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I am 23 years old and selling my Sports Car/Winter Car to gain economic freedom faster (Don't really need to do this, but I want to). Currently I make around 65K a year and bought a very cheap trailer that I currently live in due to the low living expenses (Bought the trailer for 10000, with monthly park rent expenses of 430 a month). When I sell both my vehicles, I will end up with 34K in cash.

  • 10,000 Of that money would go to paying off remainder of the Sports Car Loan.
  • 3,500 would go to paying off the remainder of mortgage.
  • 8,000 Will go to fully buying a reliable 4WD vehicle due to the weather where I live.
  • 12,500 will be remaining after purchasing the much cheaper vehicle, and paying off both car/mortgage.
  • Currently have emergency fund of 5,000.

Other benefits of the decision include no longer paying a hefty car insurance payment for owning a sports car, dealing with the maintenance of two vehicles, no longer registering both cars.

What I am doing right now.

  • Have a credit score of approximately 765.
  • Currently investing into company 401k fully utilizing the match given by company.
  • Have a ROTH IRA on the side from previous employer.
  • Currently finishing the last of the renovations on my house, in total has cost me 8000 dollars with about a remaining 3000 to go. The house itself cost about 10,000 dollars which was the entirety of my mortgage.

Currently where I live, people are buying houses for incredibly expensive amounts, similar to that of pre-'08. I have already seen large increases in house foreclosures in my area selling well below market value. I would like to consider purchasing these properties under market value and setting them up to be rental properties.

My Question is: Should I go the route of contributing the yearly maximum to my 401K or should I take advantage of the local housing bubble in my area. There is no clear cut answer to this question, just looking for possible pointers and things I should take into consideration.

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  • Do you like DIY home repair, or do you imagine you'd hire most work out? What's the ratio of price to rent in the area?
    – Hart CO
    Jul 13, 2018 at 15:08
  • I do not mind getting into DIY home repair, I have a handyman currently who has done all my work for cheap and has done a great job. Typically, most places around my area have a monthly rent cost of about 1200-1600 a month.
    – Aszula
    Jul 13, 2018 at 15:09
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    These statements seem at odds with each other: "people are buying houses for incredibly expensive amounts" and " I have already seen large increases in house foreclosures in my area selling well below market value".
    – TTT
    Jul 13, 2018 at 19:13
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    You're making a fantastic decision about getting rid of the pointless cars. Great stuff.
    – Fattie
    Jul 13, 2018 at 21:23
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    Just a reminder - comparing 401k vs. rentals directly is probably not fair. You will be many times more involved in the rentals (even if you use a management company, and exponentially more involved if you don't). Not a bad thing, but it is worth considering in your ROI calculations. Lots of 401ks just ask your retirement date and contribution percentage then you do nothing until you want to make a change. Selecting a property, rehabbing it, maintaining it, filing taxes, collecting rent, finding tenants, etc, etc, etc, will be like a part-time job and grow with each additional property.
    – Rob P.
    Jul 14, 2018 at 12:58

9 Answers 9

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Assuming equivalent returns, the difference is cash flow timing. Rental property gives you cash (and taxes) now, while a 401(k) gives you cash (and taxes) in retirement.

Plus, a 401(k) typically includes a company match, which can increase the "return" by 50-100% before tax. That's hart to beat in any other vehicle.

So if rentals are just for additional investment income and not income, I would first max out the 401(k) match. Then I would add to the 401(k) until I get to a comfortable level of retirement savings, and THEN I would consider rental real estate.

Also, I would NOT borrow to invest in rentals - the interest eats into the returns and increases risk. You'd be better off from a risk/return standpoint staying with the 401(k) or other similar investments.

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  • Thanks for the input. I agree with what you have said. I would make sure if I were to buy a rental property, I would buy the property without borrowing money as you have suggested. I guess the question becomes, what do you do with the new income from the rental property. Save up and reinvest into another property after?
    – Aszula
    Jul 13, 2018 at 15:47
  • Yes that would definitely compound your returns. At some point I would probably diversify if you find yourself real-estate heavy, but it's essentially the same as reinvesting stock dividends (just larger chunks less frequently)
    – D Stanley
    Jul 13, 2018 at 15:55
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    Whether you borrow to invest in rental is a decision to be made on a case by case basis. Taking a rental property I owned for ten years or so, the numbers worked like this. ~100K purchase, at 20% down meant 80% on a mortgage. I got an interest only loan. I was able to keep it rented ~90% of the time, yielding ~1K / month gross. After insurance, taxes, mortgage payments, management fees etc, I was taking home about $300 / month net. So for a 20k investment, that's a little under 20% annual ROI, and when I finally sold, I was able to recover most of the initial 20K invested.
    – dgnuff
    Jul 13, 2018 at 20:02
  • @dg I'm not saying it's a terrible idea and never works; clearly it CAN work. But it does increase risk when compared to a 401(k), both in terms of variance in returns and in terms of probability of complete loss. Suppose you had gone 6 months without a renter?
    – D Stanley
    Jul 13, 2018 at 20:14
  • @DStanley Agreed, the risks are there. Hence the "case by case" comment. Real estate is higher risk, but as shown, with those higher risks comes higher return. A general rule of thumb that was explained to me about investing over your entire life is that as you get older, you should consider reducing risk and hence return, in order to ensure that you maintain the value that you've accrued over the years. On the other hand, early on is a time when a higher risk may be acceptable. ...
    – dgnuff
    Jul 13, 2018 at 20:31
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Hodge-podge of things to consider:

