Author Topic: Is there a 4% rule to retire on Real Estate?  (Read 8664 times)

dixonge

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #50 on: February 27, 2017, 04:40:44 AM »
The problem is variables. In one area, $1M of property will throw off $60k in rent, in another it will be $40k. Start with income needs, acquire sufficient property to cover income plus take care of maintenance. SWR equivalent is doubtful. This is more like dividend income.

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arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #51 on: February 27, 2017, 05:00:25 AM »
The problem is variables. In one area, $1M of property will throw off $60k in rent, in another it will be $40k.

We're trying to set rules of thumbs based on percentage of income, so how much real estate is kicking off that isn't isn't really relevant.

Quote
Start with income needs, acquire sufficient property to cover income plus take care of maintenance. SWR equivalent is doubtful. This is more like dividend income.

No, that's what we're arguing you shouldn't do.  If you do that, you are susceptible to the short and long term risks we've been discussing. And we've been talking about how to write some rules to help mitigate those risks.  Your "cover income + maintenance, it's like dividends" is the traditional way of thinking that's overly simplified and dangerous, and we're trying to discuss a better way.  :)
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Mr Mark

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #52 on: February 27, 2017, 05:28:13 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.

ahhh - some kind of a "FIREcalc for rental real estate" based on historical reality?

the variables would render any 'conclusions' so subjective as to be pretty worthless I suspect...

The easiest 'market measure' of RE yield and performance would be to look at REITs. Perhaps even looking at the residential subset of REITs. Individuals can do from a lot better than that to a lot worse, depending on their own decisions, market and performance.


Papa bear

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #53 on: February 27, 2017, 07:06:45 AM »
I'm not sure we can create a general rule of thumb here.   Real estate is so incredibly variable based on location, you can have millions of variables to determine here. If you want to determine a swr for REITs, it may be more feasible.

A swr gives you an idea of portfolio failure % over time given all historical data.  Unfortunately, we can come up with multiple scenarios where a portfolio failure can happen in localized real estate markets.  Small town job loss, natural disasters, etc. As most real estate investors can't diversify over all markets, they will be subject to local variance.

As we don't own tiny portions of every rental in the market, we are seriously at risk of very local changes.  So to create a "general" swr to cover everyone, it's almost always going to be 0. Diversifying over multiple markets will help, but I haven't ever seen any calculations for real estate portfolio variability given number and location of investments. In realistic terms for us, the small investor, even with 1mm spread over 5 markets, a catastrophe in one market will surely drop the WR down significantly. 

Obviously, as individual investors, 0% doesn't do us much good for planning purposes.   I think it's prudent to have a buffer of net income from RE over your current expenses or to have a stock/bond portfolio that complements the RE income.

Do your best to diversify in locations, both locally in neighborhoods and larger markets, hold some assets in stock/bond, and spend less than your rental net income.  And you'll still probably end up with more than you started with anyway.

And while writing this, maybe someone should think about a MMM REIT to diversify? Have all of us RE investors look in local markets for properties to purchase?




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Another Reader

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #54 on: February 27, 2017, 08:06:09 AM »
I agree with everything you said, but as an intellectual exercise, care to tackle the OP's question?

-W

I'm pretty sure I did.  OP obviously has little to no experience as a landlord.  My point is that it's unlikely, barring a major local economic shift, to have rents go down commensurate with market value drops.  Proper insurance mitigates loss in cash flow from a property being destroyed by fire or similar calamity.  Projections used in determining what is "safe" to spend should include substantial cash reserves and other investments and reasonable assumptions about declines in occupancy and market rents. 

I'm fairly conservative, so the bulk of my net cash flow right now is going to mortgage payoff and capital improvements to keep up with the market.   Some money is going to paper assets, but valuations make me hesitant to commit a lot of money to those.  I am selectively pruning the portfolio and deleveraging with the proceeds. 

As I stated, I would not currently rely on net cash flow from rental real estate and I don't have to, because my income sources are diversified.  OP should take a less black and white view of his income sources and minimize his risk by diversifying income sources over time.

ETA:  It's important to remember that stock market returns and "income" in the form of dividends are independent of location.  The only variables are state and local taxation of income and capital gains.  Real estate income and appreciation are very location dependent and can vary a lot over time.  You can't make projections of future performance of real estate income, as you can with stocks and bonds.  Those projections are the basis of the 4 percent SWR for paper assets.  For these reasons, it's not possible to formulate a "safe" spendable percentage of net real estate income that applies in all markets.  You have to make your best guess and invest where and when it makes sense to do so.
« Last Edit: February 27, 2017, 08:20:56 AM by Another Reader »

Mr Mark

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #55 on: February 27, 2017, 09:08:42 AM »
I agree with everything you said, but as an intellectual exercise, care to tackle the OP's question?

-W

I'm pretty sure I did.  OP obviously has little to no experience as a landlord.  My point is that it's unlikely, barring a major local economic shift, to have rents go down commensurate with market value drops.  Proper insurance mitigates loss in cash flow from a property being destroyed by fire or similar calamity.  Projections used in determining what is "safe" to spend should include substantial cash reserves and other investments and reasonable assumptions about declines in occupancy and market rents. 

