Author Topic: Why is it OK to accept a lower return on bonds vs real estate?  (Read 9211 times)

Mazzinator

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Why does it seem in general that it's ok to accept a lower rate of return on bonds than it is for real estate? Some people even encourage some diversity in their AA to help lower their risk during a market downturn. But, when discussing RE, here and on places like biggerpockets, if you're not getting "double digit returns" on your RE investment, then it's not a good deal.

I hesitate adding an example or numbers because i don't want to discuss whether or not the 50% rule is accurate, etc etc. but i can/will add an example if needed to get my point accross.

Thanks in advance for the discussion!!

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #1 on: March 16, 2015, 04:12:28 PM »
Real estate has much more work than bonds (both to acquire, and to collect the income) and much higher risk (eviction, damage, etc. is a lot more likely to happen to your real estate than your bonds).

Thus you should be compensated for these things.

If you can get a bond for 3-4% that takes no work, and has almost no risk of the income defaulting, why would you take a 3-4% return on real estate that takes a lot of work and might default on the income for awhile?  You shouldn't.  Thus why you want a higher return.

In addition, you need to compare it to what else is available.  If you can get a 3-4% return in real estate (poor) or can get a 10-12% return (pretty good), why would you choose the 3-4%?  You shouldn't.  Thus why you want a higher return.
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Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #2 on: March 16, 2015, 04:46:15 PM »
With real estate wouldn't you be gaining an income stream without ever touching your investment that will also increase with inflation? Plus you would need a lower amount if say you could get it at 4-6% (thinking swr)

Where bonds risk is that it is just keeping up with inflation and you would need a much higher amount to live off of it (thinking swr)

dandarc

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #3 on: March 16, 2015, 04:53:56 PM »
With real estate wouldn't you be gaining an income stream without ever touching your investment that will also increase with inflation? Plus you would need a lower amount if say you could get it at 4-6% (thinking swr)

Where bonds risk is that it is just keeping up with inflation and you would need a much higher amount to live off of it (thinking swr)
Bonds have not always yielded as little as they do right now.  That being said, the risk / work factors still apply.  Then you've also got to ask yourself - will rent increases exactly match your personal inflation?

It is not like you buy a house and the rent just comes in like clockwork without any hiccups ever.  Ask anyone who owned a lot of rental property in Flint, MI a few decades ago what can happen to vacancy rates.  Or New Orleans landlords around 2006-7, whether that income is as stable as they'd like.
« Last Edit: March 16, 2015, 04:56:00 PM by dandarc »

Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #4 on: March 16, 2015, 05:21:45 PM »
Thanks for the replies so far!

I guess i'm looking at it like this...

To help diversify.

Instead of having an AA of 100% stocks (index funds) I could have say 75/25 stocks/bonds OR why not 75/25 stocks/real estate.

And i am aiming for double digit returns, but fear i'll screw up and end up with a lower return and i'm just telling myself it'll still be ok because i could look at it like this.

And i'm also thinking of the accidental landlord in which it might be better to just keep the property and look at it as such rather than selling at a loss.

Or i'm just plain wrong and shouldn't buy income properties? Or only buy those which return double digits even if they're in less ideal locations. (I've been looking in many different towns and several states, and i pretty much consistantly come up with lower returns in better areas)
« Last Edit: March 16, 2015, 05:33:35 PM by Mazzinator »

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #5 on: March 16, 2015, 06:35:59 PM »
Or i'm just plain wrong and shouldn't buy income properties?

We aren't saying that.  I'm absolutely a fan of investing in RE.  (In case you haven't read any of my other posts here, it's my primary path to FIRE.  I have 15 rentals, and have made 1MM+ in RE.  I'm not yet 30.)

But taking a low return on real estate because you want to equate it to a different type of investment in a weird apples-and-oranges scenario?  When you do that, it leads me to believe you need to do a lot more research first (around both RE and other investment types) to understand the pitfalls and benefits of each.

Your primary question was "Why is it OK to accept a lower return on bonds vs real estate?"  What I posted earlier is the reason.  Bonds take a lot less work, and have a lot less risk.  So with real estate, you should be compensated for that extra work and risk.  Otherwise you're doing extra work for no extra return, and you may not even get the regular return you were hoping for due to the risk.  Pass.

