WCI #42: Buy One Property A Year

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli. Welcome to podcast number 42. Buying one property a year is a retirement plan.

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Our quote of the day today comes from Henry David Thoreau who said most of the luxuries and many of the so called comforts of life are not only not indispensable, but positive hindrances to the elevation of mankind with respect to luxuries and comforts. The wisest have ever lived a more simple and meager life than the poor. We hope you've signed up for the free newsletter on the site. It gives you the free 12 email financial boot camp series, updates on the blog posts and a great monthly newsletter. If you need a little bit more specialized attention, I would suggest the White Coat Investor course titled Fire your Financial Advisor. While the title is a little bit provocative, what it really does is it teaches you how to write your own financial plan and how to stick with it over the coming decades. I've been pretty amazed at the feedback. It's been very, very positive on the course. A lot of people are enjoying it, hundreds of people have purchased it and it's really been very beneficial to them. The best part about it is is there is no risk to you. If you don't like it, we'll give you your money back for seven days, every bit of it. And so go ahead and check it out and see if it's something that you think would be beneficial. You can find that easily on the homepage@whitecoatinvestor.com and learn more about it and check it out. It's really helped a lot of people, and it may be right for you. Now, if you spend all your time reading financial blogs and listening to financial podcasts and reading financial books, it's probably not for you. But if you're not a hobbyist, it could really help you to save a lot of money in the long term and get your financial ducks in the row. Today I'd like to discuss the concept of buying one property a year as a path to wealth and financial independence. And a lot of ways this is an alternative pathway to what I've been teaching for years, which is max out your retirement accounts, invest the proceeds and index funds and get on with your life. It's an alternative path, but it's also a viable path. And so if this is something that appeals to you, I think it's worth looking more into it. Here's how it works. First, you carve out part of your income, perhaps 30 to $100,000 a year, to buy property. Then you use that money as the down payment on buying an income producing property. You get a renter into it, and if you've put enough money down, it should be slightly cash flow positive. That typically requires a down payment of 25 or even 33% down. Although if you got a really screaming deal on the property, maybe even less, then you take the excess cash flow from the property, combine it with money you're carving out of your earned income the next year, and use that to save up for the next down payment. Then you buy another property in year two. In the beginning you start out managing your own properties and you learn the business of being a landlord. You start building your team, an attorney, a fix it guy, H Vac person, lawn care, a painter, a carpet person, a general contractor, a plumber, etc. And then maybe eventually you're able to add a property manager that handles all this stuff for you. But it's good if you're going to go into this business to learn the business first so you know a little bit more about how it should be done and can manage your property manager. Each year you repeat this process. The first property is obviously the hardest, and then you've got other properties helping you to buy the next one. So you start getting a bit of a domino effect. Meanwhile, the renters in these properties are slowly paying off the mortgages and the properties hopefully are appreciating in value and the rents are going up. And typically between year 10 and year 20, the annual cash flow is equal to your annual spending and you reach financial independence. So why does this work and why does it work so well for so many doctors and others? Well, it works because you never have a cash flow negative property because you put enough money down. Because if you've got properties that you're having to feed from your earned income, not only does that suck, but it also makes it much more difficult to own very many properties if you're having to feed all of them. That really is not a winning situation. That happens when you overpay for a property, and that happens when you don't put enough money down on a property. And, and that happens when you're not very good at managing or hiring somebody to manage your properties because the expenses just build up to be more than the rent and you end up having cash flow negative properties. But it works because rents generally increase and your debt gradually decreases and your depreciation of the property helps shelter your income from tax, either partially or in some situations, fully. This also gives you the opportunity to add value to your investments. You know, the stock market is a fairly efficient place. It's not perfectly efficient, but it's probably efficient enough that if you act like it is, that's the right way to invest. And that's why index funds work so well. But the real estate market, by comparison, is very inefficient. And so if you are talented or you're good at spotting a good deal, there's a lot of opportunity there to add value. Real estate is also a relatively safe way to use leverage to build wealth. But again, that depends on you actually putting some money down most of the time. There are significant downsides to this pathway to building wealth and