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Wednesday, February 28, 2024

Rental properties or equity investments? (a case study)

Have a nice day at retirement

During our recent discussion about Inflationa Badass reader came along and caught my attention by posting the following block of wisdom in the comments section:

One final note if you’re worried about inflation: hit the TV sledgehammer and go for a walk in the woods. Trees grow bigger every year unless you cut them down.”

That sentence was only part of one big rant that this gentleman named Aaron contributed at the time, and I applauded him for sharing it. Little did I know he was about to hit me with a case study request that hit home in so many ways that I knew we had to address it right away.

Underlying his question is the core of what it means to “retire.”

By my own definition, you don’t have to stop working. But you Doing You need to build such a level of freedom and wealth that the work you do is as well entirely according to your choice, instead of something you grit your teeth on and go through just because you need or want the money.

After all, the real purpose of work is to create something that is meaningful to you. Why would you ever want to stop doing that?

Aaron writes

Dear MMM,

I am a 47 year old contractor who owns a small remodeling company with five employees. My four children are now adults. We live below our means in a beautiful house I built 16 years ago on 25 acres, we will never leave… we love it.

We also own a beautiful log cabin/timber frame house from 1860, which we spent three years and tons of money saving/renovating and which we now rent out on Airbnb.

We are in the process of selling two other homes: a former home that our youngest daughter is purchasing, and a second that my team and I are almost finished renovating.

Knowing myself, I’ll probably use the money to buy another fixer, or some more land… if the price and condition are right… but I’ve also always been fascinated by the stock market.

We currently own no stocks or index funds, and we have no debt. I recently reduced my working days to four a week, and I’m quite happy with that for now.

But I did some math and if we sold the Airbnb along with the other two houses, we’d have a big enough chunk of cash to retire for the most part – only working when I really feel like it.

So the stock market is down and it’s time to sell the property and throw that into VTI, right?

I’m a hands-on guy, so it seems strange to convert three houses that I can see, touch and feel into numbers on a computer screen in the form of VTI. I’m not sure I want to do that, even if it makes sense to my math brain.

Besides stocks or rental real estate, what else could I do with the money to secure a 4% withdrawal rate in retirement?


So you probably understand why I agree with Aaron’s question. As another 47-year-old carpenter who also values ​​manual labor, peaceful forests, and uttering salty comments in response to the whiny laments of the financial media, I understand exactly where he’s coming from.

On the other hand, I am Also I’m very comfortable with stock market investing as a source of long-term wealth and security, and I have more than three-quarters of my savings invested in index funds (the rest is just my house and other local real estate and very small business ventures with friends).

So maybe the main difference between Aaron and me is that I think about houses and shares as two versions of the same thing. They are both real, concrete, productive assets and not gambling instruments or numbers on a computer screen. Understanding this connection will make you a better lifelong investor. Meanwhile, people who understand only one side or the other can become blind to what investing really means.

The real estate faithful will often talk about the specific nature of their investments. Their houses and apartments really exist, and they provide their services housing to their tenants, which is an essential human need. In return for meeting this need, the investor collects rent, which is a real and sustainable source of income.

And your ownership of the houses and apartments is guaranteed and protected by our legal system and financial institutions, something that makes trust possible. And to trust is the basis of a society’s prosperity.

But sometimes these people go too far and claim that real estate is the only real investment, blinding them to the value of investing in other companies through stock ownership. This blindness can lead to “crusty multi-millionaire landlord syndrome” – the guy who owns 400 rental properties and is always looking for the next deal, but can never really sit back and feel retired, no matter how big the empire grows. Because for most people, owning real estate is a… active business rather than a truly passive investment.

The stock market faithful Another problem may arise: a focus on stock prices rather than corporate ownership. When you hear people talk about the ‘200 day moving average’ or ‘support level’ or ‘death cross pattern’, you can safely assume that they are suffering from this condition.

And it’s the same thing that fuels price speculation on things like cryptocurrencies, meme stocks, and other volatile fads: they’re hoping for a result (rising asset prices) without taking into account what actually creates the underlying value value (income).

Men's Deluxe Muscle Chest Batman CostumeMeme Stocks / Crypto Trader

If there is no income, there is no value. Betting otherwise is like trying to get in shape by putting on a fake Batman-style padded muscle suit instead of doing the actual barbell exercises.

