The SWR on Real Estate Investments

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What is the SWR of a paid-off Cap Rate 6 Property?

<3%
1
6%
3%
2
13%
4%
6
38%
5%
1
6%
6%
4
25%
>6%
2
13%
 
Total votes: 16

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The SWR on Real Estate Investments

Post by White Coat Investor »

It's generally acknowledged that the SWR on a stock and bond portfolio is somewhere in the range of 4%, although very pessimistic/conservative folks think that might be something slightly lower. Although this forum isn't nearly as big on direct or syndicated real estate investments (preferring instead low cost stock and bond index funds, with a tilt to REITs if more real estate coverage is desired), I would say that one big advantage of non-REIT real estate investing is that you can use a higher withdrawal rate while even decreasing shortfall risk.

Consider an investment property with a cap rate of 6. (Cap rate equals net operating income divided by the value of the property. Net operating income equals gross rents minus expenses). It is not that difficult to find a property with a cap rate of 6, even if you're paying someone else to manage it and putting money regularly into a fund to pay for a new roof, new windows etc. If a cap rate 6 property appreciates at the general rate of inflation, and it carries no mortgage, it should have a return of 8-9%, about what you would expect over the long run from a good stock index fund. The return comes primarily from the net operating income and secondarily from appreciation. While the appreciation may be highly volatile (perhaps just as volatile as that of a stock index fund, even if you don't see it because it isn't marked to market each day), the net operating income isn't anywhere near as volatile. High returns + low volatility = a higher SWR. I see little risk in spending the net operating income of a property like this, while allowing the appreciation of the property and rents with inflation to provide an inflation adjustment, hopefully gradually increasing the net operating income over time.

What do you think? Is the SWR of well-managed investment real estate higher than that of a stock/bond portfolio? If so, wouldn't this argue for including investment real estate in the portfolio, at least during the distribution phase where together with Social Security, Pensions, and SPIAs it could allow someone to have more spending than they otherwise could have from a traditional portfolio?
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Re: The SWR on Real Estate Investments

Post by sport »

I would suggest that you have made a number of assumptions that might not be true. Real estate values are neighborhood dependent. What starts out as a good neighborhood can change, and then values can decrease rather than increase. You may have trouble keeping your property rented. Zero income months will quickly drag down your return. Then there is the problem of having a bad tenant, eviction costs, damaged property etc. So, compared to a passive portfolio of securities, investment property can be a big headache that a retiree does not need to have. Multiply those headaches by the number of tenants you have. Sure, most of them will be fine. However, even a small percentage can cause huge difficulties. Even if it returned more than stocks or bonds, as a retiree, I would have no interest in signing up for that program.
Last edited by sport on Wed Dec 01, 2021 1:54 pm, edited 1 time in total.
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Re: The SWR on Real Estate Investments

Post by randomguy »

EmergDoc wrote:It's generally acknowledged that the SWR on a stock and bond portfolio is somewhere in the range of 4%, although very pessimistic/conservative folks think that might be something slightly lower. Although this forum isn't nearly as big on direct or syndicated real estate investments (preferring instead low cost stock and bond index funds, with a tilt to REITs if more real estate coverage is desired), I would say that one big advantage of non-REIT real estate investing is that you can use a higher withdrawal rate while even decreasing shortfall risk.

Consider an investment property with a cap rate of 6. (Cap rate equals net operating income divided by the value of the property. Net operating income equals gross rents minus expenses). It is not that difficult to find a property with a cap rate of 6, even if you're paying someone else to manage it and putting money regularly into a fund to pay for a new roof, new windows etc. If a cap rate 6 property appreciates at the general rate of inflation, and it carries no mortgage, it should have a return of 8-9%, about what you would expect over the long run from a good stock index fund. The return comes primarily from the net operating income and secondarily from appreciation. While the appreciation may be highly volatile (perhaps just as volatile as that of a stock index fund, even if you don't see it because it isn't marked to market each day), the net operating income isn't anywhere near as volatile. High returns + low volatility = a higher SWR. I see little risk in spending the net operating income of a property like this, while allowing the appreciation of the property and rents with inflation to provide an inflation adjustment, hopefully gradually increasing the net operating income over time.

What do you think? Is the SWR of well-managed investment real estate higher than that of a stock/bond portfolio? If so, wouldn't this argue for including investment real estate in the portfolio, at least during the distribution phase where together with Social Security, Pensions, and SPIAs it could allow someone to have more spending than they otherwise could have from a traditional portfolio?
How did rentals do during the great depression (or pick any other real bad decade for real estate)? The numbers I have seen suggested it was not a very good investment (prices were off over 50%, vacancies were way up. Note these are commercial numbers. I haven't seen rentals.) so I wouldn't be surprised to learn that the SWR rate is about the same 4%. I have to imagine that being leverage to any extent during a period of deflation would be deadly.

In the end real estate is a legit way of investing. It does take a ton more time than just writing vanguard a check a couple times/yr though. That either fits your lifestyle or it doesn't.

And from personal history, rental rates can jump around a heck of a lot. When I started working I paid 900/month for my apartment. 3 years later I was paying 1400. 2 years after that I was paying 1100 and it stayed down for another 3 years (I moved after that). If you bought counting on 1400/month, You were short 20%+/month. Now that was a market that went from tight to absurdly tight to normal.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

I think you are right on EmergDoc.

Commercial rental properties with cap rates near 10% are not impossible to find. I think it depends a lot on your local real estate market. My impression is that In high COL areas those cap rates are more difficult to find. You lose a lot of diversification that you get with mutual funds, and there is a part time job aspect if you want to maximize your returns. And having good renters is crucial. So a not small part of those the potential returns also depend on good fortune.