I'm fairly conservative, so the bulk of my net cash flow right now is going to mortgage payoff and capital improvements to keep up with the market.   Some money is going to paper assets, but valuations make me hesitant to commit a lot of money to those.  I am selectively pruning the portfolio and deleveraging with the proceeds. 

As I stated, I would not currently rely on net cash flow from rental real estate and I don't have to, because my income sources are diversified.  OP should take a less black and white view of his income sources and minimize his risk by diversifying income sources over time.

ETA:  It's important to remember that stock market returns and "income" in the form of dividends are independent of location.  The only variables are state and local taxation of income and capital gains.  Real estate income and appreciation are very location dependent and can vary a lot over time.  You can't make projections of future performance of real estate income, as you can with stocks and bonds.  Those projections are the basis of the 4 percent SWR for paper assets.  For these reasons, it's not possible to formulate a "safe" spendable percentage of net real estate income that applies in all markets.  You have to make your best guess and invest where and when it makes sense to do so.

+1

I prefer the diversity option -  a bit of paper, some residential rental, a house with a carriage house that's rentable, a bit of everything.  hopefully some SS too.

OP -  there's no analytics that enable 100% absence of risk.

As MMM points out, control expenses and when savings rate > than that, go for it. If you like the possibility of greater than 4% sustainable WR we think is doable with RE get started asap. Going straight to a million dollar RE portfolio with no experience would be a stupid plan.

But the questions you're asking sound theoretical and like somebody a loong way from having a million dollars of anything.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #56 on: February 27, 2017, 09:09:16 AM »
The problem here is that AFAIK we don't have any good historical data for rents. The OER series only goes back to 1982.

Anyone know of good rental price data for the last 100 years? The article I linked to earlier had some tangential information that was interesting but I'm not sure where they got their data (and it was just for Manhattan).

-W

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #57 on: February 27, 2017, 09:23:20 AM »
I agree with everything you said, but as an intellectual exercise, care to tackle the OP's question?

-W

I'm pretty sure I did.  OP obviously has little to no experience as a landlord.  My point is that it's unlikely, barring a major local economic shift, to have rents go down commensurate with market value drops.  Proper insurance mitigates loss in cash flow from a property being destroyed by fire or similar calamity.

Another Reader- I'm not saying Rent will go down 40-50%, but I think Rent going down 10% or having more Vacancies is realistic in a downturn.  Or am I'm mistaken?

If you have a Mortgage, a 10% decrease in Rent could mean 30% or more decrease in your Cash Flow.  This 30% decrease in Cash Flow could really hurt someone who is in FIRE.

It's realistic for Investors to have many Mortgages if they have been using Cash Flow to acquire more properties each year.  When you are FIRE you are not acquiring any more Properties.

You said "I would not currently rely on net cash flow from rental real estate." 
There are some Posters who believe you can rely on net cash flow from Real Estate as long as you only use a certain percentage of it.
This is what I'm trying to figure out.
« Last Edit: February 27, 2017, 11:55:37 AM by andysandp »

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #58 on: February 27, 2017, 09:49:25 AM »
The problem here is that AFAIK we don't have any good historical data for rents. The OER series only goes back to 1982.

Anyone know of good rental price data for the last 100 years? The article I linked to earlier had some tangential information that was interesting but I'm not sure where they got their data (and it was just for Manhattan).

-W

Yeah, this is the real problem. Combined with the fact that, because people tend to only own rental units in one or two major housing markets at a time, really we'd need separate data for each housing market, and that, since a decline in demand for rental units shows up more in increased vacancy than decreased rental prices, we'd also need data on vacancy rates for each housing market to go with the rental rate data.

Drole

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #59 on: February 27, 2017, 10:39:55 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".

+1 again.  This is what I use in my annual budgeting.  Some properties that need more work are higher, others that don't are lower.  But it seems to be averaging out.

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #60 on: February 27, 2017, 10:54:58 AM »
Well living on 50% of cash flow each year is guaranteed to never fail (just as taking 4% of your portfolio's value in that year is guaranteed to never fail). Some years will be fat, and some lean.

At that point the conversation shifts from SWR analogs for real estate to how much fluctuation in income can one expect from year to year living off of a real estate portfolio's cash flow, and what the risk of ending up with much lower income in a couple of decades is.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #61 on: February 27, 2017, 11:39:21 AM »
The other point worth considering is that real estate investing is by definition active investing.  With paper assets, you can toss your money into some index funds and forget about them for many years.  Successful real estate investors are really successful business people.  Businesses allocate capital, based on the perceived returns.  Every dollar of net real estate income or proceeds from a sale is spent or re-invested, based on what the investor perceives as the best available use for the money at the time it is received.  Sometimes the best use is buying more property.  Other times, the best investment is paying down mortgages, making capital improvements or buying paper assets.  And sometimes the best use is stockpiling cash because you see a real estate crash around the corner. 

Businesses don't have "safe withdrawal rates."  Business owners get a feel for their results over time and pay themselves accordingly.  Real estate businesses are so varied it's impossible to assign anything like a safe withdrawal rate that applies to the entire class of real estate investing businesses.  About the best approach is to do what other business owners do, look at what you have received in net income over a number of years, and decide how much you are comfortable taking out of the business.