financial independence. The first is that it requires you to learn another set of skills. And if you're a busy person, a specialized physician, maybe that's not really how you're interested in spending your time. Second, it requires significant work and effort. Don't minimize this. You're taking on a new job as a landlord. Do you really enjoy landlording more than practicing medicine? If so, why did you waste your 20s in medicine? Do you really want a second job? Those are all questions you need to ask yourself before you decide to take this pathway toward building wealth. Also, bear in mind there is risk here. Rents and property values can fall or remain stagnant for long periods of time. Don't get recency bias where you start thinking, oh, stuff went up 20% this year, it'll go up 20% every year. It just doesn't work that way. And it's even worse when you're highly leveraged, because leverage magnifies everything. It magnifies your good decisions, it magnifies your bad decisions, it magnifies your good luck, it magnifies your bad luck. And it's a good way to go broke. Lots and lots of people have gone broke being real estate investors. There's also the temptation to not fund this plan adequately and instead use more and more debt. And that again gets you into the trouble with being over leveraged. It also becomes a difficult decision, like we talked about on our last podcast, if you're not saving enough money to both max out your tax protected accounts and invest in real estate. Now if you can do both, that's great. That happens to a lot of docs actually who don't have much tax protected account access in their retirement plans. But for those who have lots of retirement space, it becomes a difficult decision. Are you going to pass up on known tax benefits, known estate planning and asset protection benefits in order to hopefully get a higher return in real estate? That can be a difficult decision. You also might not live in a low cost of living area. Putting down $50,000 on a $1 million house probably isn't going to give you a positive cash flow. And so this works great in the Midwest. It doesn't work so well in the Bay Area when you got to come up with, you know, half a million dollars or a million dollars just to get a property to cash flow. And when you're banking on appreciation, using a great deal of leverage, that's a good way to get yourself into trouble. You might get rich, but you might also go broke. You'll also find as you acquire more and more properties that banks will only give you so many loans. I think the typical limit is about 10. And if you've got more properties than that with loans on them, you're going to have to seek funding elsewhere from the sellers or borrowing against the properties you have that have appreciated. You just have to start getting a little bit more creative. You know, you may end up going to hard money loans and having to pay 8, 10, 12%. And obviously it's a lot harder to turn a profit on a property when you're paying that much in your mortgage costs. So how do you mix and match these two pathways? One, buying index funds inside retirement accounts, you know, putting 20% of your income there and concentrating on your practice. And the other, buying one property a year and becoming a, you know, real estate empire. Well, it's tough. Ideally, as I mentioned earlier, you've got enough savings to max out your retirement accounts and buy some real estate. In your taxable accounts. But if not, you're going to have to choose. One thing to keep in mind if you do plan to buy a bunch of real estate properties is that should make you favor Roth contributions to your retirement accounts. Because you'll be having in retirement all this taxable income coming from your real estate rents. You don't want to necessarily combine that with a lot of tax deferred accounts. Whereas if you're mostly just using retirement accounts, you, you can pull that money out of tax deferred accounts and use it to fill up the lower brackets. Well, if you've already filled up those lower brackets with real estate rents, you'll probably benefit more from having Roth accounts than you would from tax deferred accounts. If you're really not interested in buying and managing the individual properties, there are other options. You can buy crowdfunded properties. You can buy syndicated properties. You can buy through private real estate funds. You can, you can just buy publicly traded real estate investment trusts through an investment like the Vanguard REIT index fund at very low cost and very little hassle. So nothing says you have to go out and buy individual properties just because you want to invest in real estate. I'm far too busy between my medical career and running the White Coat investor to be running a real estate empire on the side. So this is how we do our real estate investing through funds and through syndicated properties and through real estate investment trusts. And while you give up a lot of control doing that, and maybe you give up some return and some tax benefits too, the fact that I don't have to be doing now a third job makes it worthwhile to me. And of course, remember that this is not required for a high income professional. If you put 20% of your gross earnings throughout your career into index funds, some reasonable balance of stock and bond index funds, maxing out retirement accounts when you can, investing the rest in a taxable mutual fund account is needed. You're going to have enough money to have a very comfortable retirement. But this is an alternate path. It's probably a little bit faster to get to financial independence, but does involve some additional risks. So if this is the sort of thing you're interested in, you can