And as others pointed out, vacancy rates are tied to the local economy and can really hurt realized returns, especially during a big recession. I think a key part is to avoid or minimize leverage so that you can withstand a lengthy downturn.
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Re: The SWR on Real Estate Investments

Post by kksmom »

duplicated
Last edited by kksmom on Tue Oct 14, 2014 10:28 pm, edited 1 time in total.
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Re: The SWR on Real Estate Investments

Post by kksmom »

This is based on our local real estate market/ our niche/strategy ...it may not apply to other areas/markets.

We buy investment residential rental properties based solely on positive cash flow income/cash on cash return, that it would provide. We believe appreciation is realized only when we sell and would depend on a lot of factors that would be beyond our control.... though we do add value to our properties. And appreciation is not something we can forecast long term accurately. Any appreciation realized would be a bonus.
Also besides the income, location plays a role. We dont buy in ghettos/war zones. Our market has both government and private sector employment, and has an ongoing inward migration from other states(both retirees and others)....

Some Cons to direct real estate investment from our perspective
1. Its a business/job.... a residential rental buy n hold landlording is more passive than other forms of real estate (may be not compared to investing in performing notes); but still not as passive as index investing. RE investing is all about buying at the right price- which is often buying below the market value and may be adding value to the property. Others have other strategies including appreciation, which is not our strategy.
2. It is our experience that its not easy to find a real investment deal....most are not real deals. And its difficult finding them on the MLS. Also we realize when we sell our properties its likely that it would be sold to an investor and not a home buyer, so its going to be more likely based on the financial aspects of the deal, than the retail prices that homeowners buy for.
Quite a lot of the country , esp in highly appreciating markets like california etc its practically impossible to find positive cash flow rentals.
3. Liability issues - need strong lease; preferably invest in landlord friendly state; good attorney; good insurance including umbrella/commercial insurance and possibly LLC.
4. Having to deal with people and their issues: Some may say property management- our experience is most PM companies at the level of most individual investors, are self serving/incompetent . To get the real good/competent companies you have to be a big player/part of syndicate usually.
The other part - finding the right contractor/handyman... :annoyed
5. Leverage : A double edged sword... not much of an issue as our leverage is minimal . We realize it reduces our potential returns, but we are ok with that.
EmergDoc wrote:...

What do you think? Is the SWR of well-managed investment real estate higher than that of a stock/bond portfolio? If so, wouldn't this argue for including investment real estate in the portfolio, at least during the distribution phase where together with Social Security, Pensions, and SPIAs it could allow someone to have more spending than they otherwise could have from a traditional portfolio?
Our experience is that RE returns (not REITS) provide us with higher returns than our stock/bond portfolio.... so yes.
If so why do we invest in the stock market - for diversification..
RE forms a different class in our portfolio , besides stock market. We dont hold REITS except what vanguard may hold in the TSM fund.
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

sport wrote:I would suggest that you have made a number of assumptions that might not be true. Real estate values are neighborhood dependent. What starts out as a good neighborhood can change, and then values can decrease rather than increase. You may have trouble keeping your property rented. Zero income months will quickly drag down your return. Then there is the problem of having a bad tenant, eviction costs, damaged property etc. So, compared to a passive portfolio of securities, investment property can be a big headache that a retiree does not need to have. Multiply those headaches by the number of tenants you have. Sure, most of them will be fine. However, even a small percentage can cause huge difficulties. Even if it returned more than stocks or bonds, as a retiree, I would have no interest in signing up for that program.
I agree there are headaches. But the net operating income takes into account vacancies, eviction costs, damaged property, bad tenants etc. After all that, it's a cap rate 6 property. How much of its return can you safely spend each year?
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Re: The SWR on Real Estate Investments

Post by denovo »

EmergDoc wrote:
sport wrote:I would suggest that you have made a number of assumptions that might not be true. Real estate values are neighborhood dependent. What starts out as a good neighborhood can change, and then values can decrease rather than increase. You may have trouble keeping your property rented. Zero income months will quickly drag down your return. Then there is the problem of having a bad tenant, eviction costs, damaged property etc. So, compared to a passive portfolio of securities, investment property can be a big headache that a retiree does not need to have. Multiply those headaches by the number of tenants you have. Sure, most of them will be fine. However, even a small percentage can cause huge difficulties. Even if it returned more than stocks or bonds, as a retiree, I would have no interest in signing up for that program
I agree there are headaches. But the net operating income takes into account vacancies, eviction costs, damaged property, bad tenants etc. After all that, it's a cap rate 6 property. How much of its return can you safely spend each year?

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

denovo wrote:

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
I'm using the rent money + cash reserves, (also taken into account when calculating the cap rate). If you don't think 6 percent is safe, what do you think is?
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Re: The SWR on Real Estate Investments

Post by denovo »

EmergDoc wrote:
denovo wrote:

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
I'm using the rent money + cash reserves, (also taken into account when calculating the cap rate). If you don't think 6 percent is safe, what do you think is?

How can you use the rent money? If you are withdrawing the 6 percent there's no rent money left by definition , you can't use it it to pay for major big -ticket expenses. Likewise, if you want cash reverses; it has to come out of a reduced withdrawal rate.

If you ask me I'd say a good rule of thumb is somewhere around 1 percent of the value of the building goes to maintenance for big ticket items annually. So deduct that to get from your cap rate to get SWR. I think you won't be getting a cap rate of 6 percent in most places, but that's a discussion for another thread.
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

denovo wrote:
EmergDoc wrote:
denovo wrote:

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
I'm using the rent money + cash reserves, (also taken into account when calculating the cap rate). If you don't think 6 percent is safe, what do you think is?

How can you use the rent money? If you are withdrawing the 6 percent there's no rent money left by definition , you can't use it it to pay for major big -ticket expenses. Likewise, if you want cash reverses; it has to come out of a reduced withdrawal rate.