Now that you have that answer, move past that apples-to-oranges comparison and start assessing RE on its own, figure out its benefits for you (and drawbacks) and where it fits in your FIRE plan and AA. 

"Real estate" isn't one thing, even.  There's dozens of ways to invest in RE.  That's another thing to learn about, and figure out. 

It's absolutely worth educating yourself on, and it's good you're asking questions.  Please don't let our answers discourage you.  Keep learning.  :)
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chasesfish

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #6 on: March 16, 2015, 06:58:57 PM »
The problem with real estate right now is we went through a once in a generation sale from 2008-2012 depending on your state and its foreclosure laws.   You aren't going to get the returns those properties are generating, so it's tough to gauge what a real "deal" is in the market.   I was very close to buying in the last market I lived because of a protected rental market and lack of land equaling a "bond-like" return, but it was tough to get better than 6% NOI and its tough to use leverage at that low of a return.


chasesfish

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #7 on: March 16, 2015, 07:00:17 PM »
By the way, if you want something in between, you can always purchase a REIT.  My personal favorite is EPR.  Some risk of loss, but pays a nice 6.25% yield, modest increases each year, and has little debt. 

Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #8 on: March 16, 2015, 08:16:46 PM »
Thanks for taking the time to discuss this with me. I have a hard time knowing what i don't know and i'm not even sure what to ask sometimes. Sorry it was a weird comparison.

I would think the lower return on the real estate would be less risk, work and headache because it would be a fancypants house in a nice community with top schools and great tenants. I understand shit can happen, and there are bad tenants everywhere. I'm thinking back to where i went to college and grew up. 20-30 yrs ago the same nice areas are still nice areas, the ghettos are still ghettos (for the most part)

So, my thinking was to buy one of these, pay it off, then live off the cash flow. Lower risk because it's paid for and a decent area. If it's 4-6% return, it's ok because chances are my tenants aren't going to steal my stove and the copper plumbing. And that to me seems better than buying bonds (although i can't really explain why)

I can find areas that meet and even exceed 2%. But i would think that would be riskier because those tenants are probably going to rob me blind, give me headaches and a long life of trouble.

And i can't even begin to think about REIT, but i will look into it.

Thanks again!!!

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #9 on: March 16, 2015, 09:57:00 PM »
I would think the lower return on the real estate would be less risk, work and headache because it would be a fancypants house in a nice community with top schools and great tenants. I understand shit can happen, and there are bad tenants everywhere. I'm thinking back to where i went to college and grew up. 20-30 yrs ago the same nice areas are still nice areas, the ghettos are still ghettos (for the most part)

So, my thinking was to buy one of these, pay it off, then live off the cash flow. Lower risk because it's paid for and a decent area. If it's 4-6% return, it's ok because chances are my tenants aren't going to steal my stove and the copper plumbing. And that to me seems better than buying bonds (although i can't really explain why)

Sure, that's less risk than real estate in a bad area, but less risk than a corporate bond?  Let's say you lent money to Apple, or G&E.  And on the tiny chance they're in financial trouble, you get paid back before any of their stock holders.  You think they are less likely to pay you back than a "good" tenant?  Any rental, regardless of the area, is definitely not lower risk than a bond index fund.

You can certainly do the plan you're describing, you just will make a mediocre return on it.  At that point, why not buy stocks that should return 7-10% and take no work?  The "risk" is volatility risk, which, if you can just ride it out, is very little risk over a long enough time span.

I can find areas that meet and even exceed 2%. But i would think that would be riskier because those tenants are probably going to rob me blind, give me headaches and a long life of trouble.

Yeah, avoid that.

And i can't even begin to think about REIT, but i will look into it.

Again, apples and oranges.  A rental property is quite different than a REIT.  REITs tend to move with the stock market as a whole.

Like I said earlier:
Quote
start assessing RE on its own, figure out its benefits for you (and drawbacks) and where it fits in your FIRE plan and AA. 

Some of the real estate books recommended here is a good place to start:
http://forum.mrmoneymustache.com/real-estate-and-landlording/real-estate-book-recommendations/
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Ricky

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #10 on: March 16, 2015, 10:35:19 PM »
I think you already answered your own question. In balancing risk/reward in your portfolio, bonds and real estate are just forms of diversification.