But just as importantly, a stock is also a guaranteed share of ownership in a real company, protected by our legal system and financial institutions, just like the deed to your house. While you can easily buy and sell stocks with a single tap on your phone, the actual meaning of stock ownership is complex, old-fashioned and regulated, and that’s a good thing. You are a shareholder, the right to receive company financial statements, attend shareholder meetings, vote on company initiatives, and even hire and fire board members (or become one yourself) using your voting rights.

Without trust in these institutions, including the democratic election system that allows us to keep everything running, the idea of ​​ownership has no value. somethingand a rich society cannot develop. Recording the ownership details on blockchain will not make any difference because accurate registration is not the core problem.

What matters is that People must trust each other and behave in a trustworthy manner to keep all this prosperity going. If you give up trust and fuck with democracy and begin to spread mental viruses to encourage others to bicker and distrust each other, all forms of wealth begin to crumble.

But as democracy-loving, enthusiastically voting members of a wealthy society at every election, even the midterms, you and I lean firmly on the side of trust and cooperation, and that’s why our lives look so prosperous. recently.

I encourage people to bring these two philosophies together think of each investment as just another type of rental property. What value does the house (or business) bring to society, and what are its returns in relation to the price you pay?

For example, earlier this year some friends and I were talking about Rivian, the new electric truck startup that was about to go public.

2019-05-rivian-campkitchen-006(Beautiful electric truck with extendable camp kitchen. Image credit Rivian)

“Wow, that R1T is a great vehicle – every wealthy outdoorsman wants one and all the reviews are glowing. So the IPO is probably a good investment at $75 per share, right?”said my friend.

“I I absolutely agree,” I answered, “It’s a cool truck and if they ever sold it in the actual usable size of a van, I’d buy one for myself!”

But the real question is how much of the company do you get for that $75, and when will the company have enough profit to justify the price?

At this point we could have tried to dig deeper into the details: Rivian issued about a billion shares, which means you value the company at $75 billion. So you can try to guess how long it will take before the company produces enough gain to justify this business value. Which in turn depends on their gross margins, which depend on being able to quickly and efficiently scale multiple factories and secure a flow of several thousand custom components and batteries…

But not being blessed with the power of infinite knowledge of Rivian or a psychic ability to predict the future of the auto industry. I am not qualified to speculate on the value of these shares. So instead, I just buy the entire index and get the great performance of a broad mix of companies, without incurring the unique risks that come with concentrating on one individual stock.

And it turns out that was a good philosophy when you look at Rivian’s stock price since that ill-fated IPO:

Buying a good stock at the IPO may make you look like a genius or a fool, but either way it’s mostly luck.

What does this have to do with Aaron’s question?

Aaron knows how to find a good deal on a house (which is like buying shares in a productive company), and he has the incredibly valuable skill of being able to renovate them to create new value (which is like helping his new ‘company’ upgrade his factory to generate even better revenue.)

But he should also be open to investing in other companies (via stock index funds) because they are simply doing the same thing in different ways. They will deliver solid and consistent returns for decades to come. While a well-managed rental property can sometimes yield higher returns than the stock market, a stock never calls you on a Sunday night to say the boiler is leaking or to warn you that they have to end their lease early because they have a new job. in another state.

And Aaron goes a few steps further – actively building new things and managing five employees – certainly a worthwhile pastime, but certainly not in line with my own idea of ​​retirement.

As he and I both learned at this age, building is fun, but it also puts a lot of strain on the body. Rental properties are fun, but at some point things can get old and sometimes you just want to kick back on a Sunday afternoon instead of fielding calls from your tenant or your property manager.

Investing in stocks, on the other hand, is a truly passive way to prepare yourself for the best kind of retirement: one where you’re doing the work you love, but you really don’t need the money for it.

So what would I do in Aaron’s shoes?

I would keep the houses I love living in and sell the rest if I only manage them for the money. I would dump a lot of the excess money into the sensible index funds through the financial company of my choicefeeling extra good about the fact that the shares are currently on sale.

And then, just like now, I would continue to do construction projects with good friends, only when it suits me. When evaluating a new project, instead of asking myself about the potential profit, I would ask, “Is this project so worthwhile that I would do it for free?”

If the answer is yes, then go ahead and do it and celebrate the wins and use them to enable even more generosity.

If the answer is no, the project is no. You would only be taking it upon yourself to make money, something you no longer need because you have already achieved financial independence. Leave the money in index funds and keep looking for work that really matters to you.

From what I’ve seen, valuable, fun, and valuable work is an infinitely renewable resource, and we have both at least another 47 years ahead of us.

Good luck Aaron!

In the comments: Are you committed to the stock market or real estate, or are you still undecided?

Sources & Idea Inspirations:


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