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #62 on: February 27, 2017, 08:52:10 PM »
The problem here is that AFAIK we don't have any good historical data for rents. The OER series only goes back to 1982.

Anyone know of good rental price data for the last 100 years? The article I linked to earlier had some tangential information that was interesting but I'm not sure where they got their data (and it was just for Manhattan).

-W
This is my concern.  There is no back test for any formula. And with real estate, there is the added problem of location; a formula that back tests for Reno may not back test for Atlanta.  Diversifying would help, but an individual investor, even with a few dozen properties,  would find it difficult to be diversified across enough areas for their portfolio to follow any kind of national average.

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #63 on: March 01, 2017, 02:38:39 AM »
Well living on 50% of cash flow each year is guaranteed to never fail (just as taking 4% of your portfolio's value in that year is guaranteed to never fail). Some years will be fat, and some lean.

At that point the conversation shifts from SWR analogs for real estate to how much fluctuation in income can one expect from year to year living off of a real estate portfolio's cash flow, and what the risk of ending up with much lower income in a couple of decades is.

Nah, they're not saying take 50% of net profits and live on it, they're saying 50% of gross.

And that'd be theoretical gross, not actual (e.g. a vacancy wouldn't decrease that, as it'd be expected, and part of the 50% rule).

So 50% of the gross towards expenses related to the properties, 50% profit, for your spending.  Healthy cash buffers.

You wouldn't need to vary spending, because you'd draw down some on the cash buffers during bad years, and build them back up during good ones.

Naturally, you would likely in the real world vary your spending--if you just replaced a roof, had a few vacancies, etc., you'd very likely tighten the belt some... just like the the 4% WR, you can increase spending due to inflation, and never have to decrease it, but in the real world, one would likely decrease spending during a market drop.  Similarly, one likely would decrease spending here, but in theory would never HAVE to, as the good and bad years should even out to about 50% in the long run.

The two problems are: how big of a buffer is enough, and how are you hedging the long, slow slide problem?
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Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #64 on: March 02, 2017, 09:32:53 PM »
How often does this long slow slide happen? Is it a scenario that one is likely to run into, or is it as likely as the events that would make a traditional 4% portfolio fail?

andysandp

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #65 on: March 03, 2017, 05:06:30 AM »
How often does this long slow slide happen? Is it a scenario that one is likely to run into, or is it as likely as the events that would make a traditional 4% portfolio fail?

Do people have experiences with Rents falling during the 1980, 1990, and 2001 Recessions?

Personally in 2008 my Rents dropped about 5%, but I didn't have Real Estate during the other US Recessions.  I heard in 1990-93 Real Estate was pretty bad.
« Last Edit: March 03, 2017, 05:31:11 AM by andysandp »

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #66 on: March 04, 2017, 01:51:56 AM »
How often does this long slow slide happen? Is it a scenario that one is likely to run into, or is it as likely as the events that would make a traditional 4% portfolio fail?

How often do towns decline?

Rust belt.. ghost towns.  It's an interesting question.

Anyone want to propose a method for trying to calculate that?

Do people have experiences with Rents falling during the 1980, 1990, and 2001 Recessions?

Personally in 2008 my Rents dropped about 5%, but I didn't have Real Estate during the other US Recessions.  I heard in 1990-93 Real Estate was pretty bad.

It's not a recession thing; we're talking decades, not a few years.

If your holding time is a few years, it's not a worry.
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maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #67 on: March 04, 2017, 05:19:59 AM »
Would the number of cities/towns that saw ongoing declines in population over a decade (or over two decades) be an acceptable proxy? Lots of issues, but fewer people almost certainly means less demand for rental units.

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #68 on: March 04, 2017, 09:27:22 AM »
One could dig through census data and produce a multi-decade list of counties that saw population declines. The data certainly exists, and maybe someone has already done it...though a brief googling got me only passing references ("Cook County Shrinks by 10,000 residents" sort of stuff).

Anyone want to dig around in the Census tool and figure it out?

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #69 on: March 04, 2017, 12:32:34 PM »
Absolute population decline would be a start.

Even better would be "real" population decline (as in real versus nominal)--i.e. slower growth than the country as a whole.

Just due to births>deaths+immigration the population is growing. But a town that grows much slower than the rest, even if the population doesn't DECLINE is probably losing to inflation.

Picture a small town that had 100 people in 1900 and has 200 in 2000. They have about a 1% per year growth rate (100 people over 100 years... obviously this is a simple average for me to be lazy and not have to math, rather than a compounding one).  Google tells me that USA, on the other hand, went from population of 76,212,168 to 282.2MM from 1900 to 2000.  A simple average of 3.7% per year, almost 3x that little town.  Thus, while the population didn't decline, the "real" growth was negative.
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Re: Is there a 4% rule to retire on Real Estate?
« Reply #70 on: March 04, 2017, 12:34:34 PM »
First might be gathering data on, say, the top 200 metro areas and their population by decade for 1900-2010. Norming that versus the country's population growth rate.

Choosing the bottom, say, 10% and 25% of that, and seeing what it looks like.
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maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #71 on: March 04, 2017, 04:22:28 PM »
Wow. Old census data is remarkably hard to find in easily accessible formats once you get below the state or major city level. But I finally found a county level population dataset going back to 1970. (I wanted to do census blocks, but those are a complete mess once you get out of the 21st century).



