By Dr. James M. Dahle, WCI Founder
Warning: Lengthy rant ahead.
I often run into people who are somewhat dogmatic about cash flow investing. The typical vehicle of choice is real estate, although occasionally it is high dividend yield stocks. By cash flow, I mean that they simply work at building a portfolio of investments that generates cash flow, and when the cash flow is equal to what they generate from their day job, they consider themselves financially independent. Seems simple and intuitively smart, right? Not so fast.
While there is no doubt that investing in this manner “works” and, in fact, is a great way to become wealthy, there are a few things that really need to be pointed out before jumping on the “Kiyosaki Bandwagon.” (By the way, there is no rich dad.)
I was originally going to title this post “Why Cash-Flow Investors Need to Get Off Their High Horse.” While that title probably would have been a lot more clickbaity (and lest you think that's bad, I'm all for clickbaity titles because it doesn't matter what you write if no one reads it), the current title sums up my thoughts and feelings on the matter a lot more. Like with my politics, my moderate position subjects me to criticism from both sides.
Before we get too far into criticizing these folks, I think it's important to point out a few things.
- I think investing in real estate is a great idea. It is a wonderful asset class with excellent returns and low correlations with other common investments such as stocks and bonds. There are many different ways to invest that allow you to decrease the active aspect of it. It is also a relatively easy and safe way to add leverage to your portfolio. I have owned real estate in many different forms and anticipate increasing my allocation to it in the future.
- I am a huge fan of entrepreneurship, which in some respects is simply adding value, work, and expertise to your investments. While it is unlikely that spending time and effort to pick stocks or mutual fund managers is going to be worthwhile, that is not the case with many other investments such as individual income properties.
- I like the idea of having relatively high-income investments in retirement, as long as the total return is acceptable. Real estate rents are not technically guaranteed income, but if you are reasonably risk-tolerant, they can, in some ways, substitute for it. For example, if you had a cap rate 6 property, I would feel pretty comfortable spending 6% of its value each year rather than the more standard 4% rule.
- The real benefit of real estate investing isn't the cash flow aspect of it but the solid total returns and low correlation with stocks that are available.
First, let's talk about the basics of income investing and some of the basic problems.
What Is Income Investing?
The basic idea behind income investing is that you only spend the income from your investments. Seems like a great idea, right? It's easy to know when you have enough to retire—when the income from your investments replaces the income from your job (or at least your living expenses). Plus, you know you'll never run out of money if you're only spending the income.
Unfortunately, if you become an extremist in this camp, you may get burned by several issues. There are four ways that income investors get it wrong when compared to a “total return” investor.
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- Income investors are likely to underspend: Safe withdrawal rate studies, such as the Trinity Study, have demonstrated it is quite safe (although not perfectly safe) for you to spend about 4% of a traditional portfolio each year and expect your portfolio to keep up with inflation throughout a 30-year retirement. But many traditional investments, throughout history, don't yield anything close to 4%. If you're only going to be spending the yield on these investments, you're going to be spending much less than 4% per year. That means you will need to do one of three things: have a higher savings rate, work longer, or spend less in retirement. Since you are spending less, you are also likely to leave a lot more money behind at death. In short, you'll spend less than you could have if you were willing to spend some principal.
- Income investors may not hold the best portfolio: An income investor is far more likely than a total return investor to chase yield, since every little bit of extra yield increases his or her lifestyle. However, there are many investments with a high yield whose total return may not be what you would hope. The classic example is junk bonds, and the junkiest of junk bonds these days are peer-to-peer loans. A portfolio of peer-to-peer loans may yield 20%, while only having a total return of 10% due to a high rate of default. If you're spending 20%, that portfolio isn't going to last long. That doesn't mean there isn't room for higher-yielding investments in your portfolio, but you want to make sure you are holding a diversified portfolio with excellent long-term, risk-adjusted returns. Such a portfolio almost surely will include some assets that have a low yield.
- Income investors may pay too much in taxes: As a general rule, income tends not to be very tax efficient. There are exceptions, of course, as muni bonds are usually federal (and sometimes state) income tax-free. Plus, some of the income from real estate can be shielded by depreciation, especially early on in the life of a property. Bond dividends, REIT dividends, and CD interest are taxed at your regular marginal tax rates instead of the lower dividend and capital gains rates available with stocks. To make matters worse, you have to pay those taxes even if you didn't really want to spend that income yet. There is no way to defer the income until you actually want it in the future.
- Income investors may get burned by inflation: Higher-yielding investments, such as CDs and bonds, tend not to keep up with inflation nearly as well as traditional lower-yielding investments such as stocks. If you focus too much just on income, you may forget that your real opponent in the investing game is your personal rate of inflation. If your income is steady or only increasing slowly and your expenses are increasing at a moderate rate, it won't take long before you will be faced with an unsavory choice: cut your lifestyle or sell your investments. A total return investor spending 4% of their portfolio each year has an inflation adjustment built into their plan.
Now, let's talk about some of the other problems income investors could face.
5 Other Problems Income Investors Need to Consider
#1 High Yield Does Not Equal High Return
The first problem is that many income investors do not realize that a high yield does not necessarily equal a high return. You want cash flow? I can give you 10% cash flow. Give me $100, and I'll give you $10 a year for the next 10 years. If you didn't get anything back after 10 years, you wouldn't think that was a very good investment, would you? You always need to look at the total return, even if you're an “income investor.” The classic example is a privately traded REIT that gives you “guaranteed” 8% returns a year for a decade, and then you find out your $10 shares are worth $2.70.
My daughters in The Subway at Zion National Park.
In reality, high returns come from higher risk, higher leverage, additional work, and additional expertise.
The historical return for publicly traded companies is about 7% real per year. However, it is not only possible but common for a real estate investor to have returns that are far higher than that. There's no sense in denying it, but it is important to realize what it takes to get those higher returns.
One source of higher returns is taking on additional risk. Which is a more stable, impressive business to own—a piece of Amazon or that duplex on the corner? Amazon, of course. That duplex only has a single source of income—rents—and it's subject to serious risks, such as vacancy, competition, excessive maintenance costs, general decline in rents or property appreciation in the area, etc. And that's only comparing it to Amazon, not an investment that owns pieces of thousands of companies. So you're taking on significant additional risk. Of course, you expect to have higher returns as a reward for doing that.
Your expected nominal return from an unleveraged real estate property is the cap rate. That's typically between 4%-10% plus the rate of appreciation, which generally tracks inflation (technically the land goes up faster than inflation and the building depreciates). So, it's perhaps 9%-10% total. However, once you apply leverage, the expected return goes up.
A typical loan-to-value ratio for an income property is about 2/3, so if your unleveraged return is 9%, then your leveraged return would be higher. How much higher depends on your cost of credit. If your loan on 2/3 of the value is 5%, then your leveraged return would be 16.5%, ignoring transaction costs. If you had a 15% round-trip transaction cost and spread that out over five years, that would reduce that return by about 3% a year, reducing your return to 13.5%—still a great return.
The increased return available on real estate comes from additional risk and leverage and also from the additional work you must put into the process. Obviously, that can vary from a ton of work if you are maintaining and managing the property yourself to a relatively small amount of work if you are investing in syndicated shares (where all the work is done by someone else) to almost nothing if you're investing in the Vanguard REIT Index Fund.
