question about retirement income and leverage

[Frank C.]

I have been diligently reading BP recommended books, blog posts, and listening to podcasts (45 so far) to further educate myself about real estate investing. I am very impressed with the BP website and community. I am hoping to leverage that community to help me wisely use real estate investing to improve my retirement plans.

I am nearly 47 years old. The first phase of my career required paying off school loans, getting established, and building my business. I am finally reaping the benefits of years of school, training, and time in the trenches. My income should remain high for the remainder of my career. There are few who can do what I do and the barriers to entry are exceedingly high. The only problem with my career is that it requires 60-70+ hours per week by the nature of it. It is very complex and interesting. I am definitely making a difference in people's lives. In spite of the hours, I am not interested in changing careers as great as some of the guests on the BP podcasts make their work sound. I do want to set things up so that I am not forced to work this hard beyond 60 years of age when I plan to retire.

My goal is to generate $15K per month in passive income from at least three streams by the time I retire at 60. This is substantially below my current income level, but it should be adequate for my family's needs.  There is safety in having diverse income streams and that means more than owning both small and large cap mutual funds. I am not hopeful that "Social Security” will provide much of a meaningful return so I will not depend on it in my quest to reach $15K per month. I plan on having my primary residence paid off by age 60. We are nearly 10 years into the 30 year mortgage and the interest rate is 4.25%. I have adequate amounts of term life insurance and own occupation disability insurance.

Stream 1) rental property- My wife and I plan to buy and hold single family houses for passive income to be used during retirement. I plan on buying perhaps one property per year for the next 13 years.

Stream 2) commercial property-  A partner and I own a building that is leased to a busy medical practice next to a hospital. It will be paid off in 4 years. I have have received good cash flow from this property over the years, but it will generate about $3.4K per month to each of us once the loan is paid off.

Stream 3) retirement funds- I have a Roth IRA, a couple of other IRAs, and a 401K which my employer matches. Conservatively, I should be able to earn $4-5K per month from interest/dividends from my retirement savings when I am 60. I can earn even more if interest rates drift back toward historical norms.

The rental properties need to cash flow about $7K per month for me to reach my $15K per month goal. My plan does not involve dipping into retirement funds to cover my living expenses. Rather, I plan to use only the income from the assets.  I want big margins of safety.  What is the best way to reach this goal of $7K per month from the rental properties in 13 years?

One of my other questions relates to leverage. I love the idea of using mostly others people’s money to buy assets that will be paid off by someone else, that will last for 100+ years, that will pay me almost every month, that will lower my effective tax rate every year, and that will almost surely appreciate over the course of my lifetime. In spite of these great attributes, I fear that many books, articles, and podcasts do not give enough attention to the risks involved with being over leveraged. For a guy like me, what is over leveraged? I do not need to swing for the fences. Leverage is great when the tide is high, but you get to see who is swimming naked when the tide goes out. I understand that buying at a great price, careful analysis to make sure the investment will cash flow, screening tenants well, putting aside money for vacancy, cap ex, etc. provide a good measure of protection. However, I have a nagging fear that the USA may suffer a major financial collapse, currency crisis, major war, or other catastrophe that could prove to be a challenging environment for anyone who is highly leveraged to survive financially. Thus, I want to be pretty conservative with the debt especially when I am no longer toiling at my day job. Everything in my line of work and general life experience teaches me to be aware of and to account for the black swans that can foil your best laid plans.

Starting this year, I should be able to put $30-40K per year toward rental properties or other assets. That amount will probably double in 6 years when the kids finish collage. Given my conservative nature and my financial position discussed above, how should I proceed? I will not need the cash flow at all until I retire. Should I maximize my cash on cash returns by putting as little down as possible? Should I keep a massive amount of cash in reserve? If so, how much relative to the debt? If I buy one house per year, I will be carrying perhaps $1.5 million in obligations when I am 60.  Should I aggressively pay down the debt or let the tenants pay the debts off slowly over time?  Once I reach age 60, should I sell half of the properties to pay down the debts of the best properties and keep these long term to spit out passive income? What are the implications for my retirement if interest rates go to 18%? What if rates stay near zero? What should I do with the cash flow between now and age 60 when my W2 income ceases? What question am I not asking that I ought to be?

My ultimate retirement backup plan is to delay retirement a year or two.  If the stock market tanks and interest rates go negative and a greater than ’09 housing crisis hits and unemployment goes to 30% and paying renters become impossible to find, I could always go back to work and receive high wages under any economic conditions barring something out of The Road by Cormac McCarthy.  I think that is a pretty good option to have, but I hope I do not have to exercise it.  If all that badness does happen, it will probably be a great time to buy more income producing assets I have dry powder.  I would appreciate any thoughts or suggestions about my plans.

Having said all that, I recognize that: 

There are many devices (plans) in a man's heart; nevertheless the counsel of the LORD, that shall stand. Proverbs 19:21

[Thomas Rutkowski]

You and I have a little in common. I love my job and am able to make money by leveraging my expertise and knowledge. I have no interest in being a full time real estate investor. I want to do what I do best and put the money to work in safe, high-yielding investments. I also have no interest in the pitfalls that go along with rental properties: dealing with toilets and tenants. 

I have always been on the lookout for safe, high yielding investments that are as low maintenance as possible. I want to take advantage of the power of compounding interest. The Rule of 72.

You have roughly 13 years to your planned retirement age. Using the common 4% rule (with all of its flaws), you would need $4.5M to generate a monthly income of $15K. That rule is geared towards traditional retirement assets, not real estate and financial alternatives.

Your goal of purchasing 1 property per year is "scalable" growth, not compounding. 1 should eventually turn into 2. 2 should turn into 4. And so on... This creates a lot of work and that's where I would rather just have investments that earn high returns.

I think its a mistake to pay off your commercial property. Every dollar you are using to pay down that mortgage is an investment that is making zero ROI. Take that money and find new investment opportunities instead. If you can get money at 5% and you can invest it and make 10%, how much do you want? All of it! If this doesn't make sense, just reach out privately, I'm happy to explain.

Real Estate, the stock market, and the economy are all cyclical and we are more than likely close to a correction. Right now, all of my money is going into protected positions. I want debt investments in this market, not equity investments. If you buy a rental house for $100,000, that is an equity investment. And if a slump causes prices to decline 20%, then you have lost $20,000 (or tied that money up for years if you decide to wait it out.). 

However, if I loan money to an investor at a 60% loan to value, HE is taking the equity risk. I am in a protected position. One of two things is going to happen: 1. He is successful and satisfies the loan, or 2. He defaults and the house value secures my loan. Even in my example above, a 20% market decline still leaves me intact. Leverage just makes it worse. In the first example you only lost 20% of your money. In the second example the investor loses half of their money. Leverage into equity investments is dangerous right now.

You sound conservative. You can easily accomplish your goals without risking your savings in riskier equity investments. You can earn great returns and protect your principal while achieving your objectives. Ultimately, you want $15K of monthly income. It shouldn't matter if it is a monthly interest check or a rent check.