One thing not to be confused on is both bonds and real estate can be just as risky as one another. It bears repeating that more risk = more reward and the inverse is true. Bonds come in all shapes and sizes just like real estate, so it's not accurate to say that real estate is more or less risky than bonds, since that'so too broad of a statement.

It all boils down to diversification, and you understand that, so I don't understand the reasoning behind the question.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #11 on: March 16, 2015, 10:47:49 PM »

I think you already answered your own question. In balancing risk/reward in your portfolio, bonds and real estate are just forms of diversification.

One thing not to be confused on is both bonds and real estate can be just as risky as one another. It bears repeating that more risk = more reward and the inverse is true. Bonds come in all shapes and sizes just like real estate, so it's not accurate to say that real estate is more or less risky than bonds, since that'so too broad of a statement.

It all boils down to diversification, and you understand that, so I don't understand the reasoning behind the question.

It's not just about diversification with no regard to the returns. Because if you want, I can sell you an investment 100% uncorrelated with the market.

But it won't help your overall returns.

I think you've simplified it too much.
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Ricky

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #12 on: March 17, 2015, 07:09:58 AM »
What? I was saying being diversified means also taking on different levels of risk, not just different asset classes. Yes, I'm speaking in generalities. I'm indirectly answering what the OP already knows - that lower returns are part of being diversified.

Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #13 on: March 17, 2015, 12:12:55 PM »
What? I was saying being diversified means also taking on different levels of risk, not just different asset classes. Yes, I'm speaking in generalities. I'm indirectly answering what the OP already knows - that lower returns are part of being diversified.

Thanks for your reply... And yes, this is pretty much what i am asking/saying...

If lower returns are part of being diversified, why is it ok to accept them from bonds but not from RE?

From above, the answer seems to be because it's too much extra work without the safety of lowest/lower than risk that you will get from bonds.

From my reading of other blogs and posts, it seems that the return (even in "low risk" RE) should still equate that of stocks not bonds. (Hopefully i'm saying that clearly, i know i don't write well) In other words, RE should at least equal ~6%(because it is that much more risky) and be "low risk" to make up for the inherent higher risk RE has.

I was original thinking, why can't i just sub out bonds with a low risk income property in my overall portfolio...but, apparently, you can't just do that, because they're not nearly as equal as i had thought.

Arebelspy, i did read 2 of those books mentioned, plus i've been reading biggerpockets forum/blogs for about 18months now, and i have a mentor!!! But shit, it seems i still have a long way to go, yikes!

I want to add RE because i'm mostly worried about investing in stocks then FIRE in such a sort timeframe, ~7 yrs from start to finish and i know stocks are best for longer timeframes. We went to FIRE on a specific date and the biggest unknown is just how much stocks we will have on that date (~5yrs from now) as it could be more or less..

so RE would provide a bit of "steady" income, at a higher "swr" with less of my money invested. Then we could either let the stocks compound or use a lower "swr" at FIRE.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #14 on: March 17, 2015, 12:18:24 PM »
Arebelspy, i did read 2 of those books mentioned, plus i've been reading biggerpockets forum/blogs for about 18months now, and i have a mentor!!! But shit, it seems i still have a long way to go, yikes!

Okay, that's good.  :)

Now start to learn about some of the investments you're comparing it to, in order to wrap your head around them.

And some things will only be learned with experience, unfortunately.

From my reading of other blogs and posts, it seems that the return (even in "low risk" RE) should still equate that of stocks not bonds. (Hopefully i'm saying that clearly, i know i don't write well) In other words, RE should at least equal ~6%(because it is that much more risky) and be "low risk" to make up for the inherent higher risk RE has.

Stocks should do more like 9-11% nominal, and that's what I'd want from my RE (total returns, counting appreciation at the rate of inflation and principal paydown, if applicable) at a minimum, likely more due to the work involved (real life example I posted 5 months ago).  Cheap leverage at the moment does make that quite a bit easier to obtain without a whole lot of risk added, as long as you're cash flow positive and keep good cash buffers.
« Last Edit: March 17, 2015, 12:20:19 PM by arebelspy »
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Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #15 on: March 17, 2015, 12:40:40 PM »
Ok, right, which is where the "double digit returns" number comes from...6% was the number used in the article.