  • Rent vs price ratio, typically you'd want a place that rents for at least 1% of price per month, ie $200,000 house that rents for $2k/month. Historically 2% was a rule of thumb, but that is not found in my area. Obviously the higher the better, not all areas have good rental markets.
  • How long do you intend to be in the area? Distance land-lording is more costly, so if you're not intending to stay for too long it might not be worth it.
  • Don't count on rent, and budget for repairs on day one. Your freshly signed tenant and your HVAC could flake out on day one, so ensure a healthy cushion.
  • Screen tenants thoroughly and research laws regarding rentals in your area.

Personally, I started in rentals by buying a cheap place as my primary residence (5% down, traditional loan) and saving up for another down payment as fast as possible, then converting first home to rental and buying another primary residence, rinse and repeat. This kept me out of commercial loans while getting started. It also gave me a 3-year window to try renting before deciding if I wanted to sell or not without losing the capital gains exclusion. Sounds like that would not work for your trailer (perhaps you could move the trailer to a more rental friendly area?).

I appreciate the idea of incurring no debt, and timing the market is more luck than anything, but if you're in a high-growth area then taking on a mortgage can be much more lucrative than waiting and saving, home price increases in my area have out-paced interest for the last ~8 years, if I had saved to buy my first rental in cash instead of taking on debt I'd be much further behind. No guarantees there, but weighing risk/reward is part of any investment decision.

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    I plan to stay in the area for the rest of my foreseeable future. Grew up in the area, good jobs in the area. Would prefer to live in the trailer for a long time to take advantage of the low cost of living. There are co-ops that will move your trailer for free as there has been a push to force some of the less reputable trailer parks out of business.
    – Aszula
    Jul 13, 2018 at 16:35
  • If you take on a roommate and can really accelerate savings, then you likely won't have to wait too long to buy. My approach worked for me because I wasn't in a position to take on roommates (had wife already), the trailer seems like a great choice as it really jacks up your ability to save. I just wouldn't rule out debt for your first rental without doing some math on it first, ie maybe 50% down gets you in a sweet spot.
    – Hart CO
    Jul 13, 2018 at 16:40
  • I had lived with roommates before buying the trailer for years so it doesn't really bother me at all. I would buy the first property outright instead of borrowing, but like you said, timing can really change how things turn out.
    – Aszula
    Jul 13, 2018 at 16:43
  • @MattCrandall I'd suggest researching more opinions about cash vs debt for rentals before deciding you're in the cash-camp, there are compelling arguments for taking on debt.
    – Hart CO
    Jul 13, 2018 at 17:18
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    I suggest looking for the Price-To-Rate ratio in your area. This article has it for most areas in the US: smartasset.com/mortgage/price-to-rent-ratio-in-us-cities Typically I hear that if that ratio is under 20% in a market with a good rental market, it's a good deal. More than 20% requires a much larger down payment to be worth it and anything higher than the mid-30% is probably not worth it (unless you're more interested in building equity which is a whole different target).
    – Tiago Romero Garcia
    Jul 14, 2018 at 19:21
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Answering this point of your question:

just looking for possible pointers and things I should take into consideration.

What do you know about rental properties? What do you know about being a landlord?

While there is plenty of information out there about how to buy real estate for no money down, good information about the rental business is more difficult to come by. You could spend some time looking and researching this information and seeing if it is a business opportunity for you. It may not be!

The coolest thing about all of that is that you don't really need to make a financial decision now. You could gain the information with little or no cost. You could continue to invest, and even start to work on a beefed up emergency fund.

One thing, I bet you understand, is that if you do go into the rental business a 5k emergency fund is not going to be sufficient. How large should it be? Do you raise those funds before you purchase?