If you ask me I'd say a good rule of thumb is somewhere around 1 percent of the value of the building goes to maintenance for big ticket items annually. So deduct that to get from your cap rate to get SWR. I think you won't be getting a cap rate of 6 percent in most places, but that's a discussion for another thread.
Let me break it down. Let's say this particular property is worth $200K (this is all hypothetical.) It is composed of two units which rent for $909 a piece, so total gross rent for twelve months is $21,818. 45% of that rent goes to pay expenses like vacancies, maintenance, management, and big ticket items (and if there are none, into the cash reserves). 55% becomes net operating income. 55% of $21,818 is $12,000. $12,000/200,000 = 6% cap rate. So every year, AFTER ALL EXPENSES INCLUDING EVERY OTHER EXPENSE YOU CAN THINK OF BUT HAVEN'T YET NAMED IN THIS THREAD, you get $12,000 in net operating income. How much of it can you safely spend? Is not the SWR the net operating income?
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Re: The SWR on Real Estate Investments

Post by denovo »

EmergDoc wrote:
denovo wrote:
EmergDoc wrote:
denovo wrote:

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
I'm using the rent money + cash reserves, (also taken into account when calculating the cap rate). If you don't think 6 percent is safe, what do you think is?

How can you use the rent money? If you are withdrawing the 6 percent there's no rent money left by definition , you can't use it it to pay for major big -ticket expenses. Likewise, if you want cash reverses; it has to come out of a reduced withdrawal rate.

If you ask me I'd say a good rule of thumb is somewhere around 1 percent of the value of the building goes to maintenance for big ticket items annually. So deduct that to get from your cap rate to get SWR. I think you won't be getting a cap rate of 6 percent in most places, but that's a discussion for another thread.
Let me break it down. Let's say this particular property is worth $200K (this is all hypothetical.) It is composed of two units which rent for $909 a piece, so total gross rent for twelve months is $21,818. 45% of that rent goes to pay expenses like vacancies, maintenance, management, and big ticket items (and if there are none, into the cash reserves). 55% becomes net operating income. 55% of $21,818 is $12,000. $12,000/200,000 = 6% cap rate. So every year, AFTER ALL EXPENSES INCLUDING EVERY OTHER EXPENSE YOU CAN THINK OF BUT HAVEN'T YET NAMED IN THIS THREAD, you get $12,000 in net operating income. How much of it can you safely spend? Is not the SWR the net operating income?
Right in that case , 6 percent is safe.
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

denovo wrote:
EmergDoc wrote:
denovo wrote:
EmergDoc wrote:
denovo wrote:

Even if you're taking into account these things , 6 percent is still not safe in the long-term. How you are paying for repairs, roofs, plumbing , etc?
I'm using the rent money + cash reserves, (also taken into account when calculating the cap rate). If you don't think 6 percent is safe, what do you think is?

How can you use the rent money? If you are withdrawing the 6 percent there's no rent money left by definition , you can't use it it to pay for major big -ticket expenses. Likewise, if you want cash reverses; it has to come out of a reduced withdrawal rate.

If you ask me I'd say a good rule of thumb is somewhere around 1 percent of the value of the building goes to maintenance for big ticket items annually. So deduct that to get from your cap rate to get SWR. I think you won't be getting a cap rate of 6 percent in most places, but that's a discussion for another thread.
Let me break it down. Let's say this particular property is worth $200K (this is all hypothetical.) It is composed of two units which rent for $909 a piece, so total gross rent for twelve months is $21,818. 45% of that rent goes to pay expenses like vacancies, maintenance, management, and big ticket items (and if there are none, into the cash reserves). 55% becomes net operating income. 55% of $21,818 is $12,000. $12,000/200,000 = 6% cap rate. So every year, AFTER ALL EXPENSES INCLUDING EVERY OTHER EXPENSE YOU CAN THINK OF BUT HAVEN'T YET NAMED IN THIS THREAD, you get $12,000 in net operating income. How much of it can you safely spend? Is not the SWR the net operating income?
Right in that case , 6 percent is safe.
So, I guess the question then becomes, just how much you have to budget toward the cash reserve/big ticket items. I suppose that comes down to your skill in property selection, management, maintenance etc.

But at any rate, if you can only get 4% out of your stock/bond funds, and you can get 6% out of a rental property, it seems a rather large advantage to have some real estate in the portfolio to me. That could be the difference between working extra years, having more money to spend in retirement etc. It's a big deal I think, especially with the forecasted low returns in stocks, the low yields in bonds, and the fact that cap rate 6 properties are still relatively common in many areas of the country. It's not like you have to find a cap rate 10 property. In my area, you have to look a little for a 6, but they're there. You can pick up 4s and 5s off the MLS.
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Re: The SWR on Real Estate Investments

Post by market timer »

EmergDoc wrote:Let me break it down. Let's say this particular property is worth $200K (this is all hypothetical.) It is composed of two units which rent for $909 a piece, so total gross rent for twelve months is $21,818. 45% of that rent goes to pay expenses like vacancies, maintenance, management, and big ticket items (and if there are none, into the cash reserves). 55% becomes net operating income. 55% of $21,818 is $12,000. $12,000/200,000 = 6% cap rate. So every year, AFTER ALL EXPENSES INCLUDING EVERY OTHER EXPENSE YOU CAN THINK OF BUT HAVEN'T YET NAMED IN THIS THREAD, you get $12,000 in net operating income. How much of it can you safely spend? Is not the SWR the net operating income?
If net operating income grows at the same rate as inflation, you can spend the initial 6% in perpetuity. If you might not last that long, you can actually dip into the principal, either by borrowing against the property or selling properties. I think this is a fine strategy to boost your withdrawal rate above 4%. Of course, some might not want the hassle of managing properties.
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Re: The SWR on Real Estate Investments

Post by denovo »

EmergDoc wrote:
So, I guess the question then becomes, just how much you have to budget toward the cash reserve/big ticket items. I suppose that comes down to your skill in property selection, management, maintenance etc.