Of course this map has the potential to be somewhat misleading, because large counties with few people will look more significant to the human eye than small counties with huge numbers of people. For this reason, I tried normalizing the data by the population of each county in 1970. Essentially this looks at the odds that any given person in the 1970 lives in a county which would have a smaller population in 2010 than in 1970.

50.8M people (25% of those in the 1970 census) lived in counties that would decline in population over the next 40 years.
136.5M people (67% of those in the 1970 census) lived in counties that would decline OR grow slower than the national CAGR over the next 40 years.

I think pretty much by definition the 25% of people who saw county level populations decline would have had a bad time if they decided to become landlords by buying local property in 1970. If there are fewer people left and the same number of houses (even without any new construction, which tends to still happen to some extent even in declining cities), rent and/or occupancy rates have to decline. Less sure what the last 40 years would have looked like for 42% of the population living in counties where population grew, but more slowly than the USA as a whole.

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #72 on: March 04, 2017, 04:33:07 PM »
Even this analysis required a surprising amount of data cleaning. For example, did you know we're still creating new counties for some reason? I'm looking at you Broomfield, CO. Also wiping whole counties off the map.
« Last Edit: March 04, 2017, 04:39:14 PM by maizeman »

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #73 on: March 04, 2017, 06:42:20 PM »
Wow, this is really neat.

The trend to me looks like East decline, West expand. But the west had a lot more room. I'd bet this would correlate with population density--e.g. people moving out of more populated areas.

I'm curious how it correlates with case-shiller data on prices from 1970-2010.

IMO, FL is a good place to invest.

I think pretty much by definition the 25% of people who saw county level populations decline would have had a bad time if they decided to become landlords by buying local property in 1970. If there are fewer people left and the same number of houses (even without any new construction, which tends to still happen to some extent even in declining cities), rent and/or occupancy rates have to decline.

Now this should scare people who think RE is the best for a long term ER (without the reinvestment hedge I described before).

25% chance of a long term decline via lower rents and/or higher vacancy? Let's not forget that it's likely you have lower quality tenants too (if we broadly define quality as income/class), since the better tenants have more mobility, and likely left, whereas it's often the lower class, lower income people who are "stuck" in a location. The area isn't declining in population because the jobs are abundant.

So likely worse tenant, less of them, and at lower prices. And a chance of that happening much greater than the 5% failure rate of the 4% WR.

I still think RE has tons of advantages, but people not watching out for this potential MAJOR pitfall and hedging against it for a long ER could be in a lot of trouble down the line.

Good work, Maizeman!  Definitely interested in any other analysis that comes into your head.
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Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #74 on: March 04, 2017, 07:24:19 PM »
Could this be offset a bit by the fact that lower income people are more likely to rent, and less likely to own property? While property values would no doubt suffer due to declining population, I would think rentals would still have some demand even as incomes drop. (A la 2008 ish) just a question for futher discussion.

I mean, while this could be a major setback, it seems that is is unlikely, and judging by the number of people who retire off of real estate, it doesn't seem like it's as massive a concern in real life. I would think RE investors would be screaming about this if there were really a 20-70% chance of otherwise "good" properties going"bad."
« Last Edit: March 04, 2017, 07:26:03 PM by Metric Mouse »

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #75 on: March 04, 2017, 08:16:55 PM »
Could this be offset a bit by the fact that lower income people are more likely to rent, and less likely to own property? While property values would no doubt suffer due to declining population, I would think rentals would still have some demand even as incomes drop. (A la 2008 ish) just a question for futher discussion.

I mean, while this could be a major setback, it seems that is is unlikely, and judging by the number of people who retire off of real estate, it doesn't seem like it's as massive a concern in real life. I would think RE investors would be screaming about this if there were really a 20-70% chance of otherwise "good" properties going"bad."

In 2008, there wasn't a lot of population changes associated with the downturn. There were just people who lost their houses who became renters and (mostly) stayed in the same area. It was actually *good* for the rental market (at least in the areas I have experience with) from the perspective of a landlord.

I think sustained population decline would be a whole different kettle of fish but I don't have any personal experience with it since I live in UT (and formerly CO), which has no such problem. Rather the opposite.

I've heard (and seen) of places in the midwest where you can buy yourself a palatial estate for $10k, but there's limited access to things like a post office, groceries, etc because the town has dried up and blown away. I don't think you would have wanted to own rental property in a lot of those places.

It's hard to put numbers on this, though. If you drop 10% of your population (and your housing stock stays unchanged) I'd assume rents drop 20-40% or something but I don't know how the demand curve should look for that sort of thing.

-W

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #76 on: March 04, 2017, 08:20:34 PM »
Well if the folks who owned their own homes are the ones to leave, I'd think those houses would end up on the rental market sooner or later (either the original owners cannot sell so they're stuck renting it out at whatever price they can get, or they ultimately cut the price enough that another landlord can scoop the house up at a much lower price where renting even at lower rates with higher vacancy can still turn a profit).

I agree 25% risk of failure seems high, so I've been thinking about confounding variables. Here's what I've come up with so far.