However, no matter who actually does that work, it must be done. You, as the owner, are paying for it. The additional work inputted into the process adds value to it, and that value shows up as a higher return. However, even if you are paying someone else to do almost everything on an individual property, you still, at a minimum, have to do the due diligence on the purchase.
For example, you might sit through a one-hour webinar about a syndicated real estate property and spend another hour going through the paperwork. Those two hours of time, at your hourly rate, should be added in to make a fair comparison to buying an index fund which takes me approximately 30 seconds. Also, when you are talking about exchanging your time for money, it is a good idea to consider if that is the highest rate at which you can do so—and also how much you enjoy the activity, especially for a high-income professional. Many doctors have a higher hourly rate practicing medicine, and they enjoy it more. Besides, most of us have learned there are other ways to make more money than being a doctor, and most of those involve working in the financial services industry.
Alpha is a concept well understood by stock investors but poorly understood by real estate investors. Alpha is a zero-sum game. For every dollar of alpha that I get, someone else loses one. Real estate investors often tell me that they earn 20%-30% returns, and I don't doubt them, because I have earned returns like that on some of my real estate investments. But I have also earned 3% and lost > 100% of my investment on other deals. Some of that may be luck (good or bad) and some may be skill (or lack of it). Often, it is difficult to tell which it is. But there is no doubt that alpha is a lot more accessible in real estate than it is in highly analyzed public securities. But that includes negative alpha, and when amplified by the effects of leverage, far more investors have been wiped out by real estate losses than stock losses.
#2 You Can Leverage Other Investments
While a mortgage loan has significant benefits over a margin loan, there are many different ways to leverage up your stock market investment. In fact, you can even borrow against real estate to do so. To be truthful, it really isn't fair to compare a leveraged real estate return to an unleveraged stock market investment, even if what we usually do is invest in real estate with leverage and stocks without.
#3 Lack of Basic Investing Knowledge
I'm not sure how to tactfully put this, but I've been surprised by the lack of basic knowledge of the tax code and the principles of investing among even relatively sophisticated real estate investors. For example, two guys who run an extremely popular real estate investing podcast (Bigger Pockets) once revealed to Clark Howard that they weren't using Roth IRAs and didn't even really understand how they work. I once had a discussion with a surgeon who has had great success with real estate and even spends time teaching others how to do it but didn't know of the existence of no-load mutual funds.
There is always a heavy denigration of the “Wall Street Casino” and “paper assets,” but I wonder if the fear of these things is, in large part, simply ignorance. I mean, an index fund investor is obviously very wary of “Wall Street” and realizes that the fewer trips into “the casino” (where the house always gets its cut) you make, the better off you will be. But the transaction and ongoing expenses in real estate are an order of magnitude (or two) higher than in stock investing, and cost always matters.
In addition, real estate investors are notorious for not really knowing what their actual return is. Part of it is they don't know how to calculate the return and part of it is they never add in all the expenses, especially the value of their time. I hear lots of bragging about 20% returns, but no one seems to acknowledge what a 20% return really means. If you can make 20% a year every year and you save my recommended 20% of gross, you can retire on 50% of your pre-retirement income after seven years and on 100% of it after 10 years. Yet, these docs who advocate this style of investing to me and brag about their high returns are almost invariably 45+ and still practicing because they have to. Serious disconnect there somewhere.
#4 Lack of Using Retirement Accounts
One of the greatest gifts given to high-income professional investors is the ability to invest inside retirement accounts like 401(k)s and Roth IRAs. Real estate investors routinely ignore these benefits. Retirement accounts simplify your estate planning; boost your investment return (by lowering your tax bill); and, in most states, provide a very high level of asset protection, even higher than that available through an LLC (which is still a good idea for an income property in a taxable account). You can certainly still invest in the asset class of real estate inside a retirement account, typically a self-directed IRA, although it is a little more complicated and expensive to do so unless you are buying publicly traded REITs.
A real estate investor will often claim their income is tax-free since they have “paper losses” to cover it. However, the truth is that paper losses are actually real losses. That's why the IRS lets you use them. The value of your structure really does decrease each year, so you are allowed to depreciate it at a reasonable rate. That's also why you have to pour money into the structure as you go along. Remember the new roof and water heater? That's what happens when something is fully depreciated—you buy another one because it is worn out. That depreciation is recaptured when you sell the property. You can put off the day of reckoning by exchanging the property, over and over again, until your death at which time you get the step-up in basis, but that is difficult to do with anything but direct ownership of the property. And those “expenses” you get to deduct? Those are real expenses too. Paying $1 to get a $0.45 deduction isn't exactly a winning formula. And it's not like your stocks (which are real companies with real expenses) don't get to claim depreciation and expenses and pass those savings on to you.
#5 Income Investors Work Too Long and Die with Too Much
Perhaps the biggest problem with being an income investor is simply that you work too long, and because of that, you die with too much. For example, in a recent conversation with a real estate investor, he noted that he wanted to maintain or even increase his income in retirement compared to what he was making now as a surgical subspecialist. This is despite the obvious mathematical fact that a typical physician investor can maintain their pre-retirement lifestyle on one-quarter to one-half of their pre-retirement income because of all of the expenses that go away or decrease at retirement (20% to retirement, 5% to health insurance/HSA, 5% to payroll taxes, 10% to income taxes, 4% to disability/life insurance, 4% to work expenses/transportation, 10% to child-related expenses/college savings, etc.).
Don't get me wrong: more retirement income is great, but the truth is that it isn't free. You exchange something for it. And what you are exchanging is your time and labor working longer than you have to or spending less than you might otherwise. That is not up for debate. It is a mathematical fact.
Total return = appreciation of the asset + income from the asset
You have to work longer, perhaps doing something you hate, and you spend less in retirement than you could and leave more for your heirs. Now, maybe that is what you want because you love your job and you would rather leave money behind than spend it on yourself. That's fine. But most doctors I know aren't willing to work longer to allow their kids to have a larger inheritance, which will probably have a negative effect on their life anyway.
Pros and Cons of the Income Approach to Financial Independence
There are two schools of thought about the figure for financial independence (FI). The first method has the advantage of being theoretically more correct. The second, however, is not without its advantages.
The first school says financial independence is a level of assets. For ease of discussion, we'll call it 25 times what you spend in accordance with the 4% rule guideline. If you spend $100,000 a year, you are financially independent when your nest egg is equal to $2.5 million. You can now spend 4% a year adjusted upward with inflation each year. More or less. Probably.
The second school of thought says that financial independence is a level of income. When the income being produced by your investments is equal to your spending, then you are financially independent. So, if you spend $10,000 a month when your investments produce $10,000 a month, you are financially independent. More or less. Probably. We'll call this school the “Income Approach to Financial Independence.” Let's go through its pros and cons.
The Pros of the Income Approach on FI
- It's easy to know when you've reached financial independence: This is really straightforward. If you spend $100,000 a year and your investments produce $100,000 a year, you know you're there. There's no dickering around arguing about safe withdrawal rates—$100,000 goes into the checking account and $100,000 comes out. You can even break it down to the month and week if you want.