And this mostly comes from a conversation on biggerpockets, where a few people suggested to me that i might want to buy a higher "class" property because i want to use a PM and to have it be more passive. They suggested, unless the PM specializes in lower class properties, it was better to buy a "C+ or B" class property. (I know these classes are widely defined, but we did define in my post)

So, from that, i started looking for better properties, but found their returns were much lower.

So, i guess, i'm trying to find the "sweet spot" (who isn't) where the return meets risk. Without just blindly accepting "double digit returns" I mean, i got it, but i wanted to know WHY...

Thank you all soooo much!! Seriously, i feel so stupid sometimes, but you all made me feel so welcome and helpful in explaining it to me.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #16 on: March 17, 2015, 12:51:00 PM »
So, i guess, i'm trying to find the "sweet spot" (who isn't) where the return meets risk.

That's the trick.  It's a balance.. really terrible low end properties in rough places can generate 20%, 30%+ returns.  On paper.  Good luck collecting.

Really high end properties in great areas (or popular ones at least) can generate sub-3%.

Finding the balance that works for you - good returns but in decent areas - is the trick.  You'll have to find "gems," and look hard to find ones that are nicer in okay areas, or cheaper in really good areas.

Without just blindly accepting "double digit returns" I mean, i got it, but i wanted to know WHY...

That's 100% what you should be doing - trying to figure out why, and not blindly accept, and if you can't, ask.  :)
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clifp

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #17 on: March 17, 2015, 01:37:00 PM »
Mazzinator

I notice that you are also in Oahu.  Besides all the challenges that Arebelspy talked about, location location, location isn't just a saying in real estate it really matters a lot. We live in one of the nice areas that Arebelspy talked about, so for instance I'd be lucky to get 3% cash on cash return renting my house and in general most place in Hawaii would have a similar returns just including rents.  Price appreciation is how people make money in real estate in place like Honolulu, San Francisco and that is always a crap shoot..   When I finally started invested in real estate, I did it the same place that arebelspy did in Las Vegas, because at the time it was possible to get 10%+ cash returns simply on rent, and much higher if you use leverage.  However, eventhough we invested at the same time, with the same realtor, I know his returns were better. He didn't have to pay a property manager (I'm on my 3rd property manager) and he had a greater understanding of the local RE market than I have..  So while  I do know plenty of who have made a ton of money in Hawaii real estate it is far harder for somebody like you to get started in it. There are plenty of place in the country where you can buy houses for much less than the down payment needed in Hawaii.

Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #18 on: March 17, 2015, 04:59:05 PM »
Clifp, thanks for your response. Yes, i currently live on oahu. I am a sahm and army spouse, and we will be moving back to the mainland this summer, so i'm not looking to buy here.

I have been looking at serveral locations and have narrowed it down to Pittsbugh, Savannah and Charlottesville. All for different reasons. We are moving to Cville next and we will be eligible for 100% financing and $0 due at closing. So, i'm making sure the property would still be a great rental, with the lending as a bonus.

It would still cash flow ~$100/month even with conservative rents, 50% rule and the 100% lending. I don't even know how to calculate the CoC returns for that??? But paid off/no mortgage it would be ~6% But i have to make sure it fits in my overal goals.

For the record, if anyone cares or not, we already max out a tsp, 2 iras, pay extra on low interest SLs, save a bit in a taxable account, and have a small EF...with RE being the last step.
« Last Edit: March 17, 2015, 05:02:14 PM by Mazzinator »

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #19 on: March 17, 2015, 09:21:20 PM »
It would still cash flow ~$100/month even with conservative rents, 50% rule and the 100% lending. I don't even know how to calculate the CoC returns for that??? But paid off/no mortgage it would be ~6% But i have to make sure it fits in my overal goals.

That sounds like it has possibility.  Post specific numbers (rent, purchase price, taxes, insurance, mortgage rate, down payment amount, etc.) when you get a chance.
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Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #20 on: March 17, 2015, 10:59:35 PM »
It would still cash flow ~$100/month even with conservative rents, 50% rule and the 100% lending. I don't even know how to calculate the CoC returns for that??? But paid off/no mortgage it would be ~6% But i have to make sure it fits in my overal goals.

