Mindy Jensen: Today’s Finance Friday guest is hoping to retire at the age of 47, but she feels like she’s stuck in the middle class trap. Will she be able to retire, given how much of her current portfolio is tied up in retirement accounts? Stick around for Scott and I to wrap up at the end because we want to hear from you, our BiggerPockets Money community, because Ally has a lot of options to choose from. Hello, hello, hello and welcome to the Bigger Pockets Money podcast. My name is Mindy Jensen and with me as always is my photogenic co-host, Scott Trench.
Scott Trench: Thanks Mindy, great to be here and looking forward to creating a complete picture of Ally’s financial situation here. BiggerPockets has a goal of creating 1 million millionaires. You’re in the right place if you want to get your financial house in order because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting. Before we bring in Ally, we want to thank this episode’s sponsor, Connect Invest. Real estate investing simplified and within your reach. Now, let’s get into the show. Ally, we’re so excited to have you on BiggerPockets Money today. Welcome.
Ally: Thank you for having me. Excited to be here.
Mindy Jensen: Ally, can you share where your journey with money began?
Ally: My journey with money. So I came from, my parents were very frugal. I was one of four. Um, an example of my dad’s frugality would be, we would go to, go out to lunch at Wendy’s, and he would order, uh, one large soda, no ice, and six cups. So that is a sort of background that I came from. He always said, no debt, pay for everything in cash. Everything, you know, we always were saving money from a young age. Um, and that’s carried on as I’ve become an adult. I, you know, right now I have a 1999 car. Always been saving since I was little. Um, my first car I bought only went in reverse. Um, so we were able to get a good deal on that.
Mindy Jensen: Did you fix it or did you just try and drive backward? I feel like, I feel like that’s inviting a…
Ally: My dad fixed it. Yeah, my dad was an engineer. He fixed it. We got it for $400. It was a BMW. Uh, only went in reverse so yes. Um, lots of fun stories like that, but made it interesting. I was always very embarrassed, but um, you know, today I understand why he taught us that.
Mindy Jensen: Allie, I think we have the same dad. I was also always very embarrassed about the cars that we drove, although we didn’t have one that just went in reverse. My dad was always working on them because they were so old and so breaking down. Um, so I am, I am right there. We are soul sisters. Where are you based and let’s talk about your career.
Ally: Sure. So I reside in the lovely Laguna Beach in Orange County. So it’s, uh, a very expensive place to live. I was fortunate to be able to get a house here when everything was half off in 2011. So I was able to, with the money I had saved since I was little, um, put a down payment and, and buy a house where I could never afford it right now. My job is I do sourcing for, uh, facilities management company for a big tech client. So I do find cost savings for a living.
Mindy Jensen: Do you enjoy that?
Ally: Yes, very much so. Yeah. No, I really enjoy my, my job and my job has a lot of benefits like they let me work from home since 2008. So I was able to raise my children and I’ve never had an expensive commute or had to invest in clothing or anything like that. So I think that’s really helped me save a lot of my money.
Mindy Jensen: Ally, let’s jump in and look at a copy of your numbers. I have a total net worth of $3.8 million, which is awesome. I’ve got income of approximately 298,000. Expenses of 9,900 a month. So I don’t think that’s where we’re going to see a lot of savings. Uh, debts are just a $600,000 mortgage at 2.75%. I consider that to be good debt. Um, and a HELOC for 440,000 at 8%, which we’ll talk about in a bit. I see that you are Airbnb-ing your property, your primary residence for two months out of the year. Is that every year that you do that?
Ally: We can only do it in the summer because I have two children. So when they’re out of school, we put it up every summer and we’re never expecting to rent it, but it always rents and it’s we get, I think last year someone paid 46 grand for two months.
Mindy Jensen: Holy cats. Yeah, I would do that again. I mean, is that like your entire mortgage payment for the whole year?
Ally: Our mortgage is 2650 a month.
Mindy Jensen: Yeah. So that I I’m doing quick math.
Scott Trench: And that just P&I?
Mindy Jensen: Yes, she’s in California. That’s not taxes or insurance.
Ally: Yeah, that doesn’t include. So everything all summed up with our mortgage is around 4,000, 4,000 total with taxes and home insurance.
Mindy Jensen: And I see a small pension and social security options for you. Um, what is your retirement goal? Numbers, timeline, et cetera.