- You tend to leave more to your heirs: Since you never spend principal, you are likely to leave more money behind to your favorite heirs and charities. At least you know you'll leave something—which, although unlikely with the other approach, is not impossible.
- You can reach financial independence faster: Many of those who endorse the income approach to financial independence are big fans of leverage, real estate, and entrepreneurship. Done well, all three of these generally lead to earlier financial independence than a traditional portfolio asset-based approach combined with a standard J-O-B.
- Behaviorally, it's easier to spend money: The biggest advantage of the income approach is behavioral, not theoretical. Most retirees struggle to spend the assets they have spent a lifetime acquiring. Every year, I beg my parents to spend more money on anything they think could even possibly provide them more happiness. I was so proud to see them fly first-class recently, probably for the first time in their life. I think many people are like that. After a lifetime of carefully shepherding assets, saving, investing, shopping carefully, and watching expenses, it's difficult to sell assets even when you know it's the right thing to do. It is hard to remember that building wealth isn't the end goal. You save money not to swim in it a la Scrooge McDuck, but to spend more money later. I think pension-holders have much less difficulty spending than others, and the income approach is much more like a pension.
The Cons of the Income Approach on FI
- You might oversave: The truth is that we are not a pension fund or a university endowment. We will all die eventually, and none of our wealth will go with us. It is entirely reasonable to spend principal during retirement. You don't want to spend so much that you run out before you die, but if you don't spend any at all, it just means you oversaved. It's the flip side of leaving more to heirs. It might even mean you worked longer than you otherwise needed to, especially if most of your investments have a relatively low income/return ratio, like stock mutual funds. Working longer than you needed to when you didn't want to is a real tragedy.
- It's tax inefficient: If you are building an income portfolio, you are, by definition, generating more income than you need from the time you start until the time you quit your job. From a tax perspective, you don't want to ever have more taxable income than you actually need to spend. It's tax inefficient. On the eve of retirement, you are generating twice the income you actually need—and you're paying taxes on all of it. That's a lot of waste (even if your fellow citizens are very grateful for the largesse).
- You can make funny investment choices: If you're not careful, focusing too much on income can result in a portfolio full of lousy investments. The higher the ratio of income/return, the more attractive an investment becomes to an income-focused investor. If you compare an investment that pays out 8% of its 10% return each year as income to an investment that pays out 2% of its 10% return, then the income guy is going to go with the first investment every day of the week and twice on Sunday. However, sometimes what happens is that the investment pays out 8% of its 5% return, i.e., some of the income being paid to you is not income at all, but principal. An investment that returns 5% a year is not superior to one that pays out 10% a year, even if its income is higher. Over decades, that sort of thing can make a huge difference.
- The highest income “investments” require more activity: The biggest issue with the income approach, however, is that the things that provide you the highest income are not necessarily investments at all. While considered “passive income,” they are more like second jobs. It's not “financial freedom.” It's really only freedom from practicing medicine. It isn't freedom from working. Whether you are coaching, teaching courses, doing medicolegal work, or running a successful physician finance blog, it's really all the same. It's hard to argue that is true financial independence, even if you like the work you are now doing more than what you used to do. Real estate can be pretty similar. It's really a spectrum. If you are managing 100 doors, you've got a full-time job. So you hire property management but discover you've still got a part-time job managing the manager. Even if you're only investing in very passive real estate syndications, somebody still has to select and evaluate the syndications as you go along. That's work. So you shouldn't be surprised that an investment you are actively working in has higher returns than an investment that does not require ongoing work.
Money Is Fungible
As mentioned at the beginning, I like the idea of having the higher income available with an income property investment in retirement for the higher reliable (but not guaranteed) withdrawal rate, even though I really don't need that income now. I have more taxable income than I want right now from my earned income. I would defer even more of that until I need to spend it if I could. The tax deferment (and lower tax rates) available from being a “capital gains investor” is not trivial. But the point is that money is fungible. I can sell mutual funds anytime I want and buy an income property, and I can sell an income property any time I want and buy mutual funds. While there are obviously transaction costs, money is fungible. You are not locked into one way to invest. To be honest, there are huge benefits in doing both types of investing.
Investors Should Take the Best from Both Worlds
To sum up, real estate is a great asset class. Investing in it has real advantages due to high returns; low correlation with stocks and bonds; and, particularly in retirement, relatively high reliable (though not guaranteed) income. But there are important concepts that an index fund investor can learn from a real estate investor and that a real estate investor can learn from an index fund investor.
Perhaps the most important one is that the intelligent investor takes the best of both worlds rather than confining themself to just one.
What do you think? Why are 100% mutual fund investors OK with being blissfully ignorant of the advantages of real estate investing and afraid to put a little work into their investments? Why are so many 100% real estate investors afraid of the stock market, ignorant of basic investing principles, and unwilling to take advantage of retirement accounts and a truly passive investment? Are you, like me, a moderate on this issue, and if so, how have you decided to blend these two schools of thought in your own portfolio? Comment below!
[This updated post was originally published in 2017.]
I agree with your thesis. Balance among different types of investments is the best path. I have used these principles of balanced investing for decades and it has worked out incredibly well.
I maxed out my 401k, 403b, 457b, SEP IRA, and traditional IRA every year, now too many millions in balances that I won’t ever need.
I leveraged into prime real estate properties where the work and the risk was low. The positive cash flow was lowest in the early years, but the long term returns have been impressive. These real estate assets now have very high market values, the underlying mortgages are paid off, and the constant cash flow is high.
And I used my entrepreneurial skills to build a medical business that is highly successful.
So at this point I have substantial assets in 4 categories, retirement accounts, taxable accounts, real estate and then there is the value of my business. Now in my 50’s, I have an 8 figure portfolio and total fredom to be in the outdoors mountain biking every day, to travel the world, to dabble in my business, and to practice medicine very part time, allowing me to enjoy my patients and my contributions to others.
My biggest struggle… having so much freedom to choose what I want to do with my remaining time on this planet. Time remains my most precious commodity.
What a wonderful problem to have! Thanks for sharing your story. Very inspirational and hope to be in your situation in the future.
Amazing article, WCI. I hesitate to invest aggressively in real estate because of the alpha issues you mentioned. I expect that professional real estate investors will earn alpha at the expense of inexperienced investors like me.
The expectation that you can achieve long-term returns of 20% in real estate is ludicrous. To put that in perspective, according to his annual letter, Warren Buffett has earned approximately 20% returns over his investment career, from 1964-2016. $100,000 invested with 20% returns in 1964, whether you get that from Berkshire Hathaway or real estate investments, would be worth approximately $1.5 billion today. I’m guessing that 20% returns are not realistic in the long run, in any asset class.
Got sucked into that reed link…just spent an hour of web surfing! Thank you for the morning read.
Yea, it’s pretty interesting the first time you see it, isn’t it? Unlike most who read it, I still find some value in Kiyosaki’s writing, but it’s important to just take it for what it’s worth.
Try reading Reed’s stuff about Real Estate and its realities. It’ll cure most of the people of real estate fever.
I agree his real estate stuff is excellent and very realistic. I found his numbers and warnings to be spot on. So many real estate books are filled with hype and fluff. None of that in Reed’s books.
Great Post! I feel like many Real Estate investors are the “Republicans” and many Index investors are the “Democrats” (Or vice-a-versa if you prefer). By this I mean that people have become so one sided, if the other side has a good idea, no matter how good that idea is they will not even listen.