That sounds like it has possibility.  Post specific numbers (rent, purchase price, taxes, insurance, mortgage rate, down payment amount, etc.) when you get a chance.

http://forum.mrmoneymustache.com/real-estate-and-landlording/case-study-buy-a-house-to-live-in-then-rent-it-out-(military)/msg532771/#msg532771

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #21 on: March 18, 2015, 02:09:43 PM »
I don't see this at that link:
Post specific numbers (rent, purchase price, taxes, insurance, mortgage rate, down payment amount, etc.) when you get a chance.

If you linked wanting to answer that post's final question:
Quote
Should i just "pick one" and post actual numbers? I already have them all done ;)

Sure!  :)
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Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #22 on: March 18, 2015, 06:24:59 PM »
Here's one recently sold...

$102k sold
$684 hoa/yr
$1213 tax/yr

30yr fixed VA mortgage, 3.25% (current rate) 0% dp
$450/month

$1,100 rent ($1,100 - $1,350 is normal for this sq ft)

550 (50% rule)
-450 P&I
=100 net

550
-110 tax
-57 hoa
-110 PM
-50 insurance
-223 vacancy/repairs (20%)

This is a house not condo. The hoa covers the community pool, gated community/security, snow removal.

We currently have $12k cash we could use for a down payment and/closing, but from my understanding going $0 down $0 cost is the way to go...??? What do you think?

After maxing tsp/ira we can save an extra $2k/month but i would need to fly there/make an offer around may..we need to close/move by mid aug. Is may a good timeframe?

There are other "ugly" homes there for cheaper ($70k-$84k), but i think the VA has lending rules on "move in ready" and with the long distance and the "big" move for our family it might be too much for any rehab/renovations.

Plus- i haven't actually seen these houses and/or rental comps...because i live so far away... So, the bigger question...

Should i fly ~12 hrs to look???

It seems very close to OK, but i'm just not sure...

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #23 on: March 18, 2015, 10:25:23 PM »
That is..eh?  Not terrible, but not something to jump on.

I don't count the HOA in the 50% rule - a house without an HOA hit's 50% over time, the HOA just adds more expense, especially for SFRs (in condos at least you can justify some of the dues going towards long term capital repairs).  So that will lower your return.  Most of the reason why that deal works is the cheap leverage you have built in.

I'm very skeptical you'll get 3.25% on an investment home.  I think you'll get closer to 5%, which probably kills this on top of the HOA comment above.

Should i fly ~12 hrs to look???

Why would you?

You need to read this topic:
http://forum.mrmoneymustache.com/real-estate-and-landlording/purchasing-real-estate-you've-never-seen/

:)

(Also, I'm moving this to the RE section of the forums, since it's now mostly about RE, and no one else seems to be responding anyways re: bonds and comparing them.)
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Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #24 on: March 19, 2015, 12:33:38 AM »
Thank you so much for holding my hand!! I feel so lucky to have your advice. I have some luck at BP too, but they seem to just keep repeating themselves..no money down, stocks are bad, etc etc. Don't get me wrong i love their advice, but i just want a diff point of view.

This will be owner occupied. It has to be to qualify for a VA loan. The army is moving us there this summer, and we won't/don't want to wait until we move to look at houses. I'm not sure i'd buy something to live in without ever seeing it. Even if we won't be living there long term.

We will probably live there a year (min time for a VA loan) but more so, because we will get official military orders (which trumps all) to move us again summer 2016. We would love to stop moving all the freekin time, but such is army life. There's always a possibilty he could stay there longer, but i know better than to hold my breath.

The other option is to wait until we get there and take our chances to find a rental. If we don't buy, we probably won't live in this neighborhood. It is far away from my husbands job, but is otherwise in a good location. I prefer living near other peers/friends we know there. We also have 2 dogs, which makes renting fun, so we're looking at around $1,500/mn for rent.

I have another question and i'm not sure if i should start a new topic... (I can move it and start a new thread, if you think i should)

Why can't i compare the return to the "4% swr"?

For example, this house once paid off, would return ~6%. So, if we hurried up and paid it off, $100k would give us $550/month asap, where we would need ~$150k for the 4%swr. And we wouldn't need to touch the $100k to get it.

Is it because that $100k won't grow like it would in stocks? But does it matter? Wouldn't we just be buying an income stream?

Or is it the whole "work/risk" thing again??

Thanks again!!

Bjorn

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #25 on: March 19, 2015, 03:19:23 AM »
Quote
Why can't i compare the return to the "4% swr"?
I'm also interested in perspectives on this, because what you just wrote is the main reason I've chosen real estate on my path to FIRE; you simply don't need to save as much.