But at any rate, if you can only get 4% out of your stock/bond funds, and you can get 6% out of a rental property, it seems a rather large advantage to have some real estate in the portfolio to me. That could be the difference between working extra years, having more money to spend in retirement etc. It's a big deal I think, especially with the forecasted low returns in stocks, the low yields in bonds, and the fact that cap rate 6 properties are still relatively common in many areas of the country. It's not like you have to find a cap rate 10 property. In my area, you have to look a little for a 6, but they're there. You can pick up 4s and 5s off the MLS.
Doc, , if we want to have a talk about including real estate in the portfolio, let's talk total return not swr. Then, we have a two part discussion. A. Should real estate be part of the portfolio? B. Should it be included in REIT; or securitized form or direct investment.


On a total return basis, REIT's and The US Stock Market have performed the same in the last ten years; approximately 8 percent a year. Therefore; I think it's alright to include real estate as part of equity allocation and there's probably some diversification benefit to it. However, I am skeptical that a direct real estate can constantly exceed the total return of the stock market unless we're not properly accounting for leverage; cost of management that we are doing ourselves; any accumulated benefit from outsized risk; such as putting all your real estate holdings in Denver commercial property hoping the Rocky Mountain Region has better prospects than the country at large.
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Re: The SWR on Real Estate Investments

Post by randomguy »

market timer wrote: If net operating income grows at the same rate as inflation, you can spend the initial 6% in perpetuity. If you might not last that long, you can actually dip into the principal, either by borrowing against the property or selling properties. I think this is a fine strategy to boost your withdrawal rate above 4%. Of course, some might not want the hassle of managing properties.
Isn't the question more is that first assumption right? Is there a 95%+ chance of it happening over the next 30 years or do you need to save money from the good years to compensate for the bad ones and what does that do to your total return. It strikes me as similar to the old school SWR math of stocks return 10%, inflation is 3% so you can spend 7%. The volatility in real estate rents tends to be less than stocks but I have a feeling the bad cases (can't find a tenant for your commercial property for 3 years, 40k jobs leave your area when a big employer leaves, tenant running meth lab) are just as bad and they will be the limiting factor.
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Re: The SWR on Real Estate Investments

Post by Rodc »

Consider an investment property with a cap rate of 6.
I don't know what a cap rate is, but is this like starting by saying "pick a stock that is above average"?

Or assuming that a stock with a higher than average dividend (and growth) will always have a higher than average dividend (and growth)?

PS: I read the definition above. Still have the questions.
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Re: The SWR on Real Estate Investments

Post by patriciamgr2 »

I think the fallacy in SWR thinking is that, once in a while, those maintenance/vacancy expenses refuse to limit themselves to your reserves, so that you are required to infuse cash. In my case, after many years of properties which (due to proactive, preventive maintenance & excellent tenants), never used up reserves, I had my "rental from hell". Ghastly people moved in across the street which made it impossible to rent the house; the A/C needed a complete replacement; & landscaping & underground sprinklers in the neighborhood were vandalized. There were legal expenses. My situation was extreme & very rare. Note that because it was tenants across the street, there's nothing I could have done to prevent them moving in to the neighborhood. [Newbie real estate investors always believe they can control any negative outcomes. I no longer believe that.] Also note that problems with residential properties are often correlated; you lose rental income just when your expenses increase.

These situations are rare, but not unprecedented. I've seen friends' properties need a roof replaced earlier than they had estimated, or have non-paying tenants "work" the system to get many months of free rent during which they are damaging the property & during which the owner needed to pay utilities to safeguard the property's value. Those situations may occur early in your ownership of a particular property when you haven't built up property-specific reserves.

If your hypothetical investor (1) has cash reserves elsewhere in portfolio dedicated to unexpected expenses in excess of his reserve for a particular rental; and (2) is willing to tolerate a dramatically lower withdrawal rate in the event of a rare negative experience, then spending the after-tax income (net of expenses & reserves) from a property seems ok. Obviously, the more properties you have & the longer you have been building reserves, the less likely you are to need to adjust your spending when the unexpected occurs. Ratcheting the SWR down a percentage or two won't cover the type of situation I'm envisioning unless you have a number of properties over which to spread the risk. It's more of a Variable Withdrawal, with the possibility of a cash call.
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Re: The SWR on Real Estate Investments

Post by patriciamgr2 »

Notwithstanding the above, I am in favor of a diversified real estate portfolio being part of a person's retirement portfolio IF they are handy, or have access to reliable handyman services.
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Re: The SWR on Real Estate Investments

Post by avalpert »

EmergDoc wrote: But at any rate, if you can only get 4% out of your stock/bond funds, and you can get 6% out of a rental property, it seems a rather large advantage to have some real estate in the portfolio to me.
Wait a second, I can get 4% out of stocks/bonds based on simulations using past data - and you can get 6% out of a hypothetical rental property you made up with no assumptions about volatility in rents/value/costs etc. Does that seem like a starting point for a real discussion?
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Re: The SWR on Real Estate Investments

Post by SDBoggled »

Agreed that withdrawal rate of a 6 CAP rate property as calculated by OP should be 6% (after sufficient reserves are established).

This is why I like rental real estate, however just a warning, I have never seen advertised CAP rates calculated to include reserves. Furthermore, CAP rates can be misleading if based on lower valued property --> e.g. roof or vacancy can wipe out many many months of cashflow.

It is certainly related to what I am willing to buy, but the major proportion of my rentals have CAP < 6% :(
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Re: The SWR on Real Estate Investments

Post by 4nursebee »

I do not understand CAP rate.
How much of a 12K profit can you spend? All of it if you have reserve to handle emergencies. Are you a doctor with money in the bank? Spend it, pay down debt, do as you wish according to your investment plans.

Cap rate is income divided by cost (or value)
12/200= 6% cap rate.

I'd rather carry a bank note at 6% for a 150K mortgage. For my simple example, I assume mortgage to be $900, two months rent extra for taxes and insurage, leaving 10 months rent on one property as income.
Cap rate= (900x10)/50K=18%. 9K profit for the year.