1) People in some currently declining cities may know that they're in declining cities so they wouldn't develop long term real estate investments as a way to retire. The rust belt has been called that since at least the 1980s. Conversely, in the 1970 census, california gained 5 representatives and florida gained 3. A person in 1970 could probably have done significantly better than random at guessing which parts of this map would be red or blue 40 years later.

2) What we're looking at hear is a 40 year interval. Most conventional retirements won't last that long, and most the the people who write online about FIREing based on real estate don't have 40 years of history yet.

3) One large ongoing trend is the move from people living in towns and small cities to a few of the biggest cities. People in small towns (declining) tend to own their own homes while people in big cities are much more likely to have to rent. So the distribution of landlords in 1970 was probably different from the overall population, but I'm using the second as a proxy for the first.

Also, keep in mind that declining (inflation adjusted) rents and problems finding tenants means it's probably an unpleasant time to own real estate but does not automatically equal bankruptcy. Later in life, if rents aren't growing fast enough to keep up with inflation and tenants are getting harder to find, in many cases there will be principal in some of the units, so folks can bridge the last couple of decades by either pumping back up their leverage, or selling off units as necessary.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #77 on: March 04, 2017, 08:22:10 PM »
Ars, happy it is of interest. I didn't realize the shiller/case home price datasets existed. Yes, would/will be very cool to compare the population growth trends and price changes for the twenty cities with individual data! For that I probably want to dig up yearly population estimates (should be available for big cities) instead of the one decade resolution data I was using for counties.

You've hit on one of my pet peeves which is that I think people tend to assume real estate is safer than the stock market because we have so much long term data on the stock market so we can start to put numbers on things like safe withdrawal rates and failure rates and no one talks about that with real estate. But the real reason we won't talk about those things with real estate isn't because it's known to be safer, we just don't have the same type of detailed long term data we'd need to give people good advice. I remember a year or two ago getting in a bit of a blow up with Mr. Orange over what the phrase "risk adjusted rate of return" actually meant, if anything, when comparing building houses on spec and stock market data.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #78 on: March 04, 2017, 08:37:18 PM »
I mean, while this could be a major setback, it seems that is is unlikely, and judging by the number of people who retire off of real estate, it doesn't seem like it's as massive a concern in real life. I would think RE investors would be screaming about this if there were really a 20-70% chance of otherwise "good" properties going"bad."

The vast majority of people who retire, even with real estate, are in their 60s. They see part of the decades long slide, but have likely way oversaved, have SS coming in, and then as the property slide happens, they die and the offspring inherit the problem.

It's a boiled frog situation.  You don't scream about it because it happens over decades.

I think it's a very likely situation for an extremely early retiree.
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Re: Is there a 4% rule to retire on Real Estate?
« Reply #79 on: March 04, 2017, 10:25:32 PM »
I mean, while this could be a major setback, it seems that is is unlikely, and judging by the number of people who retire off of real estate, it doesn't seem like it's as massive a concern in real life. I would think RE investors would be screaming about this if there were really a 20-70% chance of otherwise "good" properties going"bad."

The vast majority of people who retire, even with real estate, are in their 60s. They see part of the decades long slide, but have likely way oversaved, have SS coming in, and then as the property slide happens, they die and the offspring inherit the problem.

It's a boiled frog situation.  You don't scream about it because it happens over decades.

I think it's a very likely situation for an extremely early retiree.

So ARS, as 'an extreme early retiree who's heavily dependant on RE in one concentrated geographic location', what are your strategies for this issue? Do you siphon off the surplus RE income above your requirements and boost the IRA/Roth/VTSAX accounts?

My gut tells me it would be best to have a wide spread of income producing assets by location and type: so some US stock, International stock (not too much), some bonds, some residential rentals, some REITs, hopefully some SS, some side gigs, some AirBnB, some commodities, etc etc... But it still raises the issue of safety margin for long term %SWR calculation I guess.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #80 on: March 04, 2017, 10:35:20 PM »
I do indeed reinvest surplus rental income. Right now into equities, for diversification's sake, though I'll probably buy more RE at some point. It has a lot of attractive qualities in an investment (and some drawbacks, two big ones being liquidity and frictional costs).

I'm hoping to hit a second FI based just on paper assets by age 50 (barebones second FI before that, maybe 40?).

How much we give away will affect that though (eventually it is all going to charity, none to inheritance, but we may start larger giving much earlier).

Being 10-15 years from FI without having to work is a fun feeling. It's like my paper portfolio is racing some of the people here, though they're working 40-50 hour weeks. I'm working 2 hour weeks, if that.  Capital is really silly.

One clarification on the first part of your post:
My real estate holdings are in multiple markets, not just one.
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Re: Is there a 4% rule to retire on Real Estate?
« Reply #81 on: March 04, 2017, 10:41:59 PM »
Being 10-15 years from FI without having to work is a fun feeling. It's like my paper portfolio is racing some of the people here, though they're working 40-50 hour weeks. I'm working 2 hour weeks, if that.  Capital is really silly.