Ally: Uh, last month. Living in Laguna Beach, nobody talks about retirement. Everyone has like a Bentley or a, you know, a Ferrari or a Cybertruck and like it’s just unheard of, right? So, you know, I never really thought about retiring early until I, we used to have a financial planner, Creative Planning that would meet with us once a year and they’d say, when do you want to retire? And they, and they had a little spreadsheet they’d put up and I remember saying, well if I move that number up, how much more money do I have to save? And the, and the difference wasn’t that much. It was just like a couple hundred bucks a month. So that’s what got me really excited about like, wait, could I retire early if I just save more money now? So, you know, I never really had, I just always thought I would work till, I don’t know, 60 or 65 and then retire then, but I mean, do we, but then I started, I found, uh, Mr. Money Mustache and Scott, I read your book. Uh, and I was like, you know what? I don’t have any of these, uh, Yes, nice little plug, set for life. That was a good one. And I realized that, you know, I don’t, you had mentioned three expenses, right? The housing, which I cover with the Airbnb, the, the transportation, which um, I don’t really have and food, which my husband cooks so we always eat in, it’s better eating in than eating out. So, um, I was like, well, maybe I could do this. And then anyone I talked to about it told me, like, what are you talking about? Like, that’s just silly. Nobody was even interested in hearing about it. So that’s why I feel like I really resonated with this podcast.
Mindy Jensen: Why would you want to work until you’re 65 when that’s the only option versus giving yourself the option to work for as long as you want to, but you don’t have to work anymore.
Ally: I know. And if they would let me short-term rent my house in Laguna, which they don’t, I could have been retired so long ago. So, that’s a bummer for me. So sometimes I think about buying a short-term rental like in San Diego or something like that and um, pursuing that as well, but.
Scott Trench: And I think the most important key thing here is so glaringly obvious. It’s the problem that you came with us, you know, came to us with today, I think is the, you know, the concept of like the middle class trap with, you know, your net worth is $3.8 million. You’re rich.
Ally: I feel so poor.
Scott Trench: The house is $3 million with a $600,000 mortgage balance, give or take, left on it. And the rest of your assets are essentially all in the 401k or IRA setting for that for the other 1.4 million, right? And that’s essentially the entirety of your financial position. Is that is that correct?
Ally: Yes, that’s correct.
Ally: And it’s like, how can I access those funds? Or how can I leverage them? Or what can I do like without having to sell my house, which I I could also do.
Scott Trench: Yeah, and and this problem is starting to come out of the woodwork. Like I I don’t think I’ve talked to a lot of people that had this problem, you know, in past years. And then all of a sudden in the last month or two, I must have I must have come across a couple dozen people with a problem that’s similar to this, right? How do you feel about it? What have you thought about in the context of this housing decision, um, or how to how to access this housing, um, as you were putting all these numbers together and and thinking about coming on the show here?
Ally: I mean, I’m always kind of torn between, okay, do I, we have about a quarter acre so I could build an ADU in the backyard, rent it out, I could pay probably all cash. I could, one thing we’ve pursued but we haven’t actually been successful at is buying another house in Laguna that’s kind of not as nice or smaller, moving my whole entire family in because my kids are in school here and then renting out our primary. And then the other idea is just buying some real estate back where I’m from, which is, uh, Philadelphia area, where it’s a lot cheaper and you can get a lot more, but then managing it so far away would be difficult. Sometimes I think about too like cashing out some of my 401k to do that. But then, you know, I had this financial planner, uh who really said, you know, you, you don’t want to tap into that 401k.
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Mindy Jensen: Welcome back to the show. Have you read the Mad Fientist article called How to Access Retirement Funds Early?
Ally: Yes.
Mindy Jensen: That is one of the best, most comprehensive articles for accessing your retirement funds early. So you can tap into your 401k without paying penalties. I am assuming that you have a traditional 401k. There’s no way that I know of to get around paying taxes on this unless you only pull out a little bit, but what’s the point of pulling out a little bit? You’re not going to even be able to live off of it. Um, and this would be after you, uh, leave your job because if you do it while you’re at your job, you’re paying in the highest tax bracket possible to access these retirement funds early. Uh, but there is the, uh, Roth conversion ladder. There is the 72T. There is the, uh, just taking it and paying the penalty, although I would do that, um, after I stop working because you will still be paying taxes on it, no matter what. So I would suggest you give that article another read. Um, building the ADU in the backyard is interesting. You said you could pay for it with cash. How much would that generate in income? Like, how big of an ADU can you build?