Buy 3 more properties with the extra 150K and increase profit from 12K with 6% cap rate
to 36K and 18% cap rates. No extra outlay.

I try to keep 5K on hand for unexpected stuff.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

Here is a real data point for discussion...

Property purchased in 1997 for approximately $150k.
Financed with 15-year at 8% - $17.2k annual payment.
Other first year expenses : maintenance/repair - $5k, taxes - $3k, insurance - $2k
Gross 1st year rent (ballpark guess) - $28k
First year profit - essentially zero

Here are the numbers in 2014
Mortgage paid off in 2012 and was refinanced to a lower rate in 2002.
Assessed value - $500k
Expenses: taxes - $7k, maintenance/repair - $8k, insurance - $4k
Gross rents - $90k
Annual Profit today - $71k

I have not done a detailed breakdown on the overall return, but on the face of it things look good. I think as long as a reasonable emergency fund is available, there is no reason not to spend something close to the annual profit of $71k. We are talking about a $500k asset generating $70k in annual income... with a 4% SWR of stocks/bonds that would require saving $1.75 million to get equivalent spending levels. All that said lack of diversification is a very real risk in this example.

Additional info... this property had a very stable primary renter during this time, and there is the additional option today of putting another $250-400k into the property and doubling the rentable space and gross rental income.

Edit: I did some quick spreadsheet calcs based on an initial investment of $150k, and the positive cash flow over time with the appreciation added at the end. It's in the 11.5% annualized return range. That is assuming basically zero positive cash flow the first five years.
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Re: The SWR on Real Estate Investments

Post by avalpert »

3CT_Paddler wrote:Here is a real data point for discussion...

Property purchased in 1997 for approximately $150k.
Financed with 15-year at 8% - $17.2k annual payment.
Other first year expenses : maintenance/repair - $5k, taxes - $3k, insurance - $2k
Gross 1st year rent (ballpark guess) - $28k
First year profit - essentially zero

Here are the numbers in 2014
Mortgage paid off in 2012 and was refinanced to a lower rate in 2002.
Assessed value - $500k
Expenses: taxes - $7k, maintenance/repair - $8k, insurance - $4k
Gross rents - $90k
Annual Profit today - $71k

I have not done a detailed breakdown on the overall return, but on the face of it things look good. I think as long as a reasonable emergency fund is available, there is no reason not to spend something close to the annual profit of $71k. We are talking about a $500k asset generating $70k in annual income... with a 4% SWR of stocks/bonds that would require saving $1.75 million to get equivalent spending levels. All that said lack of diversification is a very real risk in this example.

Additional info... this property had a very stable primary renter during this time, and there is the additional option today of putting another $250-400k into the property and doubling the rentable space and gross rental income.

Edit: I did some quick spreadsheet calcs based on an initial investment of $150k, and the positive cash flow over time with the appreciation added at the end. It's in the 11.5% annualized return range. That is assuming basically zero positive cash flow the first five years.
Wow, for $7,500 a month rent I would be living in a house worth a lot more than $500k.
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

I agree that using an advertised cap rate is foolish. I've found the 55% rule is usually more useful. So someone might be advertising a cap rate 8 property, and I calculate it as a 5.

I also agree there is a risk that your calculations are wrong. For example, if you've calculated in $4K a year toward "major expenses" like roof, windows, massive vacancy etc, and you blow through your entire reserve plus $10K one year, well, that money's got to come from somewhere. It's also possible that rents can fall if every industry in town moves out or something. That's the risk you get from the lack of diversification.

So, if you can't take 6% because of that risk, how much can you take? Is it 4% like a stock/bond portfolio, or somewhere in between the net operating income and the 4% rule?

The issue with REITs is that they're just as, if not more, volatile as the overall stock market. So even with an equivalent return, the SWR from them should be the same, or perhaps even lower, than a standard SWR a la the Trinity Study. I'm interested in real estate not only for some diversification from the stock market, but also because of this potential for a higher SWR. As the poster above mentioned, $71K of profit from a $500K portfolio is very attractive. Heck, $25K of reliable inflation-adjusted income from $500K is very attractive these days.

And as far as management hassles, you obviously never get completely away from them, but you can decrease them dramatically by paying a manager, you just have to account for that expense when calculating out your net operating income.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

avalpert wrote: Wow, for $7,500 a month rent I would be living in a house worth a lot more than $500k.
It's a commercial property... and the estimate is based on the county's appraisal (which is very likely on the low side).

My hunch is that commercial property cap rates tend to be much more favorable versus residential real estate. There is probably more risk, because businesses go under all the time and stop paying rent.
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Re: The SWR on Real Estate Investments

Post by avalpert »

EmergDoc wrote: So, if you can't take 6% because of that risk, how much can you take? Is it 4% like a stock/bond portfolio, or somewhere in between the net operating income and the 4% rule?
To figure that I think you would need to look at actual experienced volatilities in real estate returns - basically do the trinity study for rental real estate, and account for whatever level of diversification you have in your real estate portfolio. My hunch is, for a well diversified set of real estate holdings the SWR will be similar to the stock/bond portfolio and for an individual who holds a small number of properties (particularly ones that are in similar geographies which tends to be the case for individuals) the SWR will be lower than that (possibly by quite a bit).
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Re: The SWR on Real Estate Investments

Post by randomguy »

3CT_Paddler wrote:Here is a real data point for discussion...

Property purchased in 1997 for approximately $150k.
Financed with 15-year at 8% - $17.2k annual payment.
Other first year expenses : maintenance/repair - $5k, taxes - $3k, insurance - $2k
Gross 1st year rent (ballpark guess) - $28k
First year profit - essentially zero

Here are the numbers in 2014
Mortgage paid off in 2012 and was refinanced to a lower rate in 2002.
Assessed value - $500k
Expenses: taxes - $7k, maintenance/repair - $8k, insurance - $4k
Gross rents - $90k
Annual Profit today - $71k

I have not done a detailed breakdown on the overall return, but on the face of it things look good. I think as long as a reasonable emergency fund is available, there is no reason not to spend something close to the annual profit of $71k. We are talking about a $500k asset generating $70k in annual income... with a 4% SWR of stocks/bonds that would require saving $1.75 million to get equivalent spending levels. All that said lack of diversification is a very real risk in this example.

