Investment Real Estate vs Annuities
My investors in Bellingham, Washington, always want to know the real scoop behind renting investment real estate. They hear a lot of non-sense and come to me asking the low down. I have so many requests on this topic that I have decided to lay it all out layman style to you. While this is not exhaustive, it will serve as a basis from which your knowledge can flourish. We will cover annuities versus rentals in this section, with more to follow in this series in additional postings.
First, why rentals?
Rentals are a great source of income. You don’t need me to tell you this, but what you may not know is why. First let’s say you have some money saved up and you want to your money to grow, as we all do. There are several readily accessible options to you. Your friendly insurance broker may tell you an annuity. Your friendly stock broker may tell you the market. Finally, your friendly Realtor will tell you Rentals. Aside from business deals let’s explore these options.
Your insurance broker sits you down and shows you a lot charts about how annuities will pay you for life. Sounds really tempting right? So what is the catch. The first catch is that the pay out is bigger for the bigger risk you take. If you invest now, you generally get punished if you need the money early for example, your child’s education or a new car. Second, you get a bigger pay out for more risk you take. Let’s say you die early, well there goes all your money. Secondly, it only pays out less than 3-5% a year. The truth is the only reason they are taking your money is so they can reinvest it and get higher returns. Then they pay you back as little as possible to reap the most gain. Great model for profit, not a great model for you.
For example, they pay you 3% and you may or may not make back your principle amount. For them, this is great. Pretend a friend comes to you and says hey, “can I borrow 10k?”. You say, “sure for 3-5%, I’ll loan it you.” Your “friend”, says, “sure, but I’ll only pay you back if you if you start taking payments in 20 years, but if you die before then I don’t have to pay you back.” Would you take the deal? There are various forms of this scheme but it’s pretty much the same concept but manipulated in various terms. There is an upside that your broker will tout. It will pay you for life! True, but this comes at a huge risk to you. If you are sure you will live to 105, then yes this might make a great deal.
Annuities versus Investment Real Estate
Let’s say your annuity will take 60k and your down payment will take 60k. Let’s review the benefits. First, your investment real estate property will pay you monthly. However, your annuity may charge you monthly to “pay into” for years to come. Your money going out into this annuity is taxed at your income tax bracket. You also have to pay 7.5% on top of your income taxes for FICA (Medicare, Medicaid, and Social Security). In addition, to that you may have to pay state income taxes. You may find this IRS tax bracket helpful. https://www.irs.gov/pub/irs-pdf/i1040tt.pdf.
So let’s say your monthly payment into your annuity is 60k plus 500 a month. But what is 500 a month? Your IRS tax bracket is 25%, your FICA is 7.5%, your state taxes are 4.5%, and unemployment/LNI is 1%. So how much do you have to make before you put away $500? It is a whopping – $806.15. That means you have to first make $806.15 and then give $500 away, hoping to live to 105, and then make 3-5% return on your investment. 3-5% is about $25 a month back on $500.
Now, your rental investment real estate here in Bellingham, WA you put 60k into it, and you self- manage. It PRODUCES approximately $1100 a month in income. That is the going rate for rentals her in Whatcom County Rental market. That means instead of spending $806 a month, you are generating $1100 a month. To put that in yearly terms, you are spending $9677 a year on an annuity, and getting $13,200 a year in rental income. This is generalities but you get the rough idea.
But Don’t I just Have to Pay Taxes on Rental Income
Yes, but not as much. Rental income is passive income, which means you don’t pay FICA, unemployment/LNI, or your income tax bracket. It is generally capped between 10-15% compared to 38%. How huge difference is that! Your making money and paying less taxes!
Added Bonus of Appreciation
Yes, the real estate market goes up and down. It took 8 year to recover from the second worst recession in 200 years. But guess what, real estate has bounced back to within 15% of pre-market highs. So there is risk but it much less than the stock market. And there is huge upside – what was your neighbors house worth 20 years ago versus now? Probably double.
Let’s catch up with your stock broker’s advice in the next blog.
Caution: There is a lot to know about Real Estate. I have spent over a decade focused on income properties, general contracting, realty, property management, commercial deals, and much more. If you don’t seek my advice, please seek an expert before going into investment real estate. Not all Realtors were created equally and not all deals are equally lucrative. Know before you go!