Ally: You know, this is the issue. So when I have like a contractor come out and bid me, they say it’s going to be minimum million bucks to build an ADU. But then you see these pre-built ones online, right? That are like $80,000 or like $150,000. So, I think I’d go for the the prefabbed one, right? Pay in cash and then I could probably get 3,000 a month. Something like that. But I would have people living in my garden, which I’m not sure.
Scott Trench: What would that do for the value of your home?
Ally: Yeah, it would probably go up a million bucks, I would guess. I mean, it would go up more if it was like a custom, if it was a custom one. If I spent a million dollars on it it would probably go up significantly more than if I bought a prefab.
Scott Trench: That would be a truly amazing statement if you could add a $150,000 prefab ADU to this property and increase the value of the property by a million bucks. But I think that’s like, that’s a good homework assignment. Has anybody done that in the local area and how did their property translate? Because like, you know, there’s all this rent and cash flow and income stuff. Like if you can spend 150 grand and make a million back in one year, then there’s no there’s no other like that that’s the best opportunity you’re ever going to get in your life. I’m skeptical that that will happen with that. But if it can, that’s the first, that would be the first avenue I’d explore. Um, from this. And and in that case, then I would be like, yes, how do we finance? How do we finance that? Is it a HELOC, is it um something else because you’ll be you you’ll be able to justify almost any source of capital for that investment. But what’s your conviction in that, in that uh, that value add?
Ally: I mean, most people around here have a ton of money, right? So they’re getting the custom-made ADU that matches their house that’s beautiful, right? I don’t see a lot of just like drop-ins, right? But so I don’t know that I’d be able to find like something like that to compare, but I do see the the people that build the custom ADUs and their value goes, there was one, there was a house down the road for me. I think it was sold for 3 million, they built an ADU and they sold it for six because the property value here is so much, right?
Scott Trench: I’d rather do that than spend 150k to make a million, if that’s true. Like you’d rather spend a million to make two, or three, you’d rather increase the value of the property by $3 million with a million dollar outlay, than a $150,000 outlay to get a million bucks. That’s another 1 point what, 75 million. That’s an enormous play.
Ally: And there’s a possibility of doing like a JADU ADU. So you could do two. You could do two adds here in Laguna. So a junior ADU and a regular ADU. So you could actually do it twice.
Scott Trench: Let me ask you this though. Why what is Do you want to be in Laguna Beach? The goal is not to retire early, it’s to retire early in Laguna Beach, right? And live something close to your lifestyle, maybe in a slightly smaller home nearby. Is that right?
Ally: Yes, ideally.
Scott Trench: What is the ideal future home?
Ally: Home?
Scott Trench: Yeah, like what what is what is your future living condition look like?
Ally: Well, I have two kids that are aged 10 and almost 12. So I think for now I need at least a three bedroom home office. I it doesn’t need to be big, but I I do think people need their own space. You know, when they go off to college or move out, I don’t I it could be much smaller, just a one bed.
Mindy Jensen: Another trap that you’re in is the, I don’t have a cute name for it. You bought a long time ago and interest rates have since gone up, property values have since gone up. I can see you starting to look for another house in Laguna Beach and finding a smaller house that ultimately costs you more per month out of pocket, which isn’t going to be beneficial to your goal, unless you keep them both and then rent this one out. Do you have any plans to sell this house or do you want to keep it as a rental?
Ally: Ideally, I’d like to keep it as a rental.
Scott Trench: What does it cost to rent the house that you want to live in for the next couple of years?
Ally: In Laguna Beach. You know, that’s another thing we’ve thought about too. Like, should we just rent somewhere else? Because you can, they range, right? They range anywhere from, I’ve seen rentals for a three bedroom house for like 4,800, up in like a certain area of Laguna. And then, you know, they go all the way up to, I don’t know, 50,000. But I would think like a nor, like a normal three bedroom nice house would probably be around $12,000 a month.
Scott Trench: $12,000 a month. Okay. That’s higher so we’re we’re in hard territory here. That’s 140, 150k a year in rent. And to buy the place, how much would one of the places you’re thinking about buying cost?
Ally: They’re usually around 14 or 15,000 a month.
Scott Trench: That’s the mortgage payment. How much is the price point?