Additional info... this property had a very stable primary renter during this time, and there is the additional option today of putting another $250-400k into the property and doubling the rentable space and gross rental income.
Or you could have bought apple stock in Jan 1, 1997 at .60 and now have something like 23 million dollars now which will generate a lot more than 70k of annual income:) Problem is that real estate doesn't triple in value in 17 years very often. If it did everyone would be a real estate investor. Or if 14% CAP rate properties that never went vacant were on every corner. Getting both of them makes RE look like a no brainer. In the common case of appreciation at inflation+1% and rental increases at about the same rate, the returns still looks good but they are not clearly better than stocks from a return point of view.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

EmergDoc wrote: For example, if you've calculated in $4K a year toward "major expenses" like roof, windows, massive vacancy etc, and you blow through your entire reserve plus $10K one year, well, that money's got to come from somewhere.
It's a good point. In the example I gave, 2 years ago there was a $40k 1 time roof expense. Flat roofs on large commercial buildings are no joke to fix. Most years (in my example) the costs are closer to $3k for maintenance and upkeep.

My example may be unusual or good fortune, but it is a legitimate example. And I would say the purchase at the time was not seen as some awesome steal... there were other deals like it at the time. The property was purchased at auction when the trophy shop that owned it went under. The primary owner used most of the space for his own business, so there was the benefit of knowing you would make your payments (to yourself).

I think part of the reason this commercial property has done well is that it is not a glamorous area or building, but it is a short drive to very nice areas and people and businesses want to be close to these areas. There is always the risk of oversupply too. If others decide to increase the supply of similar buildings, it will put pressure on what you can charge for rent. Cut the numbers by 25% and lose a couple renters and all the sudden things don't look so golden. It's a real risk you are taking. But the type of building I described would require a bigger chunk than a small duplex... making it more difficult to stay diversified with stocks and bonds in the rest of your portfolio.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

randomguy wrote: Or you could have bought apple stock in Jan 1, 1997 at .60 and now have something like 23 million dollars now which will generate a lot more than 70k of annual income:) Problem is that real estate doesn't triple in value in 17 years very often. If it did everyone would be a real estate investor. Or if 14% CAP rate properties that never went vacant were on every corner. Getting both of them makes RE look like a no brainer. In the common case of appreciation at inflation+1% and rental increases at about the same rate, the returns still looks good but they are not clearly better than stocks from a return point of view.
I gave a single real world data point for commercial rental real estate... nothing more, nothing less (and it was not a cherry picked example). Like I said, these kind of price vs rent deals in certain corners of the commercial real estate market are not an aberration. In the example I gave, I think it was and will continue to be a better investment than $150k in the S&P 500 in 1997 (about 9.5% annualized). There are certainly downfalls and potential risks that you don't have with the S&P 500... I am not saying its not there. And there is an active management/part time job aspect to it.

And in my example, the primary source of returns is rents... which are relatively stable. You are not speculating in penny stocks hoping for big jumps in appreciation... that is speculating. Putting all of your money in a single company stock is speculating.

Public stock markets are not the end all be all for investment options.
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Re: The SWR on Real Estate Investments

Post by avalpert »

3CT_Paddler wrote:Putting all of your money in a single company stock is speculating.
Is putting all your money in a single property not speculating?
Public stock markets are not the end all be all for investment options.
That is certainly true - they just happen to be one of the most accessible ways to get broad diversified holdings for most people.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

avalpert wrote:
3CT_Paddler wrote:Putting all of your money in a single company stock is speculating.
Is putting all your money in a single property not speculating?
You ever buy a house? Especially your first one?

Buying any property CAN be speculation. If you are investing in a property based on likely rents then it is definitely not speculation. Let's say you run a business and your option is to spend $15k/annually on rent or purchase a property that you can be cash flow neutral on day 1 with a similar rental cost for your rented portion of the property... what do you do?
Public stock markets are not the end all be all for investment options.
That is certainly true - they just happen to be one of the most accessible ways to get broad diversified holdings for most people.
We are in agreement on this.
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Re: The SWR on Real Estate Investments

Post by avalpert »

3CT_Paddler wrote:
avalpert wrote:
3CT_Paddler wrote:Putting all of your money in a single company stock is speculating.
Is putting all your money in a single property not speculating?
You ever buy a house? Especially your first one?
I did, and as an investment it was absolutely speculation.
Buying any property CAN be speculation. If you are investing in a property based on likely rents then it is definitely not speculation.
How is that definitely not speculation in a way different from investing in a company based on likely earnings is definitely not speculation?
Let's say you run a business and your option is to spend $15k/annually on rent or purchase a property that you can be cash flow neutral on day 1 with a similar rental cost for your rented portion of the property... what do you do?
Are you suggesting all rent/buy decisions lean in one direction? How can I make that decision without at least knowing my expected return on other uses of the capital I could be investing in my business?
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

avalpert wrote:
EmergDoc wrote: So, if you can't take 6% because of that risk, how much can you take? Is it 4% like a stock/bond portfolio, or somewhere in between the net operating income and the 4% rule?
To figure that I think you would need to look at actual experienced volatilities in real estate returns - basically do the trinity study for rental real estate, and account for whatever level of diversification you have in your real estate portfolio. My hunch is, for a well diversified set of real estate holdings the SWR will be similar to the stock/bond portfolio and for an individual who holds a small number of properties (particularly ones that are in similar geographies which tends to be the case for individuals) the SWR will be lower than that (possibly by quite a bit).
Even if there were a Trinity Study for real estate, it wouldn't be nearly as valid as the real estate market is nowhere near as efficient as the stock market. It sure would be a fun study to see though.
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Re: The SWR on Real Estate Investments