Yep! At some point in your 40s you can really start to relax if you did your homework. When I was younger I often wondered how 40-something guys managed to be so relaxed and well-off at the same time. Not even working that hard and being able to afford anything they wanted. They must have had solid investments working for them.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #82 on: March 04, 2017, 11:22:21 PM »
I do indeed reinvest surplus rental income. Right now into equities, for diversification's sake, though I'll probably buy more RE at some point. It has a lot of attractive qualities in an investment (and some drawbacks, two big ones being liquidity and frictional costs).

I'm hoping to hit a second FI based just on paper assets by age 50 (barebones second FI before that, maybe 40?).

How much we give away will affect that though (eventually it is all going to charity, none to inheritance, but we may start larger giving much earlier).

Being 10-15 years from FI without having to work is a fun feeling. It's like my paper portfolio is racing some of the people here, though they're working 40-50 hour weeks. I'm working 2 hour weeks, if that.  Capital is really silly.

One clarification on the first part of your post:
My real estate holdings are in multiple markets, not just one.

Thanks for the clarification ARS. Glad you are not 100% in Las Vegas...

So as a rule of thumb, what would you suggest a suitable target buffer is of 'excess rental returns' after allowing for vacancies, management, repairs and large capital items like roofs and HVAC systems?

If markets are efficient, you'd have to think the delta between whatever net you get from real estate and a 4% withdrawal rate on equities is a place to start. IE if you're getting an 8% ROI from your RE, live off the 4% and diversify the other 4%... But that would beg the question - what's then the benefit of RE vs stocks? Thus there should be a risk premium in RE, which means target a >1.5% rule (as the 1% rule is roughly a 6% ROI excluding inflationary cap gains, about the same as the market).

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #83 on: March 04, 2017, 11:48:22 PM »
Thanks for the clarification ARS. Glad you are not 100% in Las Vegas...

I thought you knew I had some rentals near you (Roseville, Eastpointe, even Warren).  ;)

So as a rule of thumb, what would you suggest a suitable target buffer is of 'excess rental returns' after allowing for vacancies, management, repairs and large capital items like roofs and HVAC systems?

That's what we were trying to discuss with this thread (what waltworks was pushing at earlier).

Your efficient markets is a good point, so one could try to guess and say "stocks return X% inflation-adjusted, real estate Y%, what part of Y-X is due to risk premium, what part is due to the extra work, what part is excess capital to be reinvested."  The problem is my Y% may be half of your Y%, or double it.

Essentially no real estate portfolio will be the same, so it won't be a hard number like "4%" (which really itself isn't a hard number, but based on a 60/40 stock/bond mix--Tyler's work at PortfolioCharts certainly shows different portfolios have had different SWRs in the past).  Just like a 60/40 portfolio will have a different SWR than a portfolio with 50% gold, 50% TIPS, so each real estate portfolio will have a different SWR.

So the question isn't "what is the SWR for real estate" but "What formula can we use to try and determine a safe WR for one's individual real estate portfolio."  Naturally it should already take into account all expenses (even if not experienced) and capital expenditures over a long time frame.

Then we want to "stress test' with:
A) Short term issues.  Say, 10-20% rent drops and 10-20% vacancy for a short time frame (3-5 years?)
B) Long term issues. The "slow decline" of an area whereby rents (and occupancy levels) don't keep pace with inflation (costs of repairs, and costs of your own expenses growing)

What are the probabilities of each of these?  You'll never be 100% safe, so what level is enough to be comfortable?

More importantly, what formula, or system, can we make to create a way to evaluate a rental portfolio and decide "this is sufficient to provide X annual capital with a reasonable degree of safety in the short and long term"?

I'm not sure yet, but some interesting points have been made towards things to consider when thinking about it, and some cool data by maizeman.   :)
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maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #84 on: March 05, 2017, 01:08:53 PM »
I wanted to test if rural areas and small towns were throwing off my data, so I tried running the same analysis for major cities (defined at either all cities >100k in 1970 or the top 50 cities by population in 1970) and the numbers are actually more striking.*

Of 150 cities with more thank 100k residents in 1970, 58 lost population over the next 40 years. Weighting for population size like above that works out to 40.7% of people in a >100k city living someplace that would lose population.

Of the top 50 cities in 1970, 24 lost population, but with population weighting that works out to only 43.3% of people in the top 50 cities in 1970 living in cities that would lose population.

Here's how the data looks for the top 50 cities.



Dashed line is the overall CAGR for the united states population over the same time frame. The other reassuring thing about looking at this graph is that the CAGR rankings make sense. I wouldn't have wanted to own property in the 1970s in the cities that are showing up as having significantly negative growth rates with the exception of maybe Washington DC and Boston, but I don't know enough about the history of each city to know if it would have been worth holding on to property there over the past 40 years to enjoy the current booms in rents and property values both are experiencing.

*I should mention that these numbers are based on population within the legal city boundaries. Most cities have two population numbers, one based on the legal city itself, the other on the population of a contiguous urban area. The census calls the latter "Metropolitan Statistical Areas" and then tend to grow with new suburban developments. To show what a difference this makes: the number of people living within the legal boundaries of the city called "New York" in the state of New York was 7.9M in 1970 and only increased to 8.2M in 2010. The population of people in new york metropolitian area (which would include all those people, plus those living places like East Brunswick, Farmingville and New Rochelle**) was already 16.2M in 1970 and was up to 18.4M by 2010.