Ally: You can’t get anything under two mil here. So what I’ve been doing, so say a house is up for a long time, I’ll sort it by length and I, then I’d offer 18 and every once in a while they’ll say okay, and then they get a couple other bids and somebody else bids me. I mean, that’s kind of what’s been happening. I wouldn’t pay more than 1.8, but you’re getting a a not a very nice house at all.
Mindy Jensen: Yeah, I don’t see a lot of $1.8 million properties.
Ally: Yeah, you have to create the 1.8 million.
Mindy Jensen: I’m not seeing anything for less than, Oh, here’s one for $7,900 a month. Five beds, five baths. And if you rented out your place, could you rent out your place for $10,000 a month? It looks like you can rent it out for a lot more.
Ally: So long term, like if I was to do an annual lease, I probably could get 10 or 11 or 12 maybe. But on Airbnb like in the summer, I can always get 20. So I think if I did furnished Airbnb, a lot of people are remodeling their house, they want a place for like six months. So people would write me because I used to just have it up, my house up all the time on Airbnb and so people would say, hey, can I rent your house starting tomorrow for six months? And I’m like, you know, maybe if you could rent it in two weeks, we could do that. And then I’d be frantically searching on Airbnb for a rental.
Mindy Jensen: I mean if you could do that and get what, 20,000 a month for your property and you’re renting a property for let’s say 10,000 a month then and you’re paying 4,000 for your expenses for your house, you’re still making $6,000 a month and your expenses are $9,000 a month so you just need to cover $3,000 a month which you can do uh by accessing your retirement funds early. Scott, do you think that 3.8 could get her some uh, some, some $3,000 a month?
Scott Trench: I think that’s the big question here is is should you like if you’re going to move out of the house, should you sell or keep the house here? And I think that’s the like that’s the fundamental decision and we’re operating under the paradigm of keeping the house and how do we use that to drive income. And I think that that’s a question that needs to be posed here is there’s $2.4 million probably conservatively in equity in this house. And the $2.4 million in cash or after tax, I calculated the equity you would realize to 1.863 million. um, on this, uh, uh, at least, um, if that if you could sell out there like we can generate a lot of cash flow um, with $1.8 million in cash. um, in a number of buckets. So I think that’s the big, that’s the big question here um, is is what do we do like how how does it feel to even talk about selling the place?
Ally: You know, I’m open to it because if that means that I could be work optional and you know, have more freedom and still live a life in Laguna Beach, traveling and doing all these nice things then yeah, I mean, I’m open to it. And I don’t want to just have this house with a ton of equity and it be wasted. You know what I mean?
Scott Trench: Well, let’s let’s walk through the long-term rental case real quick. I I, um, I nerded out and I did a, um, a spreadsheet here.
Mindy Jensen: Right now, Scott is using his should I sell or rent spreadsheet to run the numbers for Ally. Go over to our YouTube channel, youtube.com/biggerpocketsmoney to see Scott in action. It’s fascinating.
Scott Trench: And I’d love to just kind of walk through and see how this feels, um, at the highest level and say like, here’s this is the value. You think it’s about $3 million today?
Ally: Yes.
Scott Trench: We don’t have to worry about the original purchase price in, well, actually, yeah, what was the original purchase price for this?
Ally: It was 940.
Scott Trench: 940. Okay. And you bought that 10 years ago, but we don’t need that date right now. What is the mor, when when did you get your current mortgage?
Ally: You know, I refinanced back when everything was really cheap. So, I would say during Covid.
Scott Trench: So, like probably around this time, like December 2021 kind of deal?
Ally: Yeah, that sounds perfect.
Scott Trench: And your mortgage balance is 650ish?
Ally: You know, we, uh did a remodel. So we got a lot of work done on our house and then we took that money and rolled it into the refinance when we did our refinancing that number.
Scott Trench: So I need this number to be the but what was it? Was it is it is it close to 650?
Ally: Yes.
Scott Trench: Okay, great. And then this, does this look reasonably close? We got 2400 in P&I, 12,000 in annual property taxes, and 2200 in annual insurance.
Ally: Yes.
Scott Trench: $3_600 a month in mortgage…
Ally: It’s it’s around 4,000, yeah.
Scott Trench: Okay, I’m going to bump this up to 3% then. Um, that’s probably a little closer. What is the interest rate on the mortgage?
