'stach to generate that 40k WR. Real estate wins (and enables much earlier time to FIRE - how much do value should we assign to that extra work free % of your life?)!!!

And if you are smart, pick the right areas, and gain some benefit from scale, you could probably do (a) better than the 1% rule, (b) reduce expenses to less than 50% and (c) cover quite a bit of your normal expenses (like car, phone, office) from your pre-tax rental expenses. Leverage could probably boost cash on cash returns even further.










arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #49 on: February 27, 2017, 03:31:15 AM »
I agree with all of your math, but it doesn't answer walt, or the OP's, question.

If you're spending 60k, it leaves the problem of no buffer for downturns leading to higher vacancy and lower rents, nor the "long slide" problem I point out in the linked post, whereby SWR < ROI.

If you're spending 40k, and ER with 2/3rds the stache to cover that, again, same problem.

So the question is, really, what parameters do you suggest to cover those two scenarios?  How much of a buffer is required, how much reinvestment do you need to do to cover a potential inflation erosion, etc.?

That's the question.  Not a simple "what does a rental portfolio look like in FIRE" but "what does a robust one look like, and what sort of buffers do you need"?

Your post is spot on for a "real estate versus stocks" thread.  This is more like "can we figure out a WR rule of thumb for RE," where a comparison with stocks isn't too relevant.
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 two 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.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.