Why any high income Real estate investor wouldn’t use a Stealth IRA and Roth IRA and solo or group 401K is beyond me. Why Index investors completely abolish Real Estate from their arsenal also seems silly. A little more moderation would likely be good for us all. My current portfolio is about 80% index and 20% Real estate because I am “lazy” and don’t have the time to commit to a higher Real Estate portion. If I wanted to work harder or learn more it would probably be more weighted toward Real Estate. I do appreciate that there is much less correlation from “the market” to my real estate holdings. Over the course of 30 years I expect this to make a difference even if it is not huge. Keep your minds open and keep learning. If you have zero knowledge of one and a huge knowledge of the other, then read a few books and learn something new.
Completely and utterly agree with your assessment.
Im certainly more engaged than you would find time value effective/prudent but thats only because the level of passion you have in blogging about personal finances, I have in real estates. In fact, in the midst of obtaining a real estate license as we speak. Not with intentions to sell but to gain knowledge, experience, and most importantly to network.
My thought is high income earners, as long as theyre disciplined and follow all your outlined personal financial advice, have an added value of….steady high income, strong network of other higher income earners, amongst others.
Particularly enamored by the concept of long term buy and hold rental properties . The concept of using someone elses money to build equity, leveraging that equity to reinvest (or cash flow once mortgage is fully paid is quite nice too) tax benefits of mortgage interests/depreciation, appreciation is also a nice “icing on the cake,” and most of all, love the networking aspect. Agree that none of this is all that “passive” per se with potential for massive “headache,” factor.
Not to say there arent easier ways to achieve but nonetheless, there is certainly a role and intangible value when you network, have access, and followers from high income earners circle ie: the WCI website itself. ?
“Why are 100% mutual fund investors okay with being blissfully ignorant of the advantages of real estate investing and afraid to put a little work into their investments?”
Outside of an REIT index fund, I don’t do real estate because, 1) I have no interest in being a landlord or maintaining properties, and 2) I already save and invest enough from my medical practice alone that very few ventures beyond my day job are worth my time anymore.
Accidental landlord here…..Rollercoaster ride.
At first it was great, easy tenants, condo appreciating, rents skyrocketing……
Then it sucked, a few crazy tenants, more stuff needs fixing…..
Was always encouraged that I would hold it to sell in early retirement to minimize tax on capital gains, maybe 1031 exchange into something easier along the way…..still was optimistic……
Then I started to realize that this plan wasn’t going to be so easy. Will have larger forced 457b drawdown in same time period. Rental sale will crowd out other goals of low tax bracket Roth conversions and tax gain harvesting. Complicated maximizing whatever ACA subsidy, AHCA tax credit, or Medicare premium
subsidy might be available.
Despite hot local real estate total return would have been higher in market index funds (even accounting for tax savings with depreciation)
Bottom line, wish I would have sold the damn thing as a resident. Back to the basics. Medical students and residents should probably just rent!
Like you and WCI, I’ve been an accidental landlord on a couple properties. Although we didn’t have anything happen that I would consider a nightmare, I learned enough to know that any future real estate investments will be entirely hands-off.
Index funds may not be the quickest path to wealth, but they are among the surest. Using real estate takes a combination of additional work, risk, and maybe luck. I’m perfectly content with owning nothing but our primary home, modest second home, and Vanguard’s REIT index fund. I may venture into some crowdfunding deals when I’m in lower tax brackets.
Best,
-PoF
I agree it’s tough to do well when you become an accidental landlord. As you’ll recall, my experience was pretty rotten too. I got a really big tax write-off one year though!
I was an accidental landlord the first time, and got a tax write off as well unfortunately.
Although that was a bad experience, it wasnt on purpose and had no intent or forethought (that was the problem really) so I dont hold that as a reason to stay out for good.
Just did it on purpose this time, with property managers that arent too expensive at all, and to me, totally worth it. This is our test run, I hope it goes well since the return is hard to ignore, even if the only thing that happens is they pay off an asset for me that I can roll into something else. I have low expectations not even looking for some profit margin but asset accumulation.
I might do an airbnb if this goes well, and try that out as well.
I’d love for it to be even more hands off, for maybe a percent or two less return, but havent found a great syndicate that hits all the spots just right. Looking forward to your syndicate post.
Excellent all around on all points, great discussion of these topics.
Insightful article! I’m a real estate investor, a decade into it with a decent size portfolio. I’m a moderate like you, but i wasn’t like that 6 years ago before I had my twins so I had a ton of time and sleep before kids. I am happy to share my perspective as a real estate investor. I also have my registered funds in stocks.
Regarding your question ‘why are so many 100% real estate investors afraid of the stock market, ignorant of basic investing principles and unwilling to take advantage of retirement accounts and a truly passive investment’
Based on my experience and knowing so many other real estate investors, to be a good real estate investor takes a significant amount of time to learn, even for investing in residential starter homes because it’s Equivalent to running your own business. Investing in real estate is requires a lot of knowledge and in depth knowledge that it consumes so much of your time that learning about dividend investing, stock market unfortunately becomes a lower priority for many people. Also, the stock market is volatile and you can see your paper assets dropping in value in real time (or up in value), this full transparency is scary for a lot of people. it’s not quite the same with real estate., you have to do some work to figure market value. Also, as a person that needs more control, the stock market doesn’t give you that sense of control like real estate,
For example: Investing in a property feels like you have more control, you can control who you rent too, how you market it, how to renovate it, how to sell it, etc. And it’s tangible, a brick and mortar asset. Many people are uncomfortable with the lack of control in the stock market. You can’t influence how well the markets perform.
I’m not arguing which is better, I’m just saying that it comes down to what you as an investor are comfortable with, what your personality is like, how involved do you want to be, what are you more knowledgeable in, and where is the opportunity, etc..,then you choose what to invest in accordingly.
A lot of real estate investors only drink the real estate coolaid and comfortable staying there, because it’s working for them.
I’ve been investing since I was 20, between stocks then moving to majority real estate then adding in more stocks.
I like investing in both, I take the blended approach, leaning towards more passive real estate investments as I age (like investing in mortgage funds) .
Also, To take the passive approach means you are ok to give up control too, And it depends if your time is the most valuable thing …which it is for me now.
Hey WCI,
Slow day in clinic so I was reading some old articles: https://www.whitecoatinvestor.com/our-real-estate-empire/. Do you have updates on how your syndicated RE deals are doing? Also maybe your thoughts regarding RealtyMogul vs RealtyShares?
I’ve already written an update which will be out in the next few weeks.
During the last market downturn I took the plunge on real estate investing but with the requirement that it be as passive as possible so I hired everything out. The most I had to do was answer some emails and make a few phone calls when the leases turn over. These were simple single family homes. The results now five years later are a 19% gain on one and an 8% loss on another with one more house in possession. And that doesn’t count my time. That is way below the average return of my index funds I’ve been buying along the way.
The problem with trying to make the real estate investments completely passive is all the profit was eaten up, at least in my limited experience. Plus if I want to make more money, nothing can beat my hourly rate as an MD.
I still like the idea of buying commodities in the form of wood and plastic and glass and copper wire and having people rent those commodities from me but buying those commodities at an appropriate price takes some skill.
