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I have 401k's from previous job (wife and I) Can someone convince me that I shouldn't cash out and buy (2) houses that will generate me$2200 a month in rent..$1700 net approx? We also max out 2 new company 401k's so we still we be in market. Need allot of money in 401k at taking out 4% to get $170

I already have 2 rental properties so I'm not a newbie. according to my calculations, I'd need $500,000 in 401k approx. withdrawing 4%. Then I get taxed..also fees and such volatility etc. etc. We're in our mid 40's. We could generate the same income with allot less money and use that money now as well or just save etc. etc. I realize tax implications and penalties but at these housing prices it's hard to ignore this way of thinking. Am I crazy? Do I need to go see a shrink? Thoughts on this situation would be helpful. Thanks, J

Jun 22, 2012 by Justin from Bothell, WA in  |  Flag
4 Answers  |  6 Followers
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2 votes

Justin - before deciding to do so, consider the tax penalties and ordinary taxes on early withdrawal from the 401ks. I would consider this part of the initial cost of investing in the real estate properties. Then consider the liquidity constraints on the real estate, the associated annual maintenance costs and the future liquidation costs. I would suggest a cap rate of roughly 10% would be necessary to make this all worthwhile.

1 Comment   |  Flag   |  Jun 22, 2012 from Clinton, NJ
Justin

Thanks John, I failed to mention that I haven't rolled over the 401k's they are just sitting there waiting for me to do something. I just hate the fact that since we are already maxing out 401k's (have been for 3-4) years in our new company 401k's, and all of the exposure to the market. I'd rather diversify and have some income coming from other places rather then "hoping" that I'll have enough money in the market 15 years from now when we are thinking about retirement. Thanks for your response! Have a good day. J

Flag |  Jun 22, 2012 near Bothell, WA

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2 votes

Justin,

Please keep in mind that as I answer this question I am drawing on 16 years of experience of working with thousands of families over those years. Just like a teacher, who sees students who do well and do poorly, so do wealth managers see clients who do well and others who do poorly. There are almost always clues to their success or failure. While this is likely the ONLY time you are at the point of making this decision - we have seen the successes and failures of others.

First - a few years ago, there were all these people yakking about how "you can't lose money in real estate." "They're not makin' any more dirt!" they said. Well - guess what? Tons of people lost tons of money in real estate over the last several years and now, you can't say "you can't lose money in real estate" without getting laughed out of the room.

I personally own rental properties, and have for years. I hate them and would sell them in a minute. Most of them have been moderately profitable, but certainly nothing to write home about. And there are always problems - repairs, taxes, easements, regular maintenance, tenant damage... and not to mention the times that they DO sit there empty and don't generate any money. So the assumption that these houses will just squirt money at you every month is a fallacy.

All that being said - if you are absolutely serious about it and I cannot convince you otherwise, after watching so many other people go down this painful path - then I would maybe suggest you look into what is called a "self-directed IRA." There are a FEW custodians (just google "rental real estate in an IRA") who allow you to:

1) Roll your 401K to their IRA 2) direct your IRA to buy the house within the IRA. The IRA becomes the owner of the house, not YOU 3) Keep all transactions - income and repairs - INSIDE the IRA.

This completely avoids the early withdrawal taxes and penalties that John mentioned above. However - you do not avoid the pain of rental property ownership that I mentioned above. Essentially you will go from your present state of "hoping you have enough money in the market" to "hoping your tenants pay on time, hoping they don't burn down your house, hoping no one gets hurt on the property, hoping you don't have to pay for repairs, hoping property taxes and insurance don't go up... etc. etc. etc."