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    Correct. I would increase my emergency fund to around 75,000 before pulling the trigger on any rental property purchases. Like you said, more research needs to be done.
    – Aszula
    Jul 13, 2018 at 15:45
  • @MattCrandall Reading your comments and your initial question, I'm tempted to say you might want to consider altering the question you ask yourself from "Should I invest in Rental Property now?" to "When should I invest in Rental property, and what do I need to do (i.e. build the buffer fund), and what do I need to learn?" By that I mean don't alter this web page, but do start considering that alternative question, do the research involved, and start saving into your buffer fund." ...
    – dgnuff
    Jul 13, 2018 at 20:54
  • ... One last piece of advice, despite the cost, get a property management company. You do not want to have to deal with your renters face to face. In my extremely humble opinion, remaining an anonymous landlord has advantages that far outweigh the cost of having a management company, plus they have all the infrastructure in place to find, screen, and place renters.
    – dgnuff
    Jul 13, 2018 at 20:57
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Currently where I live, people are buying houses for incredibly expensive amounts, similar to that of pre-'08. I have already seen large increases in house foreclosures in my area selling well below market value. I would like to consider purchasing these properties under market value and setting them up to be rental properties.

I'm not sure that this is the best response to a bubble. Consider a property that is selling for 20% below market value:

  1. Does it have problems that make it worth less than market? Is the foundation cracked? Does it need a new roof? Is the interior dated? Is the basement leaking? Is the previous owner mad about the foreclosure and likely to sabotage the house? So on and so forth.

  2. What is the real value of the property? Outside a bubble, we can estimate with the market value. But in a bubble, the market value is incorrect.

If you have a 50% bubble and the property's market value is $75k, then its real value is $50k. But it's 20% below market value now (by our assumption), so $60k. Should you pay $60k for a property that is really worth $50k? Probably not.

Now, I know nothing about your local housing market, not even where it actually is. I don't know how overvalued things are. But buying into an overvalued market is questionable. You will lock in the price of the house while being subject to the market in terms of rental income. And with foreclosure auctions, you are highly vulnerable to problems that you couldn't fully vet because the auction is as is without prior examination. To make that work, you need to buy a lot of properties so as to amortize the cost of the bad purchases with the profits from the good purchases.

This seems more like a situation where you should be selling off your over-valued real estate for the incredibly expensive prices. After the bubble pops, you can buy at much reduced prices with far lower risk.

If you really want to become a landlord, why not look into buying land where you can start a trailer park? That would at least save you $430 a month after you move your trailer there. Work with a co-op to become the place where people fleeing their landlords move. It doesn't have to be big. Perhaps enough room for ten to twenty trailers. Paying $40k up front to save $430 a month is a decent deal itself. Add tenants slowly, so you only have to take the good ones.

Make sure that the land is zoned right for the trailer park. Otherwise they might not let you do it.

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    Many of the towns in my state prevent you from creating trailer parks as they don't generate enough income to sustain the towns needs. You can expand already existing parks but that is about it.
    – Aszula
    Jul 13, 2018 at 19:29
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Ideally, your emergency fund should give you about 6 month of living expenses, so your 5k feels a little light.

If you pay income taxes, maxing out your 401k is almost always a good idea since you can save it as pre-tax money. Assuming you are in the 22% tax bracket, putting 10k into a 401k will save you $2200 in taxes (if done correctly). That's a rate of return, that's hard to beat (regardless of the actual investment returns).

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    Don't forget the biggest benefit of a 401(k) - the company match! And technically the taxes are deferred, not saved.
    – D Stanley
    Jul 13, 2018 at 15:29
  • @DStanley Agree about the deferral. You can't avoid paying taxes: Al Capone learned that one the hard way. ;) On the other hand, you may well be at a lower tax bracket when you do retire, I know for a fact that I sure will be, in which case that tax payments will be reduced. So in that respect there is a tax savings, just don't ever assume it'll be a 100% tax savings.
    – dgnuff
    Jul 13, 2018 at 20:45
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I would definitely seek the advice of a good financial advisor. Interview quite a few to find one you are comfortable with and seems knowledgeable. Seek out free dinner opportunities where they market themselves, you'll get a free dinner out of it, some knowledge about the business, and usually a free consultation.

I wouldn't necessarily invest anymore in your 401K, but that depends on what your tax situation looks like. If it isn't going to reduce your taxes a significant amount (like dropping you into the next lower tax bracket) then I'd recommend investing in a Roth IRA.

I personally wouldn't recommend rental properties. I've personally found it very aggravating to get people into your nice property who just abuse it to heck, steal appliances, bash holes in walls, etc. Not all of them do, but enough to turn me off the business (OTH my brother, who is a general contractor, has several rentals and doesn't have a problem with them).

A good financial advisor will have access to several non-stock market investment opportunities - be sure to ask about these when interviewing them. If they don't, or what they offer sounds sketchy, then keep looking. It took me over 18 months to find a really outstanding advisor, but it's been well worth it.