find more information about it both on the White Coat Investor website as well as passive income MD's website. And really get into becoming a landlord and earning this money on the side. A little bit of a second job, a little bit of investment that you have more control over. But if you really dislike the stock market, this is another method to become Financially independent. All right, let's go over some questions that have been sent in from readers. Here's our first one. If it is recommended to save 20% of your salary a year toward retirement, one can put $18,000 into a 403 and $11,000 into spousal and individual backdoor Roth IRAs. Where's the additional money supposed to go? Well, if you've maxed out all your retirement accounts, the place to invest is just in a taxable non qualified investing account. And you can buy similar investments to what you can buy in your retirement accounts. In that taxable account, you can buy the same index funds that you would like to buy inside a Roth IRA in that taxable account. Now, it helps if you pick particularly tax efficient mutual funds such as a tax exempt bond or a municipal bond mutual fund or Total Stock Market Index or Total International Stock Market Index, those sorts of very tax efficient funds that can reduce your tax costs. But basically that's the answer. Once you've maxed out your retirement accounts, if you need to save more for retirement, you do so in a taxable account. You can also invest in real estate there if you like, as noted earlier in the podcast. Okay, here's another related question. When you say save 20% of your salary, does that mean part of that 20% goes to paying off student debt, saving for a house down payment, or is that additional savings above and beyond the 20%? Well, the 20% is for retirement. If you need to save up a house down payment, if you need to save up college savings, if you need to pay off student loans, if you need to save up for a new car, that's all above and beyond the 20%. So what does that mean? Well, that means you really can't be ever spending more than about 50% of your gross income. And that's just the way it is. If you want to become financially independent before retirement age or even at retirement age, you're going to have to save some significant sums of money. And your savings rate is how much you're saving divided by how much you're making. And 20% is really what it takes for a high income professional to have an adequate retirement. The kind of retirement you're looking forward to having is going to take about 20%. Now, 15% might get you there, but 5% is not going to get you there. And so if you're having to ask about, well, do my student loan payments count and does saving for a house down payment count and that sort of stuff, chances are you're not saving enough money. And so that is the secret. The first few years out of residency before you get used to all that money, try to live as close to your resident lifestyle as you can and use the difference to pay off your student loans, save up a down payment, max out those retirement accounts, get college funding accounts started, etc. And that's the way to become wealthy as a physician and have all these choices in your career that you're going to want to have, because 10 years from now, it's going to matter a lot more to you than it does right when you come out of training. Okay, here's another question that came in. This one is asking about 1099 income. It's asking, do any of these sources of income outside of my employed MD job qualify me for tax advantage investments that would be more beneficial to me than investing in taxable accounts with Vanguard and or real estate? Well, this particular questioner, and I don't read the entire question because it's a couple of paragraphs long, was interested in opening an individual 401k to do online surveys. Well, let's go over what this is useful for, right? Even if you have just a little bit of 1099 income, that allows you to open an individual 401, which can be very useful. If you need to roll over a big SEP IRA to allow you to start doing backdoor Roth IRAs, that's super useful. But the fact is, you can't contribute a lot of money in there if you're only making a couple hundred bucks doing surveys a year. It's just limited. Your contributions are limited by how much that business makes. And so if the business doesn't make a lot of money, you can't make very big contributions to it. You can roll over all the money you want in there, but you can't make big contributions to it. And so then you start looking at your other sources of income and remember that 1099 income is not all earned income. The only money that counts toward retirement accounts is earned income. If you have some K1 where you're not really participating in the partnership and they pay you a certain amount of money, or you got some sort of 1099 income that doesn't represent earned income, you can't use that to make retirement account contributions. And so when you look at your other sources of income, it comes down to whether they're really other jobs or not. If there are other jobs that can be used to go towards your solo 401k, if it's not really another job you can't do that. Here's a complicated question. When a cash balance plan is created, is there any flexibility for individual plan members to direct investments or are all contributions managed as one fund? Well, remember, a cash balance plan or defined benefit plan is really another 401k masquerading as a pension. And so you have to follow pension rules. Then when you close the plan in five or 10 years for some reason that you know is legit to you and legit to the IRS, then you roll that money into your 401k or your IRA. But in