Posted by John Corey on May 21, 2006 at 10:14:15:
Frank,
Using the glass is half full I will conclude the following from what you wrote.
The fundamentals of what I posted work just fine. How much you need might be more than one would expect. Hence you just need to grow the assets more or earn a better return on the assets when in retirement.
John Corey
PS. I agree about the medical costs growing faster than many other things.
Creating a retirement fund - Posted by John Corey
Posted by John Corey on May 20, 2006 at 08:31:19:
The following is a high level view so some of the details are not optimized or spelled out.
Lets start.
Assume that when you retire you want passive income and you figure you can earn 5% on your money (gross). That you will do nothing at all to earn the 5%. Completely passive.
If you live on X today then you will need 20X to retire. $50K today gross (before tax) means a pile of money equal to $1M invested at 5% to produce the $50K passive. Forget inflation for this discussion.
How can you get there?
If the average house price in your area is $50K then you could buy 2 a year (at full price). If the average is $100K then you could buy 1 a year (at full price). Any ability to find a great deal at a discount just improves the math.
Lets assume you buy $100K a year (2 times $50K or 1 times $100K). After 10 years you have what you need but you do not have much equity yet. Hence you have laid the foundation but you do not have the full solution yet.
Over the 10 years and for years to come you rent the property. The tenants pay a fair rent and they are happy with the trade. They get housing and you get the mortgage paid off. Lets assume rents go up but your mortgage is fixed. Further assume a good debt to income coverage ratio so all running costs are really covered by the rents. Harder when you start. Easier after a few year of rent increases.
Maybe you pay the property off in 20 years as rents have gone up faster than the increase in costs so you have been throwing some extra cash at the mortgages to pay them off early. Or pick 30 years. Pick what ever works for you but assume the mortgage gets paid off. No refi’s.
Now for retirement
You have $1M in today’s dollars worth of equity and income rolling in. You want to end your career as a landlord and choose to cash out. Ignoring the closing costs and other things like taxes (there are ways to address these points but I want to focus on the big picture) you collect you $1M in equity.
Taking the cash down to your friendly banker they offer you 5% on a CD and you have your retirement income.
Does everyone follow the model so far?
Your tenants are like you staff. They get up in the morning, go to work and earn money so you can retire. You use bank financing to grow your business with the staff producing the income necessary to pay off the debt. You are ill some days and yet the staff are still there working away to pay your bills.
At the end you cash out and you have a passive income.
Coming clean…
I glossed over a lot of details. Most all of the hurdles can be addressed by minor changes in the high level assumptions. Hence it can definitely work. The model takes the application of time and effort in a focused way.
The point?
People sometimes miss the big picture in their rush to hit a home run or get rich quickly. They fail to see that if you can get a large number of people pulling for you the result will be greater than doing it all yourself. Let time and the efforts of others (the tenants in this example) make the difference.
There are optimizations and ways to convert the above into a 10 year plan. Lets see where the discussion goes before trying to turn the above into a do it now, get rich quick model.
John Corey
Re: Creating a retirement fund - Posted by Frank Chin
Posted by Frank Chin on May 21, 2006 at 08:53:21:
John:
Inflation, and health costs are the two big “unknowns” in retire planning. For this reason, I did not count on a fixed percent (5%) for a certain target fund amount ($1,000,000).
I watched my dad and his contemporaries plan for retirement, and in the late 1960’s, when some of his freinds retired young, $100,000 was considered a “princely” sum. Back then, you can live on $5,000/year, collecting 5% on $100,000 in CD’s.
Fast forward 30 years, and you’ll find the amount revised upward ten fold to $1,000,000, and retirement planners would tell you that you’ll probably need several million, at least $2,000,000 minimum.
Rather than basing retirement on a percentage of fixed target, I did something similar to dealmaker. I see that a free and clear 3 family house in NYC would earn me 25% or more of what I need, currently around $2,500/month, after taxes, utlitlies and insurance. Four of these would equal $10,000.
I know of a local retired grocer, who owns two “2 families”, and one large “3 family”, all free and clear. He lives in one of the two 2 families rent free and DOES NOT rent out the other unit, using it for grandchildren to visit. The other two nets him over $5,000/month, more than enough live on, he says.
There’s two schools of thought on retired people based on one’s lifestyle.
One is a quiet lifestyle like my dad and the grocer. The children are grown, they do not vacation much, collect social security. For this group, I see them comfortably living at less than $5,000/month. They tell me being able to relax at home, no worries, is the best retirement.
