401k, cash, & strategy for beginning to build a rental portfolio

[J.Michael Edwards-Toepel]

Hey folks!

I had some trouble figuring out where this fits, as it's more of a strategic decision I'm hoping to get some other perspectives about. I'm going to just kind of bare all of the thoughts that have been slowly turning over in my head the past few weeks. These thoughts have been coming to a bit of a point where I think I need someone to point out what I'm missing, or where I'm off base.

I've been working pretty hard of late on figuring out how to get the best start building a portfolio of rentals for cashflow. The more I think about this, the more I am trying to figure out the best way to make sure my strategies allow for me to maximize my returns and, more importantly, reinvest them to build as quickly as I can (with some safety built in, of course). The end goal is financial freedom through stable income, and the sooner I can get there the better.

Here are my thoughts. First, I am selling a home I put into rental when I moved at relatively short notice for work. My conservative calculations have me walking away, after putting some money into it for staging, closing costs, realtor fees, and the like, with about $55k. Using 20% down loans, I am looking at a turnkey provider that has pretty compelling returns. (I've looked here on BP and found a number of threads with folks that have done business with them and are in the process of doing more). The current home is just cash flowing about $150 / month, which I know isn't enough for what that equity could do (I estimate, with leverage, purchasing 2 - 3 cash flowing properties in other markets). Also to note, the home is in MN (very competitive market) and I live in AZ (also very competitive). Hence the interest in turnkey operators that can help me get going in other markets.

Here's the part I'm struggling with: I have a 401k from a previous job that has a hair over $50k in it. My plan was to roll this to an SDIRA (self-directed IRA), but I'm not a fan of the fact that my uses for these funds will be more or less limited to non-leveraged vehicles. After a lot of research I think my best bets will be finding a flipping partner and/or looking at notes. I don't have the time to see these flips through with my 60+ hr / week job, but then finding a reliable partner for flipping is no joke. Note investing is pretty compelling as I look into it, but I have a long educational road before I can move on that.

Whatever vehicle I use for the SDIRA, one problem remains: I cannot touch this wealth until I am 59.5, or about 30 years from now. If my over-arching goal is to become financially free as early as possible, I cannot get around the idea that liquidating my 401k instead and combining these funds with my sale proceeds to get another 2 - 3 properties. I'm not talking about ignoring retirement accounts - I'm contributing to my current job's 401k for full match, and though it's at a lower level than the other account, I also don't expect to quit this job in the near future. Also, the more I look at income producing properties, the more I can't help but think retirement accounts really don't look terribly attractive when juxtaposed with building an empire of cash flowing rentals. With the appropriate focus on finding the right markets and with adequate reserves for rainy days, I feel like they are so much more reliable in the long term.

This train of thought has culminated in a few spreadsheets and a conclusion I'm finding difficult to avoid: If I were to liquidate the old 401k and go for building as many properties as I can early (don't worry - I'm very analytical and will not reach for deals that don't meet my cash flow and market parameters), it could mean the difference between my initial net cash flow funding a new property each year right off the bat, versus needing 1.5 - 2 years to build for the next property. This is with a baseline of cash set aside for each property to make sure I am prepared for repairs and capex.

Put more succinctly, when I look at the 401k I see 3 options:

Keep it in 401k/IRA, in stocks

• Unpredictable return, with little real control
• Keep tax deferred benefits
• Cannot use without penalty for 30 years

Roll over to SDIRA

• More control over return, more stable instruments are available
• Keep tax deferred benefits
• Fairly limited on vehicles that I can use due to leverage being (in my analysis) untenable
• Cannot use without penalty for 30 years

Cash out, invest in cash-flowing rentals

• More control over return, more stable instrument
• Take a big tax / penalty hit now
• Taxed on gains each year
• Most flexibility on what vehicles I can invest in
• Can build rental portfolio more quickly (more to begin with, plus quicker path to use proceeds for new properties)
• Can access these funds for "retirement" without relying on an arbitrary legal age

I can show some more detailed numbers if you think it'll be helpful, but even if you take my analysis at face value, I'd love thoughts on the options I'm considering. I know the bullets under the third option may seem a little skewed, but I'm really trying to capture all of the nuance / flexibility I see with that path.

I apologize for the novel, but I really wanted to paint a full picture for anyone crazy enough to read all of it and, crazier still, offer their two cents. I'll be especially grateful to anyone that wants to chime in that has been at this game for a long time, and especially over a market cycle or two...  I really don't know what to expect for what could go wrong with the rental portfolio strategy aside from the usual horror stories that all seem to stem from a lack of due diligence, rosy projections, or just plain bad luck.

Thanks to all who got down to this point, and I hope this can encourage some great discussion!

[John Woodrich]

Am I looking at your numbers correct, you are planning on purchasing each house with $16,000 down and you are expecting $6 - $7,000 in annual cash flow on them?  Where are you planning to invest? 

If you distribute out your 401(k) and if your balance is $50,000 you will likely end up with only $30,000 to invest.  This assumes a federal marginal rate of 25%, state taxes of 5%, and your early withdrawal penalty of 10%.  If you are working 60 hours per week your marginal tax rates could be higher which would reduce your proceeds.  In MN $30,000 doesn't get you very far unless you are going to work in North Minneapolis.

Last question - Is your financing going to hold up to the pace you want to grow the business?  That seems to be where many people get stuck, they can't meet the debt to income requirements.  Say you have a house with a payment of $700 and rent of $1,000, that is a 70% debt to income ratio which is a killer.  It sounds like you are planning to leverage up quite a bit and this may stop you.