Best bet is to index your way to financial freedom. Simple and just about guaranteed
Perfect timing. I recently stumbled upon your interview on that income investing podcast with the surgeon that you mentioned and just re-listened to it last night. I come from a family of contractors/real estate developers and have always been interested in real estate investing, but like you, I would consider myself moderate on the issue. I’m fully in the low cost, index fund camp at the moment while still paying down student loans and finishing residency, but hope to have the best of both worlds in the future.
Hi new to this site. How about getting into real estate though sites such as ,Realtyshares ?
I’ve been dabbling in it. You can read more about it here today: https://www.whitecoatinvestor.com/our-real-estate-empire/
or in a couple of weeks I have a new post coming out with more information.
When I saw the title I thought there would be more about other types of income investing, such as dividend stocks. I got into a discussion with another physician in the doctors lounge who is probably in his mid-50s and told me he exclusively invest in dividend paying stocks. Since he’s a nice guy in several years my senior I did not make a big deal about it but did advise that he look into other strategies. One point of contention is that he seems to think because he reinvests his dividends that they are tax-free. I did not think this was true. Thoughts?
Hmmmm. If he is investing via a ‘regular’ taxable brokerage account, he should be getting a 1099-DIV that he reports on his annual 1040. The money is yours, even if you choose for it to be automatically re-invested. The IRS will tax it one way or the other.
If he has a self-directed IRA brokerage account, then the taxes will be deferred and all gains will be taxed as ordinary income.
If he has a self-directed Roth IRA brokerage account, then what he said would be true.
“he seems to think because he reinvests his dividends that they are tax-free”
He doesn’t know what he’s talking about.
The taxation of dividends has nothing to do with what you do with them after they’re paid out. If they’re in a taxable account, they’re only tax-free if you’re in the 15% marginal federal tax bracket (he’s not) and they’re considered qualified dividends.
If they’re held inside a tax advantaged account, whether he reinvests them or not, tax will be due at his marginal tax rate when he withdraws the money.
Best,
-PoF
Definitely not true. I definitely focused on the real estate folks, but I run into a similar issue all the time with the dividend stock folks and the same issues apply. It doesn’t matter what your dividend is if the total return sucks.
It’s the same story over and over again.
Like Bernstein would say (I think), we as individual investors don’t have any better means or tools to identify high dividend stocks before everybody else also knows about them. By then, these dividend stocks become “hot” in the market & overpriced, and the returns are not impressive after that. And let’s not get started on timing them.
I used to be very confused about how investments in a taxable account are taxed. I did some research and ended up writing a post about it that you might find helpful. http://www.livefreemd.com/a-taxable-account-isnt-actually-that-bad/
I agree. There are significant tax advantages if you understand the rules. I wrote a post about it a long time ago and will probably hit it in the podcast in April.
https://www.whitecoatinvestor.com/retirement-accounts/the-taxable-investment-account-2/
This one is more recent:
https://www.whitecoatinvestor.com/12-rules-for-simplicity-in-your-taxable-non-qualified-investing-account/
Thank you for the additional information in those posts. I’m currently trying to keep things simple by automatically reinvesting dividends and not engaging in tax loss harvesting, but I agree it is important to understand the implications of those decisions.
Does automatically reinvesting dividends create any tax hassle when I eventually sell shares from my taxable accounts in retirement? Or will my long-term capital gains taxes all be calculated automatically?
The brokerage will calculate, but I like avoiding small tax lots so I just have all dividends go into a MMF and I reinvest them manually in taxable. I reinvest dividends in tax-protected accounts.
Brokerages recently began tracking and listing basis but for us older folk that might make their records incorrect, eg where we transferred already owned shares to our Vanguard account. Luckily the final sale price was lower some than at the time of transfer but I still included a note with the 1040 as to why Vanguard’s 1099 understated our capital gain. Another reason to do like WCI. And another example: selling the kid’s DRP for college was an Excel spreadsheet adventure with 4 tiny purchases a year over her lifetime.
I’m an Independent and believe a place for both real estate and equities.
Primary goal: tax shelter as much as possible since highest income years are now (probably).
1. Max tax shelter – 401k/403b, 457b, DCP, Roth, IRA, Keough , whatever one can
2. Taxable — this is where the depreciation on real estate can really impact and act like a tax shelter with a lower capture tax rate == essentially a tax shelter. Not as good as the pre-Bush days, but still pretty solid for high income earners.
–Real estate isn’t easy and has a learning curve and takes time–it’s NOT an index fund, nor the full benefits realized using a REIT or Peer investing like RealtyShares.
The passive income does come up nicely with the longer one holds . We’re year 5 into our holdings and rents have done nicely as well as overall appreciation. It’s a nice asset class to have that further diversifies our stock heavy tax sheltered holdings.
I’ve been invested in both equities and “passive” real estate (single family homes managed by professional property managers) for over 30 years. Over the last several years, I’ve swung much more heavily into real estate related investments. Here’s my take, as a high income non-medical professional:
-Many investors underestimate vacancy and maintenance/repair/make-ready costs. I have a portfolio of single family homes in the Dallas/Ft. Worth area, managed by an excellent property manager. Still, I find that I need to budget 20% of gross rents for these costs. I suspect the same is true for most markets with good cash flow across the US. (Investors who manage the properties themselves can probably lower these costs significantly, but the trade-off is of course their time.)
-I used equity mutual funds to build up a substantial retirement account. Several years ago, I transferred the funds to a self-directed IRA, which I’ve invested exclusively in real estate notes (private loans to other real estate investors). Since I want to stay passive, I don’t aggressively look for high-interest loans which I must individually “vet”. Rather, I found a company I trust that qualifies the investors and services the loans. The interest rate is lower than I could get as an active note purchaser/investor, but much higher than I could get from bonds or safe dividend stocks.
-Beware of investing retirement account funds in leveraged real estate or syndications. Any time an IRA uses leverage, UBIT (Unrelated Business Income Tax) may be due – and the rates are punitive (nearly 40% Federal on income above $12,000). (Depreciation may shelter the income during the life of the investment, but when the investment is sold, you may lose half of the leveraged part of the gain to Federal and State UBIT. This issue is particularly acute for syndications, which usually use significant leverage. Many promoters do not understand this issue. I’ve put some of my taxable account funds into syndications; I would never invest retirement funds in them.)
Great tips. I bet you could write a pretty good guest post on it. If nothing else, I’d like to hear about your process for finding your property manager. I would also be interested in learning more about the company doing the notes and how you found them.
The key for me was finding a good local real estate investment club with a focus on education and networking (not a club whose primary purpose was to sell stuff). There I made contacts that led to acquisition of my Dallas/Ft. Worth property portfolio, finding my property manager (it took two tries – the first manager came highly recommended, but their maint/repair costs were unacceptably high), and finding the firm I use for my note investments. In all cases, I found folks I trusted with a lot of active real estate experience to serve as mentors/advisors.