Jon Castle http://www.WealthGuards.com

3 Comments   |  Flag   |  Jun 22, 2012 from Jacksonville, FL
Jonathan N. Castle, MSFS, CFP®

But just to make a small addition - and since you are not a rental property newbie - in all my 16 years, I have NEVER (not EVER, not even ONCE) met someone who was ready to retire successfully who got there by buying and owning a bunch of rental properties. Not once, contrary to Dave DelDotto and all these other people who write about how successful they were doing rental properties. Not ONCE. And I have seen a LOT of people over the years. Usually at age 60-65, when they are wanting to retire, they've got all these rental properties and are trying to figure out how to sell them. And no one wants to buy them for the price they want... so they end up taking a bunch of owner-financed notes back... half the time they get the houses back to fix up and tinker with again. While their friends who just put money in their 401(k)'s all those years retire happily with a bunch of money in their IRAs, no headaches, and travel and enjoy their retirement. Just saying what I see, that's all.

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Flag |  Jun 22, 2012 near Jacksonville, FL
Michael L. Wilson, MBA, CFP®, CRC®

I think Jon hit the nail on the head! If you really want to go the rental property route, then the key is to avoid any 401k early withdrawal penalties and taxes. The self-directed IRA may indeed be the way to go; just be sure to pull in a really good tax advisor before you pull the trigger. It would not be fun to discover a few years after the fact that the IRA was not set up properly to hold rental property.

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Flag |  Jun 22, 2012 near Orland, IN
Justin

Thanks Jonathan and Michael, I have looked into a self-directed IRA and may go that route. Jonathan, I appreciate you throwing out all of the scenarios. Yes, many things to consider. Certainly not ready to pull the trigger yet on anythng. Stock market so incredibly volatile, and just like many people you have known that have lost allot of money on real estate..there is many that have lost much more in the markets. It's all about timing, where you are in life, what your hobbies are etc. etc. If housing prices were not so low (near or at bottom?) I wouldn't even be considering such an option. I have to believe that the $80,000 house I buy (for example) that was selling at $200,000 just 2 years ago...is going to be worth almost maybe $150,000??? 15 years from now if not more. Thanks for your input, both of you. Much appreciated. J

Flag |  Jun 22, 2012 near Bothell, WA

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1 vote

Hi Justin, I think it's worth realizing that rental real estate isn't really an investment; it's a business. And, as you add properties, each property is a separate business unit. As Jon points out, at retirement it can be hard to find one person to buy all your business units... and even harder to find multiple people to buy the entire package. It just never seems to work out that way.

I'm sure you can locate a CFP® practitioner near you who is fee-only and also a registered investment advisor working under a fiduciary standard. That may be your first best investment.

1 Comment   |  Flag   |  Jun 22, 2012 from Moorpark, CA
Justin

Thanks Jim, for your comments. J

Flag |  Jun 22, 2012 near Bothell, WA

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1 vote

Given the prices on offer in some markets, I agree that a strong case can be made for buying rental properties as a part of a diversified retirement plan. Warren Buffett--a man who has forgotten more about stock market investing than most money managers will ever know--said publicly that Berkshire Hathaway would buy hundreds of thousands of rental homes if it were feasible. If not now, after a major crash and with interest rates at historic lows, then when?

That said, you should consider the following:

  1. Your expenses are ALWAYS higher than you thought they would be and your profts are ALWAYS lower. Lower your net cash flow estimate by half to be conservative, and if it no longer makes sense then keep looking for a new opportunity.

  2. Watch out for HOA fees, if applicable. In my very first experience with rentals, I failed to fully consider HOA fees, and it made the difference between my investment being marginally profitable or marginally unprofitable.

  3. Rather than pull money out of the 401k to buy the houses outright, finance the properties. If you need to take short-term loans out of your 401k in order to cover the payment while looking for a renter, this is a better alternative that withdrawing a large amount of money and taking the tax hit. If you cannot do this without assuming a reckless amount of debt, then scale back your buying plans.

1 Comment   |  Flag   |  Jun 22, 2012 from Dallas, TX
Justin

Thanks Charles for your input! Regards,

Flag |  Jun 22, 2012 near Bothell, WA

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