Post by avalpert »

EmergDoc wrote:
avalpert wrote:
EmergDoc wrote: So, if you can't take 6% because of that risk, how much can you take? Is it 4% like a stock/bond portfolio, or somewhere in between the net operating income and the 4% rule?
To figure that I think you would need to look at actual experienced volatilities in real estate returns - basically do the trinity study for rental real estate, and account for whatever level of diversification you have in your real estate portfolio. My hunch is, for a well diversified set of real estate holdings the SWR will be similar to the stock/bond portfolio and for an individual who holds a small number of properties (particularly ones that are in similar geographies which tends to be the case for individuals) the SWR will be lower than that (possibly by quite a bit).
Even if there were a Trinity Study for real estate, it wouldn't be nearly as valid as the real estate market is nowhere near as efficient as the stock market. It sure would be a fun study to see though.
Is market efficiency necessary for the study to be valid? Shouldn't the impact of the market inefficiencies show up in the data used by the study? Reliable data availability may be a big challenge.
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Re: The SWR on Real Estate Investments

Post by White Coat Investor »

avalpert wrote: Is market efficiency necessary for the study to be valid? Shouldn't the impact of the market inefficiencies show up in the data used by the study? Reliable data availability may be a big challenge.
The issue is if you are particularly skillful at buying and managing real estate, you can add real value and vice versa. That's extremely difficult to do in the public stock market. A trinity study would only give you average results, where I think your results are much more likely to be either much higher or much lower in real estate than in stocks. The bell curve is wider if you will.
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Re: The SWR on Real Estate Investments

Post by denovo »

EmergDoc wrote:
avalpert wrote: Is market efficiency necessary for the study to be valid? Shouldn't the impact of the market inefficiencies show up in the data used by the study? Reliable data availability may be a big challenge.
The issue is if you are particularly skillful at buying and managing real estate, you can add real value and vice versa. That's extremely difficult to do in the public stock market. A trinity study would only give you average results, where I think your results are much more likely to be either much higher or much lower in real estate than in stocks. The bell curve is wider if you will.
Oh no; not the Lake Wobegon argument for real estate investing.
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Re: The SWR on Real Estate Investments

Post by 3CT_Paddler »

avalpert wrote:
3CT_Paddler wrote:
avalpert wrote:
3CT_Paddler wrote:Putting all of your money in a single company stock is speculating.
Is putting all your money in a single property not speculating?
You ever buy a house? Especially your first one?
I did, and as an investment it was absolutely speculation.
So anyone and everyone who buys a house that they plan on living in for the long term is speculating? I am not saying buying a house for residence is an investment, but I think its a stretch to call it speculating unless you are buying something you can't afford expecting it to significantly increase in value.
Buying any property CAN be speculation. If you are investing in a property based on likely rents then it is definitely not speculation.
How is that definitely not speculation in a way different from investing in a company based on likely earnings is definitely not speculation?
It's pretty simple really... company earnings as a whole are much more volatile than rents. In the same way, but to a lesser extent, corporate bond payments are much more steady than corporate earnings.
Let's say you run a business and your option is to spend $15k/annually on rent or purchase a property that you can be cash flow neutral on day 1 with a similar rental cost for your rented portion of the property... what do you do?
Are you suggesting all rent/buy decisions lean in one direction? How can I make that decision without at least knowing my expected return on other uses of the capital I could be investing in my business?
No offense, but you are making this much more complicated than it needs to be. As a company you are going to pay for a place to house your business. That is an expense whether you buy a place and have a mortgage or rent.

I shared a real world example to hopefully help others, not to get in silly arguments on terminology.

Good day to you.
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Re: The SWR on Real Estate Investments

Post by denovo »

I think 3ct's numbers are a good baseline to work with; my comments shortly.
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Re: The SWR on Real Estate Investments

Post by avalpert »

3CT_Paddler wrote:
avalpert wrote:
3CT_Paddler wrote:
avalpert wrote:
3CT_Paddler wrote:Putting all of your money in a single company stock is speculating.
Is putting all your money in a single property not speculating?
You ever buy a house? Especially your first one?
I did, and as an investment it was absolutely speculation.
So anyone and everyone who buys a house that they plan on living in for the long term is speculating? I am not saying buying a house for residence is an investment, but I think its a stretch to call it speculating unless you are buying something you can't afford expecting it to significantly increase in value.
Well, there is speculation inherent in it as an investment - now to the extent they choose to ignore the financial investment they can ignore that speculation.
Buying any property CAN be speculation. If you are investing in a property based on likely rents then it is definitely not speculation.
How is that definitely not speculation in a way different from investing in a company based on likely earnings is definitely not speculation?
It's pretty simple really... company earnings as a whole are much more volatile than rents. In the same way, but to a lesser extent, corporate bond payments are much more steady than corporate earnings.
So if I was investing in the earnings of a company in a less volatile part of the economy (say utilities) then it wouldn't be speculation? Are individual company earnings really more volatile than individual rental streams - have you seen data to support that?
Let's say you run a business and your option is to spend $15k/annually on rent or purchase a property that you can be cash flow neutral on day 1 with a similar rental cost for your rented portion of the property... what do you do?
Are you suggesting all rent/buy decisions lean in one direction? How can I make that decision without at least knowing my expected return on other uses of the capital I could be investing in my business?
No offense, but you are making this much more complicated than it needs to be. As a company you are going to pay for a place to house your business. That is an expense whether you buy a place and have a mortgage or rent.
No offense but you aren't evaluating it the way any competently run business would. If I put $200k into capital investment for office space instead of say investing it in my sales staff, R&D or new machinery I'm not just interested in cash-flow neutral real estate I'm interested in the return on invested capital relative to the alternatives.
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Re: The SWR on Real Estate Investments

Post by avalpert »

EmergDoc wrote:
avalpert wrote: Is market efficiency necessary for the study to be valid? Shouldn't the impact of the market inefficiencies show up in the data used by the study? Reliable data availability may be a big challenge.
The issue is if you are particularly skillful at buying and managing real estate, you can add real value and vice versa. That's extremely difficult to do in the public stock market. A trinity study would only give you average results, where I think your results are much more likely to be either much higher or much lower in real estate than in stocks. The bell curve is wider if you will.
Hmm, well that is something more than market inefficiency - and I'm sure I can find you people who have done quite well asserting the same thing for stocks.