I can invest $260k in RE, pay it off and get $1,000 a month which would cater for my living expenses of $12k a year.
Not only will I pay it off, but the cash surplus from having tenants along the way will fasten the process.

12k x 25 = $300k needs to be saved if I choose paper investments that yield $12k/year.

To me, the difference between 260k and 300k is 2 years worth of savings.

waltworks

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #26 on: March 19, 2015, 08:00:07 AM »
How many times does the whole risk thing have to be explained? A couple of houses are MUCH riskier than a big diverse stock/bond portfolio. You cannot, cannot, cannot count on your rentals doing the same thing year in and year out. You can get sued by a tenant. You can have a natural disaster happen that insurance doesn't cover. You can have the city quadruple property taxes, etc, etc, etc.

I, like Arebelspy, own a lot of real estate (not as much, not as profitable, and a somewhat different initial strategy, but still, lots of real estate). It is great, and I'm glad I own it. But it does not make me want to dump more money in unless there is a great deal, because if I want to get low returns, I want very low risk, and RE is not low risk.

-W

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #27 on: March 19, 2015, 08:13:43 AM »
So first of all - walt's answer.  Real estate has risks that holding equity does not. 

Second, this:

Why can't i compare the return to the "4% swr"?

For example, this house once paid off, would return ~6%. So, if we hurried up and paid it off, $100k would give us $550/month asap, where we would need ~$150k for the 4%swr. And we wouldn't need to touch the $100k to get it.

Is it because that $100k won't grow like it would in stocks? But does it matter? Wouldn't we just be buying an income stream?

Or is it the whole "work/risk" thing again??

Partially, yes.  But another big problem is you don't know what the SAFE withdrawal rate is, even if you have a return on investment.

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

*Safe as in - it is sustainable long term

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

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

We had a good discussion on this once here in the forums, but I think it'd be quite difficult to find now.  Hopefully that made sense though.

With the above caveat though, often real estate often does let you FIRE with less invested (though I wouldn't call it a higher WR, but if you did divide the amount you were spending by the amount invested, it would look like a higher "WR") though.  I touched on this in the podcast interview I did on stocks v. real estate.  Link if you're interested.  It talks a lot more about the positive upside and potential higher WR you can have with real estate, if you're looking for the sunny answer (this post is more the cautionary answer).

So again, it's not an apples-to-apples comparison.  You need to judge it on its merits, rather than versus something else that doesn't apply.

Going back to walt's answer, if you take your yield and spend it all, you could - at some point - hit a immediate big problem (expensive issue insurance doesn't cover, lawsuit, etc.), you're in a really tough place.  If you take your yield and send it all, you could - over time - hit a slow developing problem like inflation eating away at you, or property taxes or materials/labor for repairs rising faster than rents.  Real estate has these risks, and you need to prepare for that.  If you've been saving a chunk of your return from RE into other investment vehicles, it'll help you weather those storms.  So that will lower the "WR" you actually should be taking, and is yet another reason why you should demand a higher ROI than simple equities, to cover those risks and the necessary extra yield/amount needed to invest to do so.
« Last Edit: March 19, 2015, 08:15:29 AM 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.

Cpa Cat

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #28 on: March 19, 2015, 08:31:49 AM »
Don't forget liquidity. If I need money right this moment and I have stocks + bonds, then I have a couple of good choices. One of them is bound to be better to sell at this moment and I can have money in my pocket in 24 hours.

If all I have is stocks and real estate, then the only thing I can actually sell is stocks. But what if it's not a great time to sell stocks? Well, too bad - because I can't sell those houses fast.

In addition to all of the other things mentioned, liquidity also has "price." Of course you should demand a higher rate of return on an investment that's illiquid.


Another Reader

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #29 on: March 19, 2015, 08:45:22 AM »
If you're in an area where prices stagnate, rents don't rise much, and inflation outpaces them, your SWR is lower than your yield.  That is, you may be earning 6%, but if your expenses and costs rise faster than inflation, you'd better be LBYM, saving a good chunk of that 6%, and plowing some of those proceeds back into more investments to keep pace, or in 20-30 years you'll be hurting really, really bad.