(My note investment strategy would be hard to replicate today. The principal in the firm, a “pillar of the community” type of guy, found he was really good at doing real estate deals and using data to predict California real estate price cycles; formed a company to educate other investors, and started a private money loan division to service qualified borrowers and accredited individuals who wanted to invest in real estate notes. Five years ago many borrowers could not get bank loans because Fannie Mae wouldn’t lend to anyone with more than 4 or 10 loans, no matter how well qualified they were, and private money was the only alternative. Now other alternative sources of financing have become available. As a result, the demand for private loans has dropped, and the company I’m using continues to service their existing lenders, but is not accepting new lenders.)
Excellent post UAPhil. I am just a senior resident, but I am now getting a $825 check per month from my RE investment.
General statement I believe in: Index fund is the easiest way to invest your money and forget about it. It’ll grow at a certain rate.
That being said. It is NOT my favorite because:
1. I now believe, after doing my first deal and gaining more confidence/understanding, that I can generate more in RE, safely.
2. I am getting market returns when I do indexing. I have NO control over it and I am not going to trade etc to gain 0.1%. That requires time and is gambling.
3. Since I don’t have control over returns, this sort of investing is just philosophically NOT investing for me. I do this because a) Markets have returned 7% in the past b) cycles happens so if market goes down then it’ll go back up. Following that comes whole bunch of academic discussions on portfolio analysis, sequence of returns risk, draw down rate etc etc. This has nothing to do with understanding income statements, business health etc. Its a scared approach for me. I want confidence and understanding where I put my money. That being said, I see where commentators/bloggers/financial people come from but not really.
As to argument about time and effort. My paycheck right now requires NO time. Just a monthly meeting with 3 other partners. Heck I am a resident, how much time do I have? I read alot and found similar thinking people. This is the same as how UAPhil joined the club. Its networking, not 10003254904358 hours that WCI is assuming you need or massive leverage.
I also have done private HML recently and returns have started to come in.
OVerall this is I understand, is passive, with higher returns. I have built in margin of safety. I consider that investment. I am also doing retirement savings/investing but honestly I just can do much more in RE and possibly in an ecommerce business with a partner. Cash flow style investing allows for increasing “velocity” of money, something I will NOT achieve in market/index investing. This $825 check? I am saving and am going to add my soon to be attending salary to go for another deal or RE notes/HML.
Anyways, a whole post can be written about this but everybody has different approach to growing money. Mine is that and couple of other undiscussed ideas. I also know WHY IRA doesn’t make sense for hardcore RE investors but it’ll be another post etc.
Short summary: UAPhil please enlighten us WHY you are doing more RE. This is more for public and not me (well not entirely true as I expect flack for my statements).
10 trillion hours? Seems a little excessive. I also disagree that a “monthly meeting” is zero time. If I have a meeting once a month, that’s a day I can’t go skiing. I’m also not sure where you get the idea that I suggest anyone needs “massive” leverage. Leverage and massive leverage are very different. In order to be cash flow neutral, a typical real estate investment can’t be levered more than 2:1-3:1 or so anyway. If you get much below that, you’ll be cash flow negative, depending of course on the cost of your credit.
I’m not sure you have a strong grasp of what you’re buying when you buy stocks. You are buying the future profits of real businesses that make real money. While you are not the CEO of those businesses, as long as those businesses keep making money you will keep making money. Market cycles get canceled out in the long run. The stock market index doesn’t go up in value because “it has always made 7%.” It goes up in value because millions of people are out there every day working hard to make their companies more profitable.
I’ve found the concept of “velocity of money” to be used most frequently by people selling something. It might be a real estate seminar, it might be mortgages, or it might be cash value life insurance, but it is rarely used by those investors who are out buying real, profitable businesses (including real estate properties) as investments.
Your allusion to IRAs not making sense for “hardcore real estate investors” doesn’t make sense. If you expect to be so successful that you’ll be withdrawing all your money at the top tax brackets, then just do Roth conversions. The tax-protected and asset-protected structure is still useful.
Tongue in cheek. But I guess it was lost on you… /s
Not zero hours but it is not much time commitment for a great return. Discouraging folks to invest for 1 hour a month? Hey everyone – is it worth it? To me it is.
I know what leverage means and what I need. But yes, what you say is true. Folks reading will benefit.
I have grasp on what it means to invest, but I don’t have control of it in the market. I don’t make decisions of how company will perform. Enron had plenty of hardworking people. It sunk. I want to minimize crappy companies (the reason for drag on market returns…one of many). There is LACK of control in the market and that is something everyone accepts. I accept. I just don’t like it, if for not much work I can make more somewhere.
YOU found velocity of concept bad. Associating with your “jihad” against whole life insurance is poor choice. Reason? completely agree thas whole life insurance is a crappy investment. But I AM using my monthly checks to save and reinvest. Please enlighten me: These streams of income increases the capital I can invest in stocks, bonds, other investments. What is wrong about that? If people don’t understand that then too bad. I get cash flow, I re-deploy that back into another investment. Biggest issue with index investing is it is NOT for monthly cash flow its to build nest egg to draw down. I don’t have enough knolwedge to develop similar thing using dividend stocks – If I try doing it it’ll be gambling. Recommendation: may be you need to not go to those seminars then.
Last point is valid, but I found this (http://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/roth_ira/withdrawal_rules)
Withdrawals from a Roth IRA you’ve had less than five years.
If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties. You may be able to avoid penalties (but not taxes) in the following situations:
You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase.
You use the withdrawal to pay for qualified education expenses.
You’re at least age 59½.
You become disabled or pass away.
You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
The distribution is made in substantially equal periodic payments.
.
What am I missing? If so then THIS is the reason to not have IRA. Access to money is just not immediate.
For the record I have roth IRA, but unless you tell me I can access it right now, it is not really a checking accout or LOC I can tap for investment.
Its just a different mind set. Different people go for different stuff. This was the genesis of my (possible) future blog. I do both investments, and am personally interested in work put in + return + long term benefit in both and document it.
That’s a long and rambling comment, so it’s tough to respond to.
There are two reasonable approaches to investing.
The first is to not put all your eggs in one basket. Think of it as buying an index fund. You get the profits of many companies and don’t need to know anything about any one company. Save a reasonable percentage of your income and invest it that way and by the time you are done practicing, there will be enough money there to live the rest of your life.
The second is to put all your eggs in one basket and watch it very closely. Think of this like entrepreneurship. There are huge risks, of course, but an entrepreneur feels they are manageable and at least somewhat in his control. There are also huge potential returns.
There are all kinds of options somewhere in between these two. Maybe buying into a real estate fund where you know the manager personally. Maybe buying a bunch of syndicated properties on RealtyShares after watching their webinars and going through the financials. I’m doing both the first and the second and a bunch of stuff in between. We’ll likely all find where on that spectrum we’re comfortable. It sounds to me like you lean more toward the entrepreneur side, which is perfectly fine. It’ll likely work out great. But that hardly means there is something wrong with the index side. Different strokes for different folks and many roads to Dublin.
I typically use velocity of money to mean adding leverage. A typical example is a guy who runs seminars here in Salt Lake. He wants you to close out your 401(k), pay the taxes and use the proceeds to buy some cash value life insurance. Then he wants you to borrow against that and buy a second home. I spent five blog posts debunking the whole concept years ago. But every time I hear “velocity of money” it reminds me of those schemes where you leverage everything you own to the hilt. Leverage works great until it doesn’t, and then you realize it works both ways. What a lot of overleveraged people don’t realize is that you only have to get rich once.