Ally: 2.75, I think.
Scott Trench: Oh, right. So I’m getting close here, right? We’re not exactly right, but we’re pretty close with the…
Ally: Yeah, yeah.
Scott Trench: Uh, I said if you sold the place, you’d have a 5.5% agency fee, 1% closing and title insurance, and that would net you $2.171 million after paying off that mortgage and paying those fees. And that would give you a net sale price of $1.8 million. Um, you are qualified for primary capital gains tax exclusion. So the first 500,000 of that are not taxed. After that, you’re going to owe 20% in federal capital gains, and do you know the capital gains rate for California?
Ally: No.
Scott Trench: All right, I’m going to put that at 9%.
Ally: Probably high.
Scott Trench: All right, how about 0.08%? 8% sound right?
Ally: No, it just mean it’s probably a lot if it’s California.
Scott Trench: That means you’re going to pay 267ish in federal and potentially about 120 in California taxes to be verified here. That leaves you with this number in terms of what you could invest in the next thing. Either this is this model was built around deploying that towards your next house. But you could also invest it in stocks or something else there. Um, and then so what it comes down to is what do you believe the stock market’s going to do over the next 20 years. If you think it’s going to return, I haven’t plugged in at 10%. You can be conservative and put it nine, but what would you say? What do you feel comfortable with? What do you think as a stock market investor, you think it’ll do?
Ally: I’d probably be conservative and say eight or nine. So.
Scott Trench: Let’s put it at 8%. And then, I have some assumptions here around rents. I plugged in 11,000. You said 10, 11, 12, so I put 11 um, on that. And I have assumptions around vacancy and all that stuff, and it gets you out cash flow of 5,500 a month if you keep it. What do you think Laguna Beach’s future appreciation is in terms of rent and price growth? Do you think it’s going to be historical average, or higher or lower?
Ally: Higher. I mean, I think I heard some stat that house prices double every eight years.
Scott Trench: That’s close to an eight year-over-one. So that’s a very aggressive assumption, but uh, and that that will if you believe these things, you’re likely to want to keep the place. And do you think that same same same is true for rent growth?
Ally: Yes.
Scott Trench: And I’m going to put expense growth lagging a little bit behind that, um, hopefully because you can still buy your roof shingles from Kansas City even as rents go up in um, Laguna Beach, is that, that feel right?
Ally: Yes, that feels right.
Scott Trench: Yeah, so it’s all what you believe here. You’re going to see that keeping it is going to produce a lot of cash flow in these assumptions. You’re going to get about $75,000 in the first year and that’s going to continue to accelerate very rapidly if you believe that rent growth is going to grow at that price range. And I can tell you already that you’re going to think, you’re going to believe that the wealth you’re going to build by holding on to this property is going to be much higher than if you invest in the stock market here. So to me, this says you are on the right track for keeping it if you believe these things. I will caution though that I’m much more conservative with my assumptions for real estate. And I would put I’ve plugged in a default of 3.4% because you never know what’s going to happen in the future there and in California’s already high. and I would put in 10% for the stock market. This is how I analyze a Denver property, but it’s completely based on what you believe. And in that scenario, you’re going to see that selling it and putting the money into the stock market would generate significantly more wealth, about 10 million incremental dollars over keeping it in that scenario. So I’d encourage you to play around with this, but that’s the big bet you’re making. The good news is, you’re really rich either way, if you hold on to this asset and the stock market, depending on either one of these things, because you got a great problem here. It’s just that’s the, that’s the tool that can help you think through it. Uh, and then one other consideration I just posed for you that I was reacting in is you’re going to be very heavily weighted to real estate. If you hold this thing and especially if you buy more compared to the stock market because of your starting position. Um, so just those are the things that popped into my head, but I think if you believe what you said there around that, there’s no question, this is a keep property and we’re we’re on the right track and I just sidetracked us unnecessarily. But hopefully that was at least a little helpful.
Mindy Jensen: Stay tuned after one final break and we’ll be back with Ally after this.
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Mindy Jensen: And let’s jump back in with Ally.
Mindy Jensen: I don’t think that’s an unnecessary sidetrack, Scott. I’m really glad that you did that spreadsheet because that’s really helpful. You put a lot of time into that spreadsheet before you brought it up, but then you just like throw all these numbers in and it shows like how you can manipulate them. I think that’s great.