What Arebelspy says here is key.  After 20 years of real estate investing and over 30 in real estate, I can say this is what you need to watch in any market where you invest to hold for an extended period.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #30 on: March 19, 2015, 09:00:15 AM »
If you're in an area where prices stagnate, rents don't rise much, and inflation outpaces them, your SWR is lower than your yield.  That is, you may be earning 6%, but if your expenses and costs rise faster than inflation, you'd better be LBYM, saving a good chunk of that 6%, and plowing some of those proceeds back into more investments to keep pace, or in 20-30 years you'll be hurting really, really bad.


What Arebelspy says here is key.  After 20 years of real estate investing and over 30 in real estate, I can say this is what you need to watch in any market where you invest to hold for an extended period.

Yeah, and I almost never see it mentioned.  It was only because of a really good discussion here that I finally wrapped my head around it.  Just because your return is $X, that doesn't mean you can spend it all, even if it's stable.  Even if you have accounted for vacancy, repairs, etc. and are dead on accurate such that a disaster never hits and your budget is 100% correct to the penny, you still might not be okay spending the rest, because your SWR could be lower than your return.

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

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

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

Bjorn

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #31 on: March 19, 2015, 10:06:45 AM »
Thanks for some excellent answers.

I will probably split my investments between real estate, stocks and cash. But it might happen in a way where I start with real estate and get that going, and when cash starts to roll in more in the future I put some of it in stocks. Ideally, I would want my income to come from 50% real estate, 25% stocks and 25% part time job, with a money cushion worth 2 years of living expenses. From that income I would want to save maybe 25% so that I keep increasing the principal I have invested in stocks.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #32 on: March 19, 2015, 10:22:30 AM »
Thanks for some excellent answers.

I will probably split my investments between real estate, stocks and cash. But it might happen in a way where I start with real estate and get that going, and when cash starts to roll in more in the future I put some of it in stocks. Ideally, I would want my income to come from 50% real estate, 25% stocks and 25% part time job, with a money cushion worth 2 years of living expenses. From that income I would want to save maybe 25% so that I keep increasing the principal I have invested in stocks.

Sounds like a good plan.

I'm also increasing my equity exposure (and thus decreasing real estate as a percent of my portfolio, even if not selling any, as it's growing but not as fast as equities that I'm adding to) over time, as I'm quite heavily tilted towards RE at the moment.

RE is the fastest way, IMO, to get to FIRE.  Diversification is the best way, IMO, to stay FIRE'd.
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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Cathy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #33 on: March 19, 2015, 10:27:21 AM »
RE is the fastest way, IMO, to get to FIRE.

The fastest way to get to "FIRE" has to be starting a business (probably an internet service), because that can make you millions of dollars in less than a year, and has done so for many people. An internet business also has startup costs of approximately zero compared to a nonzero house downpayment.

Real estate has the advantage of being more easily repeatable though.
« Last Edit: March 19, 2015, 10:29:58 AM by Cathy »

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #34 on: March 19, 2015, 10:34:45 AM »
RE is the fastest way, IMO, to get to FIRE.

The fastest way to get to "FIRE" has to be starting a business (probably an internet service), because that can make you millions of dollars in less than a year, and has done so for many people. An internet business also has startup costs of approximately zero compared to a nonzero house downpayment.

Real estate has the advantage of being more easily repeatable though.

Okay, well actually the fastest way to FIRE is buying a lottery ticket and having it win.  ;)

Not that running a business is that low probability, but certainly many more people starting a business fail than get rich off of it (especially rich enough in a year to FIRE).

But yes, add the caveat "reliably" to my statement:
RE is the fastest reliable way, IMO, to get to FIRE.

Thanks for the clarification.  :)
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.

waltworks

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #35 on: March 19, 2015, 11:05:50 AM »
A-spy, you and I both bought RE when it was crazy on sale. I did mostly appreciation bets and made a pile, you did cash flow and did even better I'd say - but I think our experience is not the norm, and it certainly won't be going forward, IMO.

RE is awesome if you find great deals and/or get lucky but I would hesitate to make any blanket statements about RE being the fastest FIRE route now, at least in the US.

-W

RE is the fastest way, IMO, to get to FIRE.  Diversification is the best way, IMO, to stay FIRE'd.