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I recommend either forgetting about real estate completely, or forgetting about it until you can do the following with ample comfort:

  1. Max out your 401k. The current contribution limit is $18,500 per year (pre-tax).

  2. Max out your Roth IRA. The current contribution limit is $5,500 per year (post-tax). You said yours was from a previous employer, so this sounds like a rollover IRA. You don't have to stop contributing to it just because it's from a previous employer.

  3. If your employer offers a Roth 401k alongside a traditional 401k, max out a Roth 401k instead. The contribution limit is the same as the 401k, but the contributions are after-tax.

I'm a fan of after-tax retirement accounts because my view is that taxes are going to be raised on all of us substantially by the time we're ready to hit retirement. Why do I think this?

The U.S. is bankrupt. We're in debt to the tune of $21 trillion, and it will continue to climb. Something like 80% of the entire federal budget goes to just military, Social Security, Medicaid/Medicare/CHIP, and interest on the debt. We're screwed. The government's only source of income is taxes. And, since the economy will never be able to "grow" us out of that big of a hole, the U.S. has only two choices: (1) collapse like Greece did a few years ago, or (2) raise taxes in combination with significant austerity measures.

Would you rather retire with several million free and clear, or several million that you have to pay an unknown amount of taxes on? Stick with the after-tax accounts.

I make about $20,000 a year more than you, and maxing out a Roth 401k and a Roth IRA leaves me with enough left over to cover my expenses and contribute about $20k a year to an emergency fund. And, since $20k is not an adequate emergency fund, I'm talking scraping together every penny for several years (no cable TV, no eating out, no vacations) to be able to live in security.

You have time on your side to make compound interest work for you. Take advantage of it! $10,000 invested at your age makes you a millionaire in retirement. As great as that sounds (and it is great), a million dollars isn't a lot of money for retiring today. Due to inflation, that same million dollars will have even less buying power for you. Max out those retirement accounts!

Now consider the other alternative: buying real estate. Some people gamble on having constant occupancy to have the tenant essentially buy the house for them. Okay, great. When they're paying the mortgage, that money's going to the bank, not to you - so what's the point unless you're playing the long game? And if you're playing the long game, you might as well invest that money instead, and have it start generating money for you NOW.

If you buy the house outright instead, it will take you many years to recover your initial investment plus what you lost to inflation and maintenance over those years - just to get back to where you started. Again, you could have invested the money instead and had it generating returns for you the entire time.

You won't be bringing in a lot of income from your tenant, either. A monthly rent of $1,000 gets you $12,000 a year pre-tax, which means if you save 100% of an entire year's rental income, you might not even be able to cover the cost of a new roof (depends on the house, but still - roofs are NOT cheap). Water heaters... furnaces... not cheap!

In the end, you'll just be throwing a lot of money after a small return that pales in comparison to what the market will give you over time. And you'll have to continuously work for that small return as compared to investing, where you can get rich by sitting back and doing nothing.

My final piece of investment advice is to do what Warren Buffet says:

  1. Invest only in low-cost index funds - no actively managed funds.
  2. Be greedy when others are fearful, and be fearful when others are greedy.
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  • Just remember that "raise taxes" can include adding taxes on Roth withdrawals :(
    – Ben Voigt
    Jul 14, 2018 at 22:19
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Whether you should contribute to your 401(k) and whether you should invest in real estate are separate issues. While having your money in your 401(k) does make investing in real estate more complicated, it does not preclude it.

Taking "advantage" of a bubble is tricky business, however. If there's a bubble, (and whether you are correct in thinking there is is itself a serious issue) that means that if you buy real estate, you will be paying more than it is "really" worth. The only way that's not a bad thing is if the bubble continues, and houses become even more overpriced in the future ... and you manage to sell before the bubble bursts. You're betting that you'll be able to take advantage of all those gullible investors overpaying for houses ... by first overpaying for a house.

Moreover, investing in real estate make diversification more difficult. Not only are you putting your money in only one sector, you're putting it in a few, or even a single, property; unless you have a lot of money, the down payment on a single house is going to be a huge chunk of your net worth.

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I would definitely

first

secure your first piece of real estate.

When people endlessly discuss real estate versus paper investments,

the utterly overwhelming thing they endlessly forget, is that your first piece of real estate - even if the bank owns almost all of it - gives you massive, spectacular, advantages in todays financial-banking-political milieu.

  • Spectacular tax advantages

  • Spectacular free-place-to-live advantages

  • Spectacular advantages to access to credit

and even, not unimportant, it makes it incredibly easier to "fill in forms" of every possible variety. Being a home owner is simply being a "first class citizen" - EVERYTHING is easier.

Secure your first piece of real estate.

And then for your "second investment" join the debate about what to gamble on.

Enjoy!

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