**I cannot help but laugh as I type this remember how bent out of shape the folks I used to know who grew up in NYC about what constituted a "real new yorker."

waltworks

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #85 on: March 05, 2017, 05:34:36 PM »
Wow, that IS striking. Many more (urban) places that lost population than I'd expect.

The problem now is to define at least loosely what happens to rents in an area with declining population, and I'm thinking that will be the sticking point here. You could have declining population but very old/crappy housing stock that is being removed from the rental pool just as fast as the population drops. Or you could have (parts of New England come to mind) places with pretty durable structures and rents that fall off a cliff. But by how much?

I bet there is some Japanese data on this sort of thing, but the land use rules there are so weird that it might be hard to do an apples to apples comparison.

-W

maizeman

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #86 on: March 05, 2017, 05:50:25 PM »
Agreed on that being the next challenge. Right now I don't have any ideas how how to get some sort of loose formula for how rents/vacancy respond to falling population. If others do, I'd be happy to do some of the legwork of tracking down numbers and testing it out.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #87 on: March 06, 2017, 03:43:49 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".

I 3rd this. I only have one property, but this is a goal of mine once I have enough rental income from more properties. For me, it's not based on any complicated math, it just seems like erring on the side of caution.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #88 on: March 06, 2017, 03:46:10 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.

I agree. I'm sure it happens (and moreso in certain markets....like in industry-driven townships), but it seems like rent values are typically in an upward trajectory (they go up, or stay the same, but rarely go down unless it's an individual decision/ agreement by the landlord).

Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #89 on: March 06, 2017, 03:57:16 AM »
I'm glad I'm fired off investments, and not real estate. This stuff is tricky. Much less work (for me) to invest in companies that hire people that work all week worrying about these kinds of things. All the (monetary) rewards, none of the effort. Perfect (for me).


Has anyone offered any other arbitrary formulas? The more I think about it, the more I like FI (real estate) = Expenses x 1.1.

Or did I miss where this was disproved?

arebelspy

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #90 on: March 06, 2017, 04:00:36 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".

I 3rd this. I only have one property, but this is a goal of mine once I have enough rental income from more properties. For me, it's not based on any complicated math, it just seems like erring on the side of caution.

Yes.  50% rule will cover typical, normal expenses. It's not cautious/conservative, IMO, but realistic.

I agree. I'm sure it happens (and moreso in certain markets....like in industry-driven townships), but it seems like rent values are typically in an upward trajectory (they go up, or stay the same, but rarely go down unless it's an individual decision/ agreement by the landlord).

It's not rents going down (that's the short term risk), it's rents failing to rise fast enoguh and high enough to match inflation, over a long period, that's the long term risk.

I'm glad I'm fired off investments, and not real estate. This stuff is tricky. Much less work (for me) to invest in companies that hire people that work all week worrying about these kinds of things. All the (monetary) rewards, none of the effort. Perfect (for me).

Sure, there's drawbacks to real estate. This is one that often isn't talked about.

But there's benefits, too.  We were able to retire literally years earlier due to the much higher WR allowed us due to real estate (I calculated something like 8 years earlier, and that's assuming we made money at the same speed, in other words, not counting how much faster we accumulated wealth with RE).

The drawbacks are well worth the benefits, IMO (depending on the person/personality, but definitely for us), it's just worth being aware of the drawbacks, and hedging against any that might derail your ER.

Ditto with equities.

Quote
Has anyone offered any other arbitrary formulas? The more I think about it, the more I like FI (real estate) = Expenses x 1.1.

Or did I miss where this was disproved?

Where's the 10% buffer number come from?
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Metric Mouse

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #91 on: March 06, 2017, 04:06:48 AM »
Where's the 10% buffer number come from?

As mentioned, it was a completely arbitrary number that allows a buffer for both short-term losses and capital accumulation to diversify for long-term declines. No one has offered anything else concrete on which to start looking at a formula, which is the question this thread is seeking to discuss.

rachael talcott

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #92 on: March 06, 2017, 05:37:06 PM »
I found some data on the census.gov page that gives historical rental vacancy rates.  That might be a reasonable proxy for how things have gone for landlords, at least on a large scale.

On edit: It also indicates that 2008 was, in general, bad for landlords.



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Re: Is there a 4% rule to retire on Real Estate?
« Reply #93 on: March 06, 2017, 06:19:46 PM »
Great find, but I'd interpret it a bit differently.

Feel free to jump in and tell me I'm a moron:
-Vacancy rates go up when the housing bubble starts and anyone with a pulse can suddenly own a home (and gigantic sprawling suburbs of McMansions start getting built to accomodate the demand). Bad for landlords... great for new homeowners!! (/sarc)
-SHTF in 2007/2008 but in many places, people aren't yet out of their houses and foreclosure takes some time. Bad for  landlords! Except those folks who start to wonder about the dropping prices of houses...
-2009-2011 (plus or minus a year depending on where you are) - former homeowners are renting, housing prices still depressed, landlord party.
-2012-2014 or so - private capital hoovers up remaining cheap RE.
-2015 - new bubble begins inflating, Waltworks sells most of his rental RE.

-W


I found some data on the census.gov page that gives historical rental vacancy rates.  That might be a reasonable proxy for how things have gone for landlords, at least on a large scale.