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #36 on: March 19, 2015, 12:19:00 PM »
A-spy, you and I both bought RE when it was crazy on sale. I did mostly appreciation bets and made a pile, you did cash flow and did even better I'd say - but I think our experience is not the norm, and it certainly won't be going forward, IMO.

RE is awesome if you find great deals and/or get lucky but I would hesitate to make any blanket statements about RE being the fastest FIRE route now, at least in the US.

We bought at a time when it was easier, but it's not fundamentally different.

Yes, when you could pick nearly any listing off the MLS and make money on it, a monkey could do it.  Now it requires more work and knowledge.  But the path in today's real estate market is the same path, and just as quick.  You just have to have the know-how and put in the time to find the deals that work.  Those deals that work = the fastest path to FIRE, IMO.
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.

Mazzinator

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #37 on: March 19, 2015, 11:36:29 PM »
You guys are all very awesome! Thank you so much for taking the time to explain this to me (and others who are reading)
And Waltworks, thanks for your, umm, honest reply and back of the head slap :)

I've been spending waaay to much time at BP, and they seem to be handing out a free pair of rose colored glasses when you join. Good thing i have you guys to help bring me back to reality, before i made any stupid mistakes..like one guy who drained his entire 401k, at a 20% loss, to "buy more houses!!!" And quit his job in 6 months and become a millionaire!! (But seriously, i think a good bit of folks on there make it seem less risky than stocks)

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

Aaahhhh, got it.

Thanks again!

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #38 on: March 20, 2015, 09:46:27 AM »
I've been spending waaay to much time at BP, and they seem to be handing out a free pair of rose colored glasses when you join. Good thing i have you guys to help bring me back to reality, before i made any stupid mistakes..like one guy who drained his entire 401k, at a 20% loss, to "buy more houses!!!" And quit his job in 6 months and become a millionaire!! (But seriously, i think a good bit of folks on there make it seem less risky than stocks)

(Emphasis added.)

So here's the thing:
1) You have to know who to listen to.  There's a LOT of people over there that flat out don't know what they're talking about, but they'll talk all day, and say it with confidence (because they think they do know).  There's very few people there who I personally listen to when they're talking, and even then, it's specific to a certain area.  J Scott, for example.. I listen to everything he says on rehabbing.  I don't know that he knows what he's talking about when it comes to stocks (just making up this example - I don't recall if he's ever opined much on equities, he might know quite a bit actually), so I wouldn't listen to him there.  Jeff Brown knows a lot about real estate for retirement, but his advice on investing in life insurance (EIULs) is so misguided it makes me a little sad.  And those are the experts that I WOULD listen to on stuff.  98% of the people over there I wouldn't even listen to in any subject, real estate including.  You have to very carefully select who knows what they're talking about.  You can generally get a gauge of this once you learn, and listen.

2) The reason why they say the above bolded sentence I quoted is because they actually believe it.  But the reason why they believe it is because they don't understand stocks.  You can't compare two things if you understand one and not the other.   So most people think real estate is risky.  They, knowing real estate better, know it doesn't have to be if you do it right - you can mitigate a lot of the risk.  So then they go "no, it's not risky! ... but the stock market is!  Therefore the real estate market is less risky than the stock market!"  They don't realize that stocks don't have to be risky if you do it right.  So they compare the two without understanding stocks.  So many of them think stocks are "gambling" - which just shows a basic misunderstanding of what the stock market is, and what investing actually is.

I say this as a big fan of real estate: if you invest in both (correctly) - over a long term, a broad, well diversified portfolio of stocks are inherently less risky than owning rental real estate.  IMO, obviously.  You may not want to listen to me.  ;)
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.

waltworks

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #39 on: March 20, 2015, 10:11:59 AM »
Agreed on biggerpockets. It has gone horribly downhill. 95% terrible advice now.

-W

arebelspy

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Re: Why is it OK to accept a lower return on bonds vs real estate?
« Reply #40 on: March 20, 2015, 10:20:19 AM »
Agreed on biggerpockets. It has gone horribly downhill. 95% terrible advice now.

Probably has to do with all the big talkers getting weeded out in the crash, so the ones left in 2009-2012 knew their stuff... then as real estate got hot again over the last 3 years it got flooded with people who thought they were geniuses.

The decline over the last few years has been quite unfortunate.  Still a few nuggets of wheat sometimes, if you want to weed through the chaff.
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.