can my bro retire?

[gips]

my brother isn't the best saver but over the last ten years, has gotten himself into a better financial position by flipping houses, purchasing residential real estate rentals and purchasing a consulting business. He is negotiating a buyout of the consulting business with his partner and is now considering retirement:

age: 64.5
marital status: single
geo: mcol in a no income tax state
401k: $200k, randomly invested in various funds
proceeds from sale of business: $600k after paying cap gains
real estate: three residential rentals, $900k of equity. He is thinking about installment sales and holding the mortgages, doesn't think he'll have a problem getting 9% interest rate. I checked with a friend who does hard money lending, the rate actually might be a little low.
ss: he's going to claim at 65, payment is $2500/month. I've suggested he delay and have provided him with opensocialsecurity link but he's set on this.
expense estimate: $100k/year which he says is padded.
mortgage: $2k/month
no other debt

so I added up his assets: $1.7mm
divided by 25: $68k
multiplied 25*expenses: $2.5mm
so seems like a $800k shortfall.

he took a different approach:
expenses: $8.5k/month
income:
ss: $2k/month
mortgages:$5k/month from three 30 year mortgages
income from portfolio: $3k/month
total: $10k

It seems to me the fly in the ointment is the mortgages. First, the principal portion of the payments are going to subject to cap gains, the interest portion to regular income tax. also, the homes will probably be sold well before 30 years so he loses his income stream.

thoughts?

[miket29]

I think his numbers are a better estimate than yours in the near term. The 4% rule you're using to estimate what he will earn is for withdrawals from a portfolio. If the homes really can generate the income he thinks then his numbers seem right.

As for taxes, he should run a tax estimator and see what it shows. Right now he's bringing in roughly $120K/yr and his expenses are $100K/yr which I assume includes his mortgage payment of $2K/mos. If so he should be ok early on in retirement.

The rub is what happens a few years down the road. With a traditional portfolio one usually has a healthy portion of bonds and then stocks to keep up with inflation. Since a lot of his income is from the homes that won't grow with inflation. Furthermore I think you're right that that stream won't last 30 years. Eventually even the worst homebuyer creditwise will build up enough equity to get a reasonable loan and pay off that 9% mortgage. It seems at some point down the road he'll be in the scenario that matches your numbers. What will he do then?

The solution seems to be to trim down that $100K/yr of expenses. Many people live a good life on a lot less. Or maybe he just figures that's a problem for future bro to worry about (to paraphrase Joey from "Friends")

[gips]

I think his numbers are a better estimate than yours in the near term. The 4% rule you're using to estimate what he will earn is for withdrawals from a portfolio. If the homes really can generate the income he thinks then his numbers seem right.

As for taxes, he should run a tax estimator and see what it shows. Right now he's bringing in roughly $120K/yr and his expenses are $100K/yr which I assume includes his mortgage payment of $2K/mos. If so he should be ok early on in retirement.

The rub is what happens a few years down the road. With a traditional portfolio one usually has a healthy portion of bonds and then stocks to keep up with inflation. Since a lot of his income is from the homes that won't grow with inflation. Furthermore I think you're right that that stream won't last 30 years. Eventually even the worst homebuyer creditwise will build up enough equity to get a reasonable loan and pay off that 9% mortgage. It seems at some point down the road he'll be in the scenario that matches your numbers. What will he do then?

The solution seems to be to trim down that $100K/yr of expenses. Many people live a good life on a lot less. Or maybe he just figures that's a problem for future bro to worry about (to paraphrase Joey from "Friends")

yes, $2k mortgage is in expenses. He found a thorough budgeting spreadsheet and I think he's got everything pretty well covered. thanks, great point on inflation! still, 9-10% nominal in retirement doesn't seem like a terrible historical return, especially if inflation comes down.

>>What will he do then?
he says he'll save surplus each month and continue to flip houses. Also, his house has a lot of equity so I suppose he could always downsize. also, his budget has a lot of discretionary expenses which, as he ages, may be lower than anticipated.

[Tinkerer-in-Chief]

If he continues to flip houses, he is not really retiring then, is he?

What’s the average annual profit after taxes he expects to get from flipping houses, and how variable will that income be year to year? Knowing that is necessary for evaluating the whole portfolio.

[delamer]

Does the $100,000 include income taxes?

Is it $2500 or $2000 for his Social Security benefit?

If total expenses are $100,000 and he gets $30,000 from SS, then he needs $70,000 from his portfolio. At a SWR of 4%, he’s right at the edge of making the numbers work.

With loan interest rates of 9%, that’s even better. But how long are those likely to last before they are refied?

[gips]

If he continues to flip houses, he is not really retiring then, is he?

What’s the average annual profit after taxes he expects to get from flipping houses, and how variable will that income be year to year? Knowing that is necessary for evaluating the whole portfolio.

he has no idea, it's become much harder because of tv shows about flipping and people/companies with more $ chasing multiple homes.

[gips]

Does the $100,000 include income taxes?

Is it $2500 or $2000 for his Social Security benefit?

If total expenses are $100,000 and he gets $30,000 from SS, then he needs $70,000 from his portfolio. At a SWR of 4%, he’s right at the edge of making the numbers work.

