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
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.
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
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.
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:
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.
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.
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.