Residual value of rental properties in retirement portfolio?

Question

Long time lurker, first time poster…  let me start by saying a big thank-you to everyone here for what I’ve picked up over the last few months – very valuable resource.  Sorry for the long lead-up to the question…

I’ve been investing full-time for a few years, have flipped a bunch of properties, and have acquired a number of rentals.  Wife works a lucrative day job but really doesn’t want to do it anymore.  We’ve got a good chunk of liquid retirement assets, a good chunk of in-process flipping assets, and a lot of equity in our primary residence.

… and then we’ve got the rental portfolio.  Let’s say it generates $35k a year of after-repair free cash flow.  In theory, that is roughly equivalent to having another $1m invested in the bank (assuming you can conservatively draw at 3.5% - I know, huge assumptions here).

Theoretically, if we were to sell the flipping portfolio, put that money in the bank and stop working, we could roughly count on a 3.5% return on the bank assets, plus the $35k a year from the rentals.

Where the problem starts is that the wife wants to see “the value” of the rental portfolio and the primary residence somewhere in “the number.”  I respond that we don’t sell the rental portfolio or we lose the income (true), but since we don’t have any kids she insists that the underlying equity in the rental portfolio needs to be considered in the model as we aren’t going to take them with us (also true).

Long way around:  how do I value the residual value of the rental portfolio as I think about retirement?  There will be a time when I don’t want to deal with them and we sell them, but I’m struggling with how I reflect that in a future retirement model.

Does that make any sense?

Thanks in advance!

Steve

Bill Gulley · Answer

Real estate assets are listed on your balance sheet at market value. For your purposes, you can estimate market value, for an accurate accounting acceptable to accounting practices you would need an appraisal.

On you balance sheet, list mortgages as liabilities at the balance owing on the date of the statement.

Assets-Liabilities=Net Worth/Equity

As an individual, you'll only really need the equity for estate planning purposes and tax liabilities of your estate, if you have a taxable liability.

Assets are not on an Income Statement, income-expenses=net income before taxes.

If you have held the real estate for a long time you might consider selling the portfolio to an established investor and do so with seller financing. You may take say 75% of market value (could be more) but finance 80%, 750K x 80% = 600k financed at say at 8% =48K.

If you sell for cash you'll be paying tax on the gain. If you finance it you'll be paying tax on the gain as it is received, a much better deal.

Your collateral for the loan is the real estate you are familiar with, you know it better than the buyer, if there is a problem, your attorney can get the property back and dispose of it again or sell it.

There are loan servicing companies that will collect payments, administer taxes and insurance and send you a check monthly. All you need to do is go to the mail box or bank.

No more cleaning or repairs and dealing with tenants.  :)

Jeff S. · Answer

It doesn't fit well with the typical retirement calculators. You could figure income if you sold it all on contract at 5.5% or whatever for 30 yrs. This could equate into a withdrawl period like with drawing cash with interest over a time period with a beginning balance.

The thing about rentals is that they are a hybrid investment and business. If you turn everything over to management it comes closer to a REIT but probably safer since REITs can seriously tank when the market softens, but rentals can too.

Eric F. · Answer

Why does "the number" matter?  What matters is income and expenses.  If your rental properties generate regular income why would you sell them and put them in a bank to get a low return?  You mention your assets but what are your expenses?  What will they be in retirement?  It doesn't matter how much you have saved if you spend more than your savings allow.

I guess the only way the value of the properties would matter is if you could sell them and get a higher return elsewhere, but I doubt you can do that reliably.

George Paiva · Answer

Be Careful I think you are trying to fit a conventional retirement portfolio of 3-5% withdrawal into a real estate portfolio.  You can try to equate the percentage of $35k from what your RE asset which most likely is more than 3.5%.  RE is not exactly as passive as you already know, not like a mutual fund.

I think the 3-5% withdrawal is ok for a 401k but for the RE I would agree with William to ensure you have a living breathing exit plan/strategy.  You don't want to be snaking toilets at 65 right?  So what will you do?  Still have a passion for RE then just hand it over to PM.  Else sell it all and move it to 401k portfolio with your draw down goals.

William Bannister · Answer

Maybe I am over simplifying but isnt the equity in each rental your net worth if you sell? Like for example 100k rental that you get 1900 a month in rents and you owe 50k isnt that 50k in equity? 100k-50k in debt = 50k value,equity? right 
   Unless your concerned your going to get sick or disabled and let property fall into disrepair when you get old and have to fire sale your income property? I guess that depends on what the exit strategy timeline is? Is it sell one at a time after you hit 55 years old till they are all gone or try and dump them all at once? this also doesn't factor what the market will be when you make this decision. the other thing is will the debt be eliminated by then as well? Few things to think about here any other opinions?
 Having comps to determine value or appraisals if they are current if you really want an exact opinion on value of your portfolio.

Residual value of rental properties in retirement portfolio?

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