With loan interest rates of 9%, that’s even better. But how long are those likely to last before they are refied?

>>Does the $100,000 include income taxes?
no
>> Is it $2500 or $2000 for his Social Security benefit?
$2500

>>If total expenses are $100,000 and he gets $30,000 from SS, then he needs $70,000 from his portfolio. At a SWR of 4%, he’s right at the edge of making the numbers work.

that's a good way to look at it. seems to me he's good to go even if he gets paid off early on the mortgages. thanks!

[22twain]

so I added up his assets: $1.7mm
divided by 25: $68k
multiplied 25*expenses: $2.5mm
so seems like a $800k shortfall.

It seems you forgot to take his Social Security into account?

[michaeljc70]

Selling rental property only as an installment sale at 9% interest rate will severely lower the number of interested buyers probably resulting in a lower sales price IMO. Anyone borrowing at 9% probably has too small of a down payment or terrible credit so it sounds risky. Yes, the property is collateral, but I've seen how much damage can be done to a property.

Edit: If your brother has to rely on high risk lending to get 9%, I'd say no he can't retire. I'd say the same thing if someone was relying on getting a 9% return in the stock market or from any other investment.

[delamer]

Does the $100,000 include income taxes?

Is it $2500 or $2000 for his Social Security benefit?

If total expenses are $100,000 and he gets $30,000 from SS, then he needs $70,000 from his portfolio. At a SWR of 4%, he’s right at the edge of making the numbers work.

With loan interest rates of 9%, that’s even better. But how long are those likely to last before they are refied?

>>Does the $100,000 include income taxes?
no
>> Is it $2500 or $2000 for his Social Security benefit?
$2500

>>If total expenses are $100,000 and he gets $30,000 from SS, then he needs $70,000 from his portfolio. At a SWR of 4%, he’s right at the edge of making the numbers work.

that's a good way to look at it. seems to me he's good to go even if he gets paid off early on the mortgages. thanks!

He needs to figure out his federal/state income taxes and add those to his expenses.

Having more than half of net worth in 3 residential properties is similar to having it in 3 individual stocks. Too risky going into retirement, especially if the properties are all in the same geographic area. So selling them is a good idea.

[midoxidil]

My personal rule (non-BH): No retirement, until mortgage paid off.

[Mike Scott]

My thought is that your brother has already decided to do this and your input will make little if any difference.

[michaeljc70]

Why isn't your brother keeping the rentals and use the rental income for retirement? My guess is because it wouldn't be enough hence turning to an installment sale.

How sure is he on the sales price of the business and the equity in the rentals? Sometimes people are overly optimistic when valuing things that don't have a clear value.

The tax implications might have a bigger impact than expected given the rentals were depreciated.

[SubPar]

Selling rental property only as an installment sale at 9% interest rate will severely lower the number of interested buyers probably resulting in a lower sales price IMO. Anyone borrowing at 9% probably has too small of a down payment or terrible credit so it sounds risky. Yes, the property is collateral, but I've seen how much damage can be done to a property.

+1 on this. I think this is going to be a non-starter for many. No way am I considering a subordinate, seller-financed note with someone I don't know.

[manuvns]

Is 68K + 2.5K SS enough to retire ? if yes then he can

[gips]

so I added up his assets: $1.7mm
divided by 25: $68k
multiplied 25*expenses: $2.5mm
so seems like a $800k shortfall.

It seems you forgot to take his Social Security into account?

yes thanks, see my post right above yours

Selling rental property only as an installment sale at 9% interest rate will severely lower the number of interested buyers probably resulting in a lower sales price IMO. Anyone borrowing at 9% probably has too small of a down payment or terrible credit so it sounds risky. Yes, the property is collateral, but I've seen how much damage can be done to a property.

Edit: If your brother has to rely on high risk lending to get 9%, I'd say no he can't retire. I'd say the same thing if someone was relying on getting a 9% return in the stock market or from any other investment.

thanks, that could be but I contacted a friend who does this for a living and he thought 9% was reasonable. having said that, my friend doesn't like the business and had decided to exit in favor of commercial real estate. I don't think he needs to depends on 9% returns as per delamer's post above. I'll mention the possibility of damage, it's a great point.

My thought is that your brother has already decided to do this and your input will make little if any difference.

thanks, this is perceptive of you, he's a little between a rock and hard place if he wants to retire as he doesn't have much else in the way of savings.
I suspect his real estate and business valuations are optimistic but he's in a lcol-mcol area, if controls expenses, I think he can manage some sort of retirement.

Why isn't your brother keeping the rentals and use the rental income for retirement? My guess is because it wouldn't be enough hence turning to an installment sale.

How sure is he on the sales price of the business and the equity in the rentals? Sometimes people are overly optimistic when valuing things that don't have a clear value.

The tax implications might have a bigger impact than expected given the rentals were depreciated.

I had the same thought and asked him about rental income to which he didn't reply but I'm sure you're correct. Not sure on valuation by I suspect they are somewhere in the range of optimistic to very optimistic. great point on the depreciation!

thanks for all the thoughtful replies!