I think you would benefit from more reading on Roth IRAs and retirement accounts in general.
Not only can you pull out your Roth IRA money RIGHT NOW, but you can invest INSIDE your Roth IRA in most investments without pulling the money out.
But it’s really not designed to be a checking account or a line of credit. If you want those features, get those features. If the tax benefits of an IRA are not good enough for you to lose immediate access to your money, then don’t use it. But I think that’s foolish. (You may also want to look into the concept of a Checkbook Roth IRA if you wish to invest in real estate in your IRA with relatively liquid access to the cash.)
And keep in mind that you can always pull direct Roth IRA contributions out tax and penalty free and use it for anything. I wouldn’t recommend you do that, but you could. The 10% penalty only applies to earnings.
Good luck with your blog.
I’m glad the blogosphere didn’t exist when I was in my twenties because I probably came off equally cocky and it would be painful to read. That said, success takes a good measure of self-assuredness.
G,
Not trying to be cocky but honestly who even has a contrarian point on this blog? The whole life insurance agents?? Lol
Anyways. Appreciate the comment.
Good points.
Re: Roth. I was mentioning what I see other investors do, not what I will do with Roth. That will remain in my “market” portfolio. The problem isn’t just access (you may call them foolish, but these investors I know are increasing their net worth by gangbusters. Kamban, can you please elaborate how the Patel’s are doing?). You can do how much in Roth IRA per year? 11,000 ? You need about 5 times that to make a small RE deal. So yea most don’t bother.
I don’t know, I could buy a house for cash with my Roth IRA. And another one with my wife’s. Those little $5,500 contributions add up after a while. You can speed the process up by doing Roth conversions.
my detailed response just got lost. Not sure why. Too lazy to type the rebuttal now.
You can’t go ski, yet you write this blog to make ~1 million dollars a year. Why? Just ski all the time. Oh yes, you find this endeavor not super taxing, enjoyable and very lucrative.
I find my way NOT taxing (one hour a month…ooohhh soo much work), enjoyable, and hopefully very lucrative soon.
The rest of points eh too much to type.
It was in the spam folder. I just pulled it out.
Who said I can’t go ski? I said I can’t go to a meeting AND go skiing at the same time.
Was trying to make a point. You can’t go ski and write a blog post. Same principle.
I’ve written several blog posts from ski lodges in the past. I could probably even do a podcast or a youtube video from a chairlift. Thanks for the challenge.
Fine. I can do a meeting on skype while in a ski lodge. Come on , you know what I am trying to say.
I’ve got to give you a hard time with all the hard times you give me!
Complete_newbie – hope this will help you understand why I decided to focus on real estate, and give you some useful insights.
-First, my background – I’m in my late 60’s, living in California, and working in the tech industry (director-level individual contributor position at a large Fortune 500 company). I cut back to working half time about 10 years ago. I really enjoy what I do, and get great mental stimulation from it, so I plan to continue working in my field at some level for the foreseeable future. I saved very aggressively earlier in my career; am now fortunate to have “won the game”. So my primary goals are to (1) preserve my assets, and (2) to get as much passive income from them as I can without risking (1).
-Earlier in my career, my investments were somewhat haphazard – a few rentals; various equity and bond mutual funds, funded primarily from savings (saved close to 50% of income for the first 15-20 years of my career).
-About 10 years ago, I became more focused financially. Decided to move more heavily into single family rental homes because, over time, on average, they are expected to provide fairly reliable income, which keeps pace with inflation. From my real estate investment club, I learned that, in the Dallas/Ft. Worth (DFW) area, you could purchase “turnkey” homes (newer homes in good working class neighborhoods, fully renovated, often with a renter already in place) that would pay $1100+/month in rent for about $110,000. I 1031 exchanged my existing rentals into DFW, and used savings to buy more DFW rentals “all cash”. My portfolio is now generating significant income that will help fund my living expenses moving forward.
But there have been some “bumps in the road”. As noted in an earlier post, my first property manager didn’t work out because their maint/repair/make-ready expenses were too high. I’m happy with my second manager. Also, property values have increased faster than rents in DFW, so my “typical” home is now worth about $160,000, with $1300 monthly rent. This means my property taxes (about 3% of home’s value in Texas) have increased much faster than my rents, which is impacting my cash flow. If this trend persists, at some point I may sell one or two rental homes to compensate for the reduced cash flow.
If I had it to do over again, I would take a closer look at apartment syndications. The trick is to find reliable, experienced syndicators you trust. Syndications are clearly more passive than direct rental investing, and, for a passive investor, might give a better financial result. But there are tradeoffs – they are much more complex, especially if inherited by family members at your death; and you have less control. (There are also commercial syndications – shopping centers, office buildings, manufacturing facilities – which can give higher returns, but with higher risk.) (I recently bought my first shares in an apartment syndication I learned about through WCI; may buy more over time.).
I also learned about my “truly passive real estate note” source through my local real estate investment club. After my retirement accounts (which were invested in equity mutual funds) recovered from the “great recession”, I decided to completely transition from equities to notes. They’re working well for me – I haven’t had any defaults; my biggest problem is re-investing funds from early payoffs. As noted in an earlier comment, it’s probably not feasible to go the “truly passive note route” today, but those who are willing to actively find and vet notes can still do very well with them. (My 401k allows in-service withdrawals because I am older than 59 1/2. This allowed me to move the assets into a self-directed IRA to purchase the notes.)
Thank you so very much. Very helpful. I don’t want to brag, but I sort of have come to similar conclusion like three months ago lol. But again, you are the man. Thank you. Inspiring.
Still I will invest in the market, index fund for 401K match and some tax protection, but it seriously doesn’t interest me much. Its acting scared. Like “hey I hope I have enough to retire blah blah”. I want to follow what you did…like now. And I am.
This is not to dog index investing. As I said, it is EXCELLENT for people not giving a hoot about extra work. But I want to see how much work I do besides medicine and what the reward is. I bet its large and completely worth it for small amount of work (to me atleast).
I don’t think it has anything to do with “acting scared.” Avoiding work? Sure. That’s one of the huge benefits of index fund investing. We get to use our limited bandwidth elsewhere in our lives.
I also agree with you that entrepreneurial work is worth it.
Do you worry about having a large percentage of your real estate equity investments in one market? I mean, DFW has been awesome for the last 10-15 years, but what if that doesn’t continue? There is a lot of pressure there these days due to changes in the oil markets.
I agree that my concentration in DFW is a risk factor. But DFW is not heavily dependent on oil; its economy is highly diversified. So I decided the risk was acceptable. (If air conditioning became un-affordable for prospective tenants, now, that would destroy DFW and the entire South. 🙂
(The alternative is to buy properties in many different markets. That would require working with many different managers and teams – not passive enough for me. But many RE investors do go this route.)
(My real estate notes are secured by individual California single family homes – also somewhat concentrated geographically, but another risk I find acceptable, given their low “loan to value” and well qualified borrowers.)
Lurker here that just wanted to add that the little bit of bickering back and forth is actually nice to see. I’ve learned from it so thank you, guys!
I’d LOVE to learn more about investing in notes/hml. WCI, future post?
I’ve got something that touches on it in 2-3 more weeks.