the meantime, it has to look like a pension, and pensions don't look like 401ks. A pension is where your employer and maybe you put some money into a fund and the employer hires somebody to manage that, and then they guarantee you some sort of benefit down the road. But you don't get to change the benefits around with a pension plan or a defined benefit plan. And so with the cash balance plan, you don't get to do that either. It's all managed as one fund. Okay, related question. How does the plan sponsors and administrators make their money? Well, typically they charge fees. These might be flat fees. They might be asset under management fees. With my partnerships plan, I think the asset under management FEES are about 0.3% per year. That covers both the management of the assets as well as the actuarial costs. Because remember, with a pension you have to have an actuary come in and do all these fancy calculations every year. And so that's one big reason why a cash balance plan generally has higher fees than a 401k. What are typical or reasonable administration fees for management of the plan? Well, certainly if you're up there paying more than 0.5% a year, I think you're paying too much because there are people willing to do it for less. But either a low asset under management fee in the 1.2.3 kind of range or a flat annual fee of just a few thousand dollars, I think is probably reasonable. If you're paying much more than that, it may not be worth having this plan at all because all of your tax savings is being eaten up by fees. Are the fees generally split evenly among plan participants or are they split proportionally based upon assets in the plan? Well, they're generally split proportionally, but lots of variation. Read your plan document. If you're setting one up. You can set it up any way you like. Really. A few other questions related to it. Can one sign in to see his OR account and a real time balance? You can sign in and see how much is in the account, but the balance might only be updated once a year. This isn't a 401k where you're going to be moving investments around from time to time. It's something that's much more hands off. If the fund consistently underperforms the assumed earnings rate, how is that ultimately reconciled? Well, the truth of the matter is, if you expect this to return 3% a year and it has negative returns year after year after year, the owners of the company are responsible to put more money into the plan. Now, if the owners of the company are also the same people as the beneficiaries, that's not necessarily a bad thing because that basically forces you to buy low. And so contributing more to your cash balance plan after a 2008 like event is not really a bad thing as long as you have the money to put in there. But it is a requirement because the employer is backstopping this plan. And so if the returns of the investments are not giving you enough money to provide whatever return you've guaranteed to the participants in the plan, you have to make that up. On the flip side, if the returns of the investments are very good, they're much better than what the anticipated return was for the plan. That money goes into a side fund where it continues to grow and build. And then when you have a down year, first you raid that side fund to make up the difference before you go to the employer in order to make up the returns below the projected returns for the cash balance plan. Okay, let's go to some questions that came in on social media. These are actually left over from the podcast. We did a couple of podcasts ago with the Physician on Fire. This one comes in on Facebook from Abigail Polzin, who asked, should I pay off my mortgage quickly now and then invest more heavily or do it the other way? Well, this is the age old question. This is the question I get more commonly than any other. And the answer is, it depends. You know, there's a lot that goes into the payoff debt versus invest question. We had a podcast on it a few episodes ago. I think we had one last year as well. I've got at least a couple of blog posts on it. I cover it in the online course, I cover it in my book. It's just a very common question and one that we will all wrestle with until that day when you're debt free. I no longer wrestle with it because I don't have any debts at all. And so it's very easy for me to make this decision, I just invest more heavily. But when I had a mortgage, I looked at it a little bit more carefully. For example, I wasn't going to pass up a Roth IRA contribution or 401k contribution, much less a 401k match in order to pay off a 2.75% mortgage. But once I had a significant amount of wealth and I'd maxed out all my retirement accounts and I was considering investing in something like a municipal bond fund in a taxable account, then paying off that mortgage starts looking a little bit more reasonable. And after a while, it just didn't make that much of a difference in my financial life whether I had a mortgage or not. And so we decided to pay ours off. But there's certainly nothing crazy about holding on to a 2 or 3% debt for a few years or even a decade or two in order to try to get better returns. Investing Just realize what you're doing. You're borrowing money to invest, and you're borrowing money, you know, because money is fungible. You're borrowing money for everything else you buy in your life, too. And that's what kind of started to bother us after a while as we realized, yes, we've got this debt hanging out there of 100 or $200,000, and now we're buying wake boats and fancy vacations to Paris. And in reality, that made us a little bit less comfortable when we thought about borrowing money in order to buy a wake boat, something