Here’s some simple math: Every $100K of 401K money leveraged in a rental will produce $200K more than stocks over 15 years…
Besides adding peace-of-mind during those days when the headlines are screaming that the Dow Jones Industrial Average just dropped 300 points, rolling-over a portion of your IRA or 401K into investment property will produce double the return. During market turmoil, you can sleep easy knowing that your property is being paid off by the renters and that your property is still appreciating in value.
How much? There are two ways to determine your payoff. The first is shown in this graph on the right, while the second can be easily calculated on a calculator or in a spreadsheet.
Our video assumes a $200K starting point, this graphic assumes a $100K starting investment. Either way, the gains are proportional. Let's dig into this graphic >>>
YEAR 0 --> Option 1 shows your $100,000 staying in an IRA (gold color). NOTE: The IRS does NOT allow you to buy stocks in an IRA on margin (with a loan). Option 2 shows using the same $100K investment (light blue) plus a 100K bank loan (violet color) to purchase an investment property (the IRS does allow this, since it’s much safer than stocks). Adding a loan to this option will enable you to create a bigger asset ($200K vs. $100K) that the expected 5% appreciation can apply to over the years. Don’t worry about the mortgage loan, since the renters will pay it off...
YEAR 5 --> Shows the IRA growing to $128,000 (at 5% compounded growth) while the value of the rental property grows to $255,000 as the renters have paid down the loan from $100K to $80K.
YEAR 10 --> Over the decade, the IRA has now appreciated to $163K while the rental has increased in value to $326K. The loan balance is now only $46K.
YEAR 15 --> Good news. The $100K IRA has more then doubled its original value and is now worth $208,000. The best news though is what happened with the rental property:
A) The renters have paid off the entire loan.
B) The property is now worth $416,000 -- more than 4x your original $100K investment.
C) The most your stocks could earn you at this point is probably a 2% dividend, producing $4K a year. However, your rental would likely be generating over $25K a year in rent with no mortgage to pay!
By leveraging the $100K you had in your retirement account in the Year 2018, what yearly income would you prefer in retirement, $4,000 or $25,000? You have a choice.
Now we all know that $200K isn't enough to buy an investment property in California, but this same "IRA vs. Rental" comparison works for any price point. For instance, if you invest $300K of 401K/IRA funds to purchase a $600K property, you can 3x the numbers above. Invest $400K to purchase an $800K rental, you can 4x the numbers, which would generate roughly $100K per year in retirement income, which is over $8K per month. Compare that to keeping your $400K in stocks where you’ll likely earn only $16K/year or $1,333 per month. If you don’t have $100K, $300K or $400K available to invest, you can partner with friends, neighbors or co-workers.
[Note for the property investments above modeled at a 50% down payment, sometimes the lender will want you to put down 55% and there will usually be some up-front expenses if the property needs work. See here and here for real examples.]
Spreadsheet Example: Below is a simple spreadsheet that models a recent set of clients that evaluated what to do with a combined $500,000 in their respective 401K's. They analyzed what would happen if they kept their money in the market or rolled-over into real estate, by setting expected appreciation for both to 5% per year. The math shows that over a 15 year period, there is an +$800,000 difference between the two. Here are the details, with the first graphic showing a partnership called "Retire Early, LLC" with $500,000 currently in a stock account (Column B).
They modeled a 5% compounded gain in a calculator and saw their portfolio over 15 years would grow to $1,039,000, Column D. That's a gain of $539K as shown in Column E. To replicate this “value” in a spreadsheet or calculator, simply type in $500000 x 1.05 ^ 15 = . The 1.05 represents a 5% increase each year.
This second section below, Option 2, is a real example of purchasing a 4BR-3BA rental for $885,000 (Column G) and putting 55% down (Column H), along with acquiring a 45% loan (the leverage). The loan fees, points and set-up fees are shown in Column I (if you'd like the details ask here). They closed on the property in April of 2018 and secured a great group of students to rent for $4,950 per month. By November 1st of 2018 (six months), they’ve collected $29,700 in rents and have aggressively paid down the loan over $21K so far.
Their loan payments, property tax, insurance and lawn care add up to $3,950/month, so they'll be able to pay down the loan an extra $600 per month in Year 1 while still reserving $400 monthly for unforeseen expenses or vacancies.
The model shows they will have the loan paid off in the 15th year (Column J). To estimate the property value in 15 years at a 5% average growth rate, the equation $885000 x 1.05 ^ 15 resulted in a rounded value of $1,839,900 (Column K), with the net gain of $1.3M (Column L).
The last section simply subtracts the 15-year value of the stock portfolio from the value of the rental property, showing a positive difference of $800,900 in favor of the real estate. What would you rather have in retirement, $1 million or $1.8 million?
Now some experts might debate that stocks enjoy a a higher longer term appreciation rate versus real estate, but others would argue that high-value leveraged rental property in a great location managed properly always has the edge over stocks in the long run. Either way, the best way to compare "apples to apples" is to set the growth rates the same. The bottom line is that there is a "Big Payoff" financially for diversifying into real estate as well as adding to your peace-of-mind.
The $800K difference is created by two main factors: <-- Click to expand and see why
1) Leverage. The IRS does NOT allow the use of margin or leverage in a 401K or regular IRA, but the they do allow leverage for self-directed IRA investments in rental property. That allows the appreciation rate (5% in our example) to apply to an $885,000 asset (Column G) instead of a $500K asset (Column B). That leverage adds about $400,000 of the extra gain in our example.
2) Renters. If you were to deposit and invest $400,000 in an IRA with E-Trade or Fidelity or another stock broker for fifteen years, would they pay you back your deposit over that time? Ha-ha, funny question. No, sorry. But if you borrowed $400,000 to buy real estate in your IRA, your renters WILL pay that loan down to zero over the fifteen years. That "renter pay-down" provides another $400,000 of gain in our example: $400K from leverage + $400K from renters = $800K larger nest egg or $6,000 per month extra income for your retirement.
After our clients finally "grok" this huge difference, their eyes usually light up big and bright. However, after about 10 seconds they frown and retort "yes, but I don't have to actively manage my stock portfolio and I would have to manage a property." Our simple response is "No worries! We'll manage it for you." Then the frown turns upside-down... Click here to learn about our property management services.
NOTE: If you can't afford to transfer the amount above out of your IRA/401K, you could withdraw less or add a partner, as shown on our Partner example.