Scott Trench: I’ll send that to you Ally, as well.
Mindy Jensen: Yeah, so you can start playing with it too and, you know, throw in different numbers and see what happens. Um, but I think that there’s a lot of opportunity for researching your local market with more solid numbers and unless your numbers are super solid. Uh, I, I’m always a little leery about counting on appreciation, but then I looked up where Laguna Beach is and I’m like, oh yeah, that’s probably going to be a safe bet.
Scott Trench: Laguna Beach is awesome. I, I, I, like, I’ve been there in San Clemente and I was like, oh my gosh, you can live anywhere in the world. One of those two places, you know, is right, is what somewhere along that that coast. It’s so awesome.
Ally: I’m from Philadelphia, so I can appreciate the, uh, the beauty and the weather and everything. But yeah, no, it’s been a, it’s it’s an amazing spot.
Mindy Jensen: Yeah, it’s really gorgeous.
Ally: Yeah. People from Texas are the ones that always rent my house, so.
Mindy Jensen: Another question you had was about your pension and should you be cashing that out right now? It’s $27,000 if you cash it out, and you’d get 477 a month if you waited until 2042 to start taking your pension. Uh, that’s, I did the math really quickly. That’s like just what, 4.5 years, almost 5 years of break even before if you took out that 477 versus taking the 27 right now. What would you do with that 27 if you pulled it out?
Ally: Put it towards my, uh, house in Laguna Beach, my second house. But I’d like to do is just buy another house in Laguna Beach. I just don’t know if it’s so crazy and I want to tap into whatever funds I have. So like I I I do have a lot of Roth in my 401k. And can I use that?
Mindy Jensen: Yeah, you’ve already paid taxes on that. I don’t know how you access your, Is that in your current 401k or in the previous… So you would have to separate from your company before you could access those funds. Scott, how do you access Roth 401k funds?
Scott Trench: Well, if it’s the principle, you should be able to withdraw the funds. The the gains will be subject to um, penalty from the, from the Roth. So you’ll pay a, you’ll pay a, uh, uh, uh, a penalty for withdrawing those early. Um, your Roth position, let me go back to what. Your Roth position is in total 243,000 and you actually put it out um, for us the contributions of 160. So you can pull out the 160 um to use toward that purpose. I’m still a little hung up though here on the should we, right? Because what you’re, what you’re doing, and and and this is fine. I just I just need to wrap my head around it because I’m not I’m not there yet, is we’re saying, okay, we have $3 million in Laguna Beach real estate and $1.4 million in equities. And our plan is to buy another three, $2 million in Laguna Beach real estate by using the stock market funds, which which is which is a like, maybe you win. I like I you know, maybe if you believe it they appreciate 6% a year and you lever up on the Laguna Beach real estate, hold on for a few decades, you’re going to get real rich. But I already have you projecting to a 20 plus million dollar net worth over the next 30 years, whether you keep or sell the first, the first home. Um, the risk, you know, at some point for me, the plan becomes about risk mitigation and making sure that you can just couch your lifestyle in place there. When would that number, when would that come in there? Like what what net worth level in my if I just handed you a pile of cash, would would uh, would feel, would you be like, okay, I’m done.
Ally: Well, I think that’s the question, right? Can I just be done? The point of buying the second house in Laguna is to say that I could be done because I think in my mind, if I buy it now and I work hard and I move into this smaller house and I house hack, um, in five years, could I sell it, make a profit and then I have that extra money to retire on, right? I don’t think I need a lot of money to retire.
Mindy Jensen: I would look into, like, I would start like find an agent that can help you in Laguna Beach and start looking for an amazing property, a dumpy property that you can make beautiful or, you know, start really learning the market and looking and seeing what’s available because the best time to make an offer on a property is when you are absolutely sure that it is a great deal. Get it under a contract and then, you know, have the super tight home inspection, see what’s going on with this property. Do you really want to tackle it? If you could buy this other property and rent out your current property for 10, $20,000 a month, it kind of doesn’t make a whole lot of sense to say, no, you shouldn’t do that. Um, I I don’t know enough about Laguna Beach real estate to be able to make a determination what the market is like right there. But over here in Colorado, it’s kind of slow. Uh, there was all this uncertainty with the election and now that the election is over, there’s all this uncertainty with will rates continue to come down or will they not come down anymore? And people are just a little hesitant to jump in. So if you could find a smoking hot deal right now because nobody else is out there buying houses, then I mean, you’ve got such a rock star of a property that you’re sitting in right now.