that was clearly not a required item in our house. And so then we decided, well, we'll just pay off this debt and be debt free. But there's lots of different ways to slay that drag. And I wouldn't necessarily feel that you have to follow my pathway on it. But if you're carrying around 8% debt thinking you're going to make better returns investing, you're probably making a mistake. Okay, our next one comes in from on Facebook from Reese Bone, who asks which loan company has the best interest rates for refinancing student loans. Well, Splash Financial is the sponsor of this particular podcast, so I guess I ought to plug them first. But the truth of the matter is it depends. Depends on your debt to income ratio, depends on your credit score, depends on how much debt you have, and depends on the company. Every company calculates out what your interest rate is going to be a little bit differently. And so that's why it's a good idea to apply to three or four or five of these companies, all of which are listed under the recommendations tab on the White Coat Investor website. But apply to four or five of them and take the one that gives you the lowest rate because you will get different rates from them and it's almost impossible to predict in advance which one is going to give you the best rate. Okay. On Facebook, Tran Tran writes in with an extremely complicated question. It didn't take long to write it, but it would take a long, long time to answer it definitively. Basically, Tran says new tax laws, S and C Corps. And when it becomes worth it to do this versus just write offs on 1099 income on personal taxes only. Well, I think what Tran is getting to here is with these changes in the tax law that passed at the very end of 2017, does it make more sense now to go start an S Corp or a C Corp in order to get more write offs? And the truth of the matter is, if it didn't make sense before for you, it probably doesn't make sense now. The main benefit to become a corporation for a physician is to get that S declaration and become an S Corp. And what this allows you to do is to mark some of your income as salary and some of your income as distribution. And the benefit of what you call distribution is you don't have to pay payroll taxes on it like Social Security or Medicare taxes. Now you've probably already maxed out your Social Security taxes on the salary portion of your income. And so what you're really saving is just the Medicare taxes, that 2.9% Medicare tax. And so if you can declare $100,000 of your income, you know, after all is said and down, maybe you save a couple thousand dollars on your taxes for each hundred thousand dollars that you declare as distribution rather than salary. If that's worth the hassle of incorporating, then go ahead and incorporate. If not, then don't bother, just be a sole proprietor. You can still write off all your malpractice insurance and your licensing costs and your medical staff dues and your white coats and your stethoscope, all that kind of stuff, just fine. As a sole proprietor, you don't have to be a corporation to do that. The new tax law does have this pass through deduction for pass through businesses, but that really doesn't affect the S Corp decision because that deduction exists just as well for sole proprietors as it does for S Corps. And the truth is, if you've got enough income that you're thinking about doing an S Corp, chances are you've got too much to get that deduction as A physician anyway, because there's a phase out on it for professional income. Alright, let's take a few questions off of Twitter. This one comes in from Joshua Alley, who asks, I want some thoughts on where to practice as a financial strategy. I see so many residents wanting city life, but rural areas pay a premium with low cost of living. Well, this is true. I mean, oftentimes by going to a more rural area, not only do you have a much lower cost of living, but you will often have a lower tax rate when you get outside of Manhattan and California and those kinds of places, New Jersey and Washington, D.C. and these places with relatively high taxes. And so you save the cost of living, you save the taxes. And a lot of times, surprisingly, you can even be paid more in a more rural area by getting out into those, you know, what are called affectionately as flyover states. And so you're saving in three different ways by going there. The downside is, well, if you really want to live in the Bay Area, you're not going to be happy in Oklahoma. If you really want to live in Manhattan, you're probably not going to be happy in West Virginia. And so I think you have to figure out what you want out of your life. There's no doubt that you, you can become financially independent faster if you live in some small town in rural Minnesota than if you live in San Diego. I have no doubt in my mind that that's true. But whether that is what you want for your life or not, you're really going to have to consider. Also, it's not like this is an all or none decision. I mean, you can go live in the Midwest for a few years, pay off your student loans, save up some money, and then move out to San Diego or wherever you want to live long term. Likewise, you can go practice in San Diego or San Francisco or, you know, New York or wherever, and then retire somewhere else like Florida or Texas and take advantage of that geographic arbitrage to someplace that doesn't have any state income tax for when you're pulling that money out of your tax deferred retirement accounts. So it's not an all or none decision. And most of us figure out where we want to be long term and then deal with the financial consequences of that. In my case, I live in Utah, which is kind of a moderate tax