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- Reader Case: Can’t Work Because of Health Issues and Worried - October 23, 2023
It’s Friday, and you know what that means: time for another reader case!
Now, I’ve just realized that it’s been a while since we did a housing-heavy case study. These are always a bitch to parse through because of the sheer volume of numbers involved, but what can I say? I like pain (just ask FIRECracker).
So I dug into my trusty pile of reader cases for a good housing-related one and as usual our readers did not disappoint.
I first heard about your blog this evening and have spend the last 5 hours pouring through your posts, which has basically forced a ‘come to Jesus’ moment on me. I always thought my husband and I were great with money and had a perfect retirement plan, but now I think we’ve gone about this the completely wrong way.
I am 35, and my husband is 38. Our combined annual income is about $160k CAD (we get bonuses that can make that number go up a little). After taxes our income drops to $110k. We also have four houses in various stages of being paid off, since that has always been our retirement plan. House 1&2 are each worth about $100k (they’re actually condo apartments), and are paid off. House #3 is worth about $180k, and has $100k in debt left. House #4 is worth $300k, and has $230k in debt left. The interest rate for house #3 is 2.99%, and #4 is 2.89%.
With H#1, we rent it out for $850 a month. Our monthly expenses for this one include condo fees of $240 a month, and (average) property taxes of $105.00. H#2 has the same expenses, but we get $800 a month.
With H#3, we rent it out for $1200 a month. Our mortgage is $680, condo fees are $220, and average property taxes are $176. The mortgage is higher than what most calculators would predict because we have it set to be paid off quicker.
With H#4, we’re living in it. The mortgage is $1270, and total monthly spending, including utilities, taxes, food, and everything else comes to about $2000, but factor in another $10,000 a year for vacations. We have a car, but it’s paid off and should have 1-2 more years of driving in it with minimal repairs.
We only have about $40,000 in savings, and another $20,000 in RRSPs, but that’s because we’ve been paying off the mortgages as quickly as we can to minimize the interest we’re paying. With our current schedule, we should have all four paid off in 6.5 years.
Our plan has always been to have all our properties paid off, work for a few more years after that to save up as much as possible for a nest egg/safety net, and then use the rent money (approximately $3000) and savings to retire by our mid-40s.
However, after reading through all your posts about getting rid of mortgages and how investing is safer than having money tied up in property, I’m wondering if we’re going about this the wrong way. We’ve also recently had to dump about $8000 in repairs on one of our units, which makes me paranoid about what else could break next. With our income and the amounts we could get from selling our houses, do you think we could retire sooner than 10 years?
Thanks so much!
You see what I mean? That’s a LOT of numbers. But we here at Millennial-Revolution don’t get intimidated by mere numbers, so without further ado, let’s MATH SHIT UP!
First of all, FOUR HOUSES? Yeesh. We debated for years about buying even a single house, but FOUR? I’m hyper-ventilating just thinking about it.
But aside from that, 4H made a totally rookie mistake when it came to how she dealt with her debt.
When you have as many mortgages as 4H does, your natural instinct would be to pay off as much of it as possible. That’s why she’s taken her considerable salary and basically thrown most of it towards paying off her debt. For most people, that’s the right thing to do.
However, 4H isn’t most people. She’s a real estate investor.
Now, I don’t write about real estate investing on this blog since I’ve never done it, and I don’t like recommending that people do things that I haven’t tried and tested myself, but there are real estate investing bloggers out there like Paula Pant from AffordAnything.com or Sam from FinancialSamurai.com that I enjoy reading and learning from.
And for real estate investors, you actually want to pay off the mortgage on investment property as slowly as possible. This is because the more debt you have on an income-producing property, the less of your own money you have tied up in that property. And since the formula for Return-on-equity or ROE is Income/Equity, it actually makes more sense to keep your Equity as low as possible to make your ROE as high as possible.
Of course, the less equity (and therefore, the more debt) you have on your property, the more likely a sudden drop in the property’s value will render you underwater, which puts you into a meat-grinder position of being unable to sell unless you cough up enough cash to cover the difference.
That’s why a successful real estate investor has to be able to:
- Find good tenants that will pay the rent on time
- Be able to keep maintenance costs low by fixing shit themselves
- Be able to delicately balance the opposing forces of debt and equity to keep their ROE high while keeping the risk of going underwater at bay
That’s why I don’t invest in real estate. I am good at precisely none of these things. And judging by 4H’s email, she shouldn’t be investing in real estate either. She seems to have figured out #1. But based on the fact that unexpected repairs cost her $8000, she doesn’t appear to be good at #2. And based on her decision to pay off her investment property’s debt first, she’s not good at #3 either.
Instead, the correct thing for her to do was to direct her money towards paying off her own mortgage (since that’s not an investment property) while keeping her 3 rental units leveraged.
But whatever. Mistake already made, let’s see what we can do about the situation.
First, let’s look at her current trajectory. 4H projects being debt free in 6.5 years. Super. Good for her.
At that time, her rental income per month will be $850 + $800 + $1200 = $2850. And her condo-related expenses per month will be $240 + $105 + $240 + $105 + $220 + $176 = $1086. That makes her net rental income $2850 – $1086 = $1765.
That’s not quite enough to cover her living expenses of $2000, so she’ll have to keep saving until she builds up a portfolio large enough to cover the difference. And of course, if she keeps getting hit with random $8000 repair costs, who knows when that’s going to happen.
But what if she were to sell everything? If 4H sells the 3 investment properties, she’ll get $100k + $100k + $180k = $380k. After real estate commissions, that becomes $361k. And after paying off the $100k mortgage on House #3, that leaves $261k.
Now hidden in that number is the capital gains tax she’d have to pay on that. That’s a number I don’t have enough information to calculate, since I don’t know her buy prices. But let’s assume she slowly sells these things off over a number of years so she doesn’t spike her yearly income too badly, and after taxes she nets enough to cover the $230k mortgage remaining on her primary residence.
Now she’s got a paid off house, no mortgage, and monthly spending of $2000. That mean she’ll need $2000 x 12 x 25 = $600k to retire. She’s got $60k now. How long will it take?
Also known as, less than the amount of time it would have taken her to just pay off her existing debt. In just 6 years, she could be retired. And not have to deal with the hassle of managing 3 properties.
So while 4H hasn’t done poorly by any means investing in real estate, for all the extra trouble she has to put up with she still trails investing in good ol’ index funds. All while putting up with the financial risk of a bad tenant, a leaky pipe, or a busted roof. If she’s really in love with real estate, she could buy REITs, yielding 5% or more without the hassle.
So I would posit this question to 4H. In 6 years, would you rather be a real estate investor and still struggling to pay off debt? Or an index investor and retired?
What do y’all think? Should 4H become 1H? Let’s hear it in the comments below!
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