I would imagine one can look at the dispersion of investment returns for those in real estate and compare it to the dispersion among stock investors to test the hypothesis.
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Re: The SWR on Real Estate Investments

Post by Lysander »

If Robert Shiller is to be believed, and I think his data are solid, real estate appreciates at the rate of inflation. So for the term of the mortgage you are losing money on your down payment. Imputed rents cover this carrying cost in a typical region. So for a paid-off property, the value of the property acts as an inflation hedge while the imputed rent is a real return that tracks wages in your area. In the long term wages also track inflation, so a paid-off property gets a real rate of return equal to the inflation rate. This is roughly equal to the rate of return of stocks. So for a real estate holding to have a SWR equal to that of stocks, you would have to hold it for twice the term of the mortgage.

Real estate as a venture is more profitable than real estate as an investment, because few people who take out 30 year mortgages are likely to hold their properties for 60 years. The money is in development, not being a landlord.
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Re: The SWR on Real Estate Investments

Post by randomguy »

3CT_Paddler wrote:
randomguy wrote: Or you could have bought apple stock in Jan 1, 1997 at .60 and now have something like 23 million dollars now which will generate a lot more than 70k of annual income:) Problem is that real estate doesn't triple in value in 17 years very often. If it did everyone would be a real estate investor. Or if 14% CAP rate properties that never went vacant were on every corner. Getting both of them makes RE look like a no brainer. In the common case of appreciation at inflation+1% and rental increases at about the same rate, the returns still looks good but they are not clearly better than stocks from a return point of view.
I gave a single real world data point for commercial rental real estate... nothing more, nothing less (and it was not a cherry picked example). Like I said, these kind of price vs rent deals in certain corners of the commercial real estate market are not an aberration. In the example I gave, I think it was and will continue to be a better investment than $150k in the S&P 500 in 1997 (about 9.5% annualized). There are certainly downfalls and potential risks that you don't have with the S&P 500... I am not saying its not there. And there is an active management/part time job aspect to it.

And in my example, the primary source of returns is rents... which are relatively stable. You are not speculating in penny stocks hoping for big jumps in appreciation... that is speculating. Putting all of your money in a single company stock is speculating.

Public stock markets are not the end all be all for investment options.
The point is sample sizes of 1 are not valuable. The fact that my first stock I picked in 1996 was a 10 bagger doesn't mean I wasn't incredibly lucky. At the time I would have told you I did my due diligence:) Individual properties are like picking individual stocks. You will great returns, some ok, some poor, and some horrible ones. Your story if the tenant would have closed his business and you spend 3 years trying to find a new one, would be a bit different. Figuring out what that average is almost impossible and given the value you bring, maybe not very useful.
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Re: The SWR on Real Estate Investments

Post by bottomfeeder »

Can anyone provide general guidance on tax implications of brick and mortar real estate investments vs taxable stock/bond index investments, assuming 401K etc maxed out yearly? I ask because my accountant told me today I need another property...

Any book recommendations on the general topic of real estate investing?

thanks in advance
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Re: The SWR on Real Estate Investments

Post by Lysander »

bottomfeeder wrote:Can anyone provide general guidance on tax implications of brick and mortar real estate investments vs taxable stock/bond index investments, assuming 401K etc maxed out yearly? I ask because my accountant told me today I need another property...

Any book recommendations on the general topic of real estate investing?

thanks in advance
One advantage of real estate (if you have beneficiaries) is that your beneficiaries can legally live in your property rent-free, which is a massive gift that is untaxed.
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Re: The SWR on Real Estate Investments

Post by Rodc »

In the long term wages also track inflation, so a paid-off property gets a real rate of return equal to the inflation rate. This is roughly equal to the rate of return of stocks.
The long term real rate of return for stocks is roughly 0%?
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Re: The SWR on Real Estate Investments

Post by Lysander »

Rodc wrote:
In the long term wages also track inflation, so a paid-off property gets a real rate of return equal to the inflation rate. This is roughly equal to the rate of return of stocks.
The long term real rate of return for stocks is roughly 0%?
I should clarify: a paid-off property gets a real rate of return equal to the nominal inflation rate. This is roughly equal to the real rate of return of stocks.
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Another important consideration - Real Estate Investments

Post by Hiker-Biker »

Whether RE is leveraged or paid off, it is beneficial to own some investment properties to potentially lower one's tax rate in the distribution phase. The schedule E write offs include passive losses of up to 25k/year for actively managed properties. If you obtain a real estate license and put in the required 750 hrs the IRS stipulates, you can write off all expenses related to your real estate portfolio.

This is important when you when you consider RMDs. We have already accumulated passive losses which we are carrying forward until we sell our properties. When our AGI decreases, we can use these losses. We use a property manager - one that is competent and trustworthy. After all, the management fee is just another deductible expense.
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Re: The SWR on Real Estate Investments

Post by 4nursebee »

Using SWR in relation to this real estate example strikes me as a misuse of term. Spending profits does not diminish the value of the investment. It does not erode ones principle.
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Re: Another important consideration - Real Estate Investmen

Post by kksmom »

Hiker-Biker wrote: If you obtain a real estate license and put in the required 750 hrs the IRS stipulates, you can write off all expenses related to your real estate portfolio.
A common misconception- Per IRS guidelines, one doesnt need , real estate license to qualify for "real estate professional " tax status.
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