Hey,
NP. I did it to get WCI angry. /s
I invest in “notes” but I create my own. As a resident. Yes you heard it right. Find templates online, but to actually have lien on a property is beyond scope and state dependent and you better consult attorney.
I much rather type all this on my own blog though – so stay tuned. Briefly, Your exposure to HML can be had through crowdlenders, but I don’t consider that HML – you are buying notes secondary from an aggregator and that is what WCI will post about. Thats fine, but realize they get a good cut (they are middle man).
I would say that majority of readers here are just better off following indexing all the way for everything. Its easier and not much management and that is the message of the blog which is fine for a busy doctor.
I just like experimenting and learning and entrepreneurship just is fun for me.
You’ll know you made WCI angry when you find your comments don’t post here any longer. 🙂
It’s all about diversification. Real estate is all fun and games until the local market collapses because the local industry fails. The markets all food until the bubble collapses. Bonds are great until interest rates rise too far. Commodities are good why the economy rides high. All have potential non correlated down sides.
Reasons why I don’t own any real estate:
1) My time is precious and I am not interested in learning another skill or another trade. I am also not interested in having to directly manage properties or those investments to maximize gains.
2) I have created a pathway to financial independence in my early 40s that only involves index funds. Adding more sofisticated investments may get me there a little sooner but at what cost? Currently the few extra percent in gains on some of my investment just don’t make it worthwhile to spend my time and energy on.
I love the idea of real estate investing but at this time I do not want or need the hassle of it. Maybe in retirement or semi retirement I may be interested in taking the time to learn. For the time being I will stick with what I know.
I (or members of LLCs) have several investments in private businesses. A couple have exit strategies. They haven’t paid any dividends but they could offer a big capital gain payoff in the future and that would be great. Or they may go nowhere – such is the risk of early startup private placements, Angel investing, VC etc.
There are, however, a few other companies or partnerships that I invested in that pay large dividends. The assets continue to grow despite very large quarterly dividends. It does create a tax issue. Some K-1 consider it ordinary income and others consider it “real estate” income and since the businesses are similar I’m not sure why… but at any rate I don’t need the income. I actually could live well off the dividends alone from just those 2 investments. Although they increase my taxes it doesn’t make sense to sell the investment. I got my money back in about 18 months so it is a no-lose situation. I’m not sure what my point is here except maybe that sometimes even when you don’t seek income or dividends they come your way and despite the tax, they can be worth it.
I agree that more dividends, like more income, is a good problem to have. It might not be the most tax-efficient way to make money, but it sure beats not making money at all.
Dividend and income investing in general is not something I thought much about when I was younger. If you accumulate a large enough portfolio it happens. I find even without being a “dividend” investor my taxable account throws off more than enough money for me to live on. I find no need to chase high dividend stocks or junk bonds. I anticipate the problem with too much income to worsen in the next few years because interest rates will rise some increasing the payout from muni bond funds and dividends are low right now. This is a first world problem. If you invest your money in a diversified way early in your life you can coast into retirement . Many roads to Dublin be it real estate or index funds or even individual stocks. The key is to save it in the first place and put it to work. Real estate is too much work for me personally. I do own several properties but I consider them consumption items.
I love your analysis. Now that I have more time on my hands I’ve been contemplating picking up a rental property. It’s just hard for me to justify the additional work and mental bandwidth that the property will take up for marginal extra returns over my REIT holdings. However if the right deal comes up, we are ready to pounce. My brother picked up a couple properties recently at auctions, and should make a good profit flipping them. The key for us would be to make our money when we buy the property, not when we sell.
But I’m also happy not stressing about my investments at all 🙂
In reality none of what we’re doing in the market is technically “investing” since were in the secondary market, unless of course you have access to an IPO, etc…Everyone calls it investing and thats fine, but its a savings plan of course.
Real estate is more like investing as are individual businesses, etc…RE can be an exciting idea but there is certainly a good bit of work involved, and not the fun intellectual work, the PITA kind of work. At some point most busy docs probably would rather trade the headache for simplicity. I was gung ho about RE for a while, but getting harder to trade away my non headaches away as I get older. Discount is acceptable taking that into consideration.
I have my test RE/landlord deal, but I wonder if I’ll truly enjoy it rather than a similarly matched market endeavor. The tax benefits are whats hard to ignore. Very interested to see how all these syndicate deals mature since they are relatively new and not all benefits are available on all platforms.
Zaphod. Thank you. Your first paragraph is what I have concluded independently except ofcourse I get lambasted for being “rough/cocky/self assured” when I try making that point. You did so eloquently and succinctly.
Great post.
I am a member of a Real Estate Investment group as well as being a RIA and spoke on this very topic to the group Wednesday. I echoed some of your points about making sure your comparisons with other investments were apples-to-apples (risk adjust the hurdle rate, use total returns, don’t let leverage distort your analysis, don’t ignore the opportunity cost of your labor, and for heaven’s sake use an after-tax return).
I’ve found real estate folks are loathe to diversify, putting every dollar they have (and three they don’t) into real estate.
What do you think about this:
http://blogs.wsj.com/moneybeat/2017/03/17/new-real-estate-funds-try-to-make-concrete-liquid-for-investors/
I think I don’t have a subscription to the WSJ. I assume they’re referring to all the new funds out since the JOBS act. The difficulty comes in choosing which one to invest in. Just not much data since it is all new.
Hi WCI, great article. Income investor writers and bloggers are a bit of a pet peeve for me. I don’t appreciate that they are espousing their readers to continue working years beyond when they need to in jobs they hate in order to live off income alone.
Curious, though, what’s your source for this statement? “Your expected nominal return from an unleveraged real estate property is the cap rate, which is typically between 4 and 10% plus the rate of appreciation, which generally tracks inflation (technically the land goes up faster than inflation and the building depreciates,) so perhaps 9-10% total.”
I find evidence that over decades in the US, real estate returns are about 1% over inflation: Case Shiller http://www.multpl.com/case-shiller-home-price-index-inflation-adjusted/
And doesn’t it make logical sense? If workers make 3% more per year on average, but the price of homes goes up by 9% per year, then pretty soon homes become unaffordable!
This blog post, while tongue-in-cheek, exposes a lot of the risks and costs of real estate. It’s primarily focused on one’s own home, not rentals, but many factors still apply: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
Full disclosure: I’m a 100% mutual fund investor/retiree with 14% in REITs. I am a TOTAL RETURN investor, living off both dividends and price appreciation.
Shiller’s index tracks only the price increase of a purchased home that is lived in. He doesn’t count the dividends (i.e. saved rent) as part of that return. Nor does he track the income from an investment property. If you think that’s the return real estate investors are actually getting, I think you probably ought to take a closer look.
Think of it this way. You buy the house next door for cash and rent it out. I appreciates at the same rate as your house. That rate is probably something between 2 and 4% over the long run. Something between inflation -1% and inflation + 1%. But that’s not all you get. You also get the income. So rent minus all your expenses is still a positive number. Probably something like 4-5%. So add that to the appreciation. That’s your return.
Thanks for replying and the education!
The odd thing was that he was pretty much advocating for what I do- invest in index funds, invest in real estate, buy some bonds, do what Bogle and Buffett say etc. Not sure what got him so fired up. He seemed more mad that WCI was profitable than anything.