burden, kind of a moderate cost of living. There are certainly cheaper places to go than this, but it's a good mix of where we want to live and reasonable financial benefits for living there. Okay, this next one comes in on Twitter from frugalishphysician who asked do you think people who have been financially successful have an obligation to help those who are struggling? And if so, what do you think that obligation is? I do think I have a responsibility to others. I view my money as kind of a stewardship mentality, that I am the steward of this money for the next 40 or 50 years and that society and God expect me to manage it well and as do my future family members. And so I think I have an obligation to manage it well, to invest it well, to give it well and to spend it well. And so that for us means giving money to charity. It means giving money to family members. Particularly in this case, we tend to give towards college savings funds for our nieces and nephews. It means saving up money for my own children. And you've read elsewhere on the blog, most likely about the different ways in which I give them money. You know, the 20s fund and their college savings fund and the Daddy Match in their Roth IRA for any earned income they have, but also, you know, future heirs and thinking about how we can make life easier for them. But that also applies to people who are struggling, you know, and that's where the charitable contributions come into us. We were very proud in 2017. It was the first year we gave more money away than we spent. And we hope that will continue to be to the trend for many, many years. So, yeah, I think that's pretty important to give money away to people who are struggling. And I don't count taxes in that either. You know, when it's mandatory, that's not really giving money away. Okay, this one comes in on Twitter from Nick Diente. Hope I'm pronouncing that right. Who asks, what are your suggestions for those living in New York City, all five boroughs, about buying real estate where a two bedroom condo starts at greater than $500,000. You're really in a tricky situation there because a physician income is not nearly as impressive in New York City as it is in Tennessee. And you know, it's relatively easy to buy one property a year when you live in Tennessee and you can find properties for $100,000 or $200,000 or $300,000 or whatever. When you're going to Manhattan and you can't find anything for less than a million dollars, it becomes a little bit harder on a physician income to buy those sorts of rental properties, much less, you know, something to live in that you want to live in. And so it becomes much trickier. You've got a Few options. One, you can save up for longer. Instead of buying a property every year, you could buy a property every two or three years. Another option is to invest elsewhere. You know, you can buy turnkey properties out of state. I'll never own a rental property out of state again, at least not by myself, just because it's too big of a hassle for me. But that is an option. If you really want to own rental real estate and it's just not affordable or doesn't seem to be a good deal in your local area, you can also invest in other stuff. You can invest in REITs, you can invest in syndicated properties, you can invest in funds or crowdfunded real estate. You can also just invest in stock and bond mutual funds. There's nothing that says you have to invest in real estate. And so there are a lot of options there. But certainly it becomes more difficult the higher the houses cost in relation to your income. Okay, another question coming in on Twitter. This one's from Lauren Klick who asks, is it beneficial in any way to have a 501C if one owned a private practice, could the charity legally financially benefit the private practice in any way? I think the idea here is to Somehow use a 501C or a non profit as part of your practice in order to provide medical care to low income persons. I think what Lauren is trying to do here is probably not what she thinks it's going to do. I mean, 501s are great for charitable purposes and you can donate money into a 501C3 even if you own it or even if you manage it rather and get a charitable deduction for that. But what most doctors do for low income persons is they just take care of them and don't charge them. Now that doesn't allow you to get any sort of a tax write off because you never had the income that came with seeing that patient. And so you can't take a tax write off for something you never got any income for. I'm very much aware of this, given that our practice sees almost 20% of its patients who don't pay us, you know, they're self pay or what we call no pay patients. And so there's really not a lot of benefit there to somehow trying to work a 501C3 into the practice to try to somehow financially benefit you for what you're doing anyway. If you want to take care of low income people, I recommend you just see them as part of your practice. Decide how much of your time you're going to dedicate to that. Make sure you can keep the practice financially viable and you know, and pay all of your employees and stuff because they might not feel nearly as strongly as you do about working for free. But I don't think getting into the 501c3 mess is really going to help you there. Now if you're doing some other thing on the side where it makes sense to be a non profit, then sure, go through the paperwork and the costs of starting up a 501C3 and donate money to it. Take those donations off your taxes, but I can't think of a really great way to combine that with your practice in order to help people or somehow reduce your tax burden.

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