Before my dad was bedridden, and hired an attendant during the day, I was shocked that he told me his monthly expenses were below $1,000.00. Living in a free an clear property helped. He does not own a car, depending on neighbors for shopping or walking to neighborhood stores. For years, he bragged that “not having a car” paid for his retirement. He tells he his grocery bills runs around $300, $400 tops, a month. Add electric bill of $50 to $75.00, the basic phone bill (he refuses to pay for touch tone), insurance, and now medical expenses off $200.00/month, he merely needed $1,000.00/month.
The local grocer told me that what he make on rent is more than enough for his needs.
On the other extreme, some active retiress plan to travel, and enjoy the early part of their retirement much more. I can see that they would need at least $10,000/month, or perhaps more.
One nice thing about basing retirement on rentals is that it is “inflation” adjusted. As my dad owned a commercial property, commercial rents went up about three fold from the 1960’s to the 1980’s, and again three fold from the 1980’s when he retired to today. Indeed, went up ten fold from the 1960’s to today.
Someone with $100,000 retiring in the 1960’s making 5% on it would not see his “passive” income going up ten fold, or three fold from the 1980’s.
Further, I see no need to “sell the property” at retirement, if one owns some small commercial properties, with minor property management help. Lessee’s of commercial properties pay RE taxes, fuel, and do maintenance. Not only does it take inflation out of net rents collected, they provide property management services.
With the proper type of tenants, turnover can be kept to a minimum, unlike residential tenants that move about every other year.
I see my dad retiring very well on ONE commercial property. And because he had other savings and social security, he banked his rent checks for the last 20 years after the property was free and clear. And then, it was only a 5% mortgage of $15,000 before it was paid off!! Just putting the rent away alone added another million or two to his net worth.
As for myself, I accumulated a nice 401K nest egg that would certainly exceed $1,000,000 by retirement, but it’ll be for pocket change by then. I don’t expect $1,000,000 to support myself at retirement.
One other important element in retirement planning is insurance, and for someone with wealth, “long term care insurance” is worth a look. A major illness, and a stay a nursing home facilty a $300/day would quickly wipe it out.
While my dad was smart enough to get “Blue Cross” to supplement medicare, after a mjor operation, he stayed at a nursing facility where “Blue Cross” only covered the first TWO MONTHS of rehab, and he was on his own for the third month, at $300.00/day, when he insisted on “checking himself out”. Said he didn’t like the food. I thought it wasn’t bad as I ate his dinners during my visits, bringing him real food from the Chinese takeout. The split pea was so delicious, that the staff gave me several bowls that was left over!!
He could have paid a small amount to Blue Cross for what they call “endorsement H”, which would have covered it all. He has since bought the coverage.
John, basing retirement on “passive income” of only 1MM, ignoring inflation, is asking for trouble, and even 5MM would be inadequate if you live a retirement of 30 or more years. Factor in either an active lifestyle, or major medical bills, certainly is inadequate.
One other point.
Many on this board deride “collecting rent”, pointing out the quick profits of flips.
I have to say watching my dad the last several years is that it’s awfully hard doing flips hooked up to an oxygen tank, with an attendant helping you shower.
Rents checks - NO PROBLEM. I can even help to pick it up!!
CONCLUSION
Do all your flips young, and get a commercial property. Teach your kids how to collect the rent checks while your attendant help you shower.
Frank Chin
Re: Creating a retirement fund - Posted by dealmaker
Posted by dealmaker on May 20, 2006 at 12:07:46:
I like it John! In fact I did something similar.
My reasoning was; if the “average” rent is 20%-25% of the “average” income, then I would need 5 or 6 PAID OFF ppties to generate an “average” income. I know the strict math says 4 to 5, but I threw the extra one in there to cover taxes, vacancies and maintenance.
I ended up with 16 units. 10 I owned with my wife, the other six I owned “1/2 houses” with family members. Every extra nickel I got I threw onto principle. I got to the point where out ppty income exceeded our “regular job” incomes, schweeeet!
When I decided to move out of the metro area (Houston) and move to a lakeside community for retirement (at 53 years old btw) I started liquidating. One key point that I discovered was that when you own ppty FREE AND CLEAR you can offer great terms to buyers and thereby jack up your sales price above market. We also took our highest price unit and did a 1031 into the house we wanted for our retirement place. We rented it for two years and then moved into it so we can’t sell it yet because of the new “five year” rule.
The only downside to selling the units was I discovered that those deals have to be a “happy/happy” deal. Notice I didn’t say “win/win” deal. By happy/happy I mean that you (the seller) have to be happy with the price, and happy with the interest rate. Since it’s no longer a rental you can’t correct underpricing in a year or two when the lease expires!
Anyway, thanks for pointing out to others a good way to take a long view on REI.
dealmaker