On edit: It also indicates that 2008 was, in general, bad for landlords.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #94 on: March 06, 2017, 08:30:02 PM »
Great find, but I'd interpret it a bit differently.

Feel free to jump in and tell me I'm a moron:
-Vacancy rates go up when the housing bubble starts and anyone with a pulse can suddenly own a home (and gigantic sprawling suburbs of McMansions start getting built to accomodate the demand). Bad for landlords... great for new homeowners!! (/sarc)
-SHTF in 2007/2008 but in many places, people aren't yet out of their houses and foreclosure takes some time. Bad for  landlords! Except those folks who start to wonder about the dropping prices of houses...
-2009-2011 (plus or minus a year depending on where you are) - former homeowners are renting, housing prices still depressed, landlord party.
-2012-2014 or so - private capital hoovers up remaining cheap RE.
-2015 - new bubble begins inflating, Waltworks sells most of his rental RE.

-W

Yep.  You pretty much nailed it.  It was not much fun to be a landlord between the second half of 2004 through late 2008.  By early 2009, vacancy started dropping quickly and rents started up.  In 2009 you couldn't give houses away to the average buyer.  I bought my last short sale in early 2012, and I only got it because the previous buyer backed out a week before COE and I had the cash to close on time.


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Re: Is there a 4% rule to retire on Real Estate?
« Reply #95 on: March 06, 2017, 08:40:19 PM »
Great find, but I'd interpret it a bit differently.

Feel free to jump in and tell me I'm a moron:
-Vacancy rates go up when the housing bubble starts and anyone with a pulse can suddenly own a home (and gigantic sprawling suburbs of McMansions start getting built to accomodate the demand). Bad for landlords... great for new homeowners!! (/sarc)
-SHTF in 2007/2008 but in many places, people aren't yet out of their houses and foreclosure takes some time. Bad for  landlords! Except those folks who start to wonder about the dropping prices of houses...
-2009-2011 (plus or minus a year depending on where you are) - former homeowners are renting, housing prices still depressed, landlord party.
-2012-2014 or so - private capital hoovers up remaining cheap RE.
-2015 - new bubble begins inflating, Waltworks sells most of his rental RE.

-W


I found some data on the census.gov page that gives historical rental vacancy rates.  That might be a reasonable proxy for how things have gone for landlords, at least on a large scale.

On edit: It also indicates that 2008 was, in general, bad for landlords.

That makes sense if you have the means to buy new houses during market downturns, or cash to weather the years with high vacancy rates, but the goal was to try to figure out some sort of method for predicting relatively safe spending rates to weather the bad times.  One component of that being discussed above is location risk, but I would think that another is the risk of an increase in the overall vacancy rate.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #96 on: March 06, 2017, 09:10:02 PM »
Sure, MY point was that the 2007/8 housing crash is not a good example of a risky scenario for landlords. Overall it was a very good event for landlords.

Maybe I misinterpreted you.

-W

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #97 on: March 06, 2017, 09:37:16 PM »
Sure, MY point was that the 2007/8 housing crash is not a good example of a risky scenario for landlords. Overall it was a very good event for landlords.

Maybe I misinterpreted you.

-W

Lots of investors lost their shirts in 2007-2012.  They were overleveraged, undercapitalized, and betting on short term appreciation.  Many were cash flow negative, using their job income to sustain the rentals.  They lost their job income and then they lost the properties.  Conservative investors that were well capitalized survived the crash and used their cash to buy more properties when they were on sale for half price.  So the risk depended on how savvy an investor you were.

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #98 on: March 07, 2017, 04:49:23 AM »
Sure, MY point was that the 2007/8 housing crash is not a good example of a risky scenario for landlords. Overall it was a very good event for landlords.

Maybe I misinterpreted you.

-W

Lots of investors lost their shirts in 2007-2012.  They were overleveraged, undercapitalized, and betting on short term appreciation.  Many were cash flow negative, using their job income to sustain the rentals.  They lost their job income and then they lost the properties.  Conservative investors that were well capitalized survived the crash and used their cash to buy more properties when they were on sale for half price.  So the risk depended on how savvy an investor you were.
Maybe a 10% buffer would have helped?

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Re: Is there a 4% rule to retire on Real Estate?
« Reply #99 on: March 07, 2017, 06:15:16 AM »
Sure, MY point was that the 2007/8 housing crash is not a good example of a risky scenario for landlords. Overall it was a very good event for landlords.

Maybe I misinterpreted you.

-W

We're probably misinterpreting each other. We're imagining different landlords with different financial situations. You're thinking like a business owner, and I'm imagining an early retiree who just wants rental income without needing to grow the rental business in the future.

One of the points that got this thread rolling was that someone who has $1mil gross rents and $950K in expenses has $50K to live off of, and might think that they can retire, especially if their expenses are only, say, $40K.  But a 5% increase in vacancies could mean that that early retiree now has nothing to live off of for the year.  And if the increase in vacancies means a decrease in rents (haven't done the correlation yet) it's even worse.  They might have a negative cash flow for a year.  How much cash would a landlord need to have on hand to cover that bad year?  I don't know, but it seems like there ought to be some way to account for the risk of leveraging. 

RT