Scott Trench: My concern here though is just like, we’re already at $3.8 million in net worth and it’s so heavily exposed to Laguna Beach real estate. To double down again could be a winner. It could be a winner. Like there’s no there’s it could you you that could absolutely be the right choice. But then and it’s like why? Like what is that end-state portfolio going to look like? In five years, is your plan to sell the property that you just purchased and then rent somewhere else, move back into the first place? Like what is the long-term, like what does the retirement lifestyle look like um, from there? And that’s what’s, that’s where I’m I keep getting hung up here on this because like, I’m not I’m not I’m not sure how that, how that translates into the goal of retiring early, um, quite as clearly. Could you maybe explain that to me what, like maybe what I what I’m missing there?
Ally: Well, I think I just go back and forth, right? Between those two. Do I just take it easy, retire early, and I’m good to go? Or would it be helpful if I had another revenue stream to kind of help? Because right now I’m stuck, so I I I have till I retire, I really don’t have that much cash, right? It’s all tied up either in my house or my 401k. My cash can’t get me through if I were to retire right now. So how do I bridge that gap between where I am right now at age 47 and you know, that that next 13 years, right? With the cash that I have. So, I guess in my mind, I think, well, I need like a another property or something to providing income for me, or another property I could sell that would provide income to get me to that retirement.
Scott Trench: Yes. Okay. So, the the the issue for your retirement, if I’m looking at, if I’m zooming out is you spend very reasonably for your income level here and relative to your overall asset base. But that’s an illusion because to live the lifestyle that you want to live in Laguna Beach is $12,000 a month between rent and utilities. That is being masked right now because you bought your house so long ago and have such a light mortgage on that. So to live in your house, that’s the cost right now, uh, and you need to generate, you need something else to generate the $120,000 per year that you spent, right? Um, some other some other asset situation to do that. But what’s happening in reality is you’re you have 2.6 million dollars in assets locked up in order to in order to have this expense profile um, right here. So you really like in some ways we could think about it as like what’s the expense, um, you’re you’re você tá trancando, uh, 2.6 million dollars to keep your expenses 7,500 to, you know, $9,000 below what they would otherwise be for your housing in that and that’s the fundamental problem that we’re working through here. And I’m trying to figure out, okay, if you move, you’re going to be and you would rent, you’d be spending that amount of money. Or you’d need about 2 million at least in a paid off property, um, or a very lightly levered property to have the same expense profile. And so that brings me back to how do we unlock this 2. I’m sorry, it’s 2.4 million in equity in the house and use it to fund retirement. Um, or what else can we use to get there? One other question we haven’t talked about on that concept is you make $298,000 a year and you spend 10,000. Net of taxes, how much are we actually accumulating on an annual basis from your job. Like that’s another asset if you will that we haven’t thought about over the next five years. We accumulate 50k a year or 100k a year?
Ally: Well, I think before I, you know, was filling out your spreadsheet and things like that, what I’ve always done in the past is I’ve paid myself first by maxing out my 401k, maxing out my HSA, maxing out, uh, dependent care, things like that. But once I started filling this out, realizing like I need more cash, that and I did your little budget exercise, I was like, okay, why don’t I start putting away, I think I’m trying to save right now like 8,000 a month. Like this is just brand new. But that’s what I can probably work to save, 8,000 between seven and 8,000 a month.
Scott Trench: Awesome. And are you also contributing somewhat down that stack of retirement 401k, dependent care, etc, all that kind of stuff?
Ally: So I just had to do my enrollment and I, so what I did was my company matches the first 5% so I did 5% my uh, 401k. HSA, I heard Mindy say you always should max out the uh, the health savings.
Mindy Jensen: If you have a high deductible plan, yes, because you can either use it to have tax-free expenses for your uh, medical expenses in the current year, or you can save your receipts and cash flow your expenses and go down the road and cash them out later.
Ally: Yeah, so that’s what I did. So I just signed up last Friday, but that’s what I did. So I, I think I put 8,000 in that and then 5% in my 401k, but it’s not what I’m used to. I’m used to like totally maxing that out. So like I was a little bit uncomfortable lowering that. I think I’ve changed it like three times since. Like going back up and down. But uh, I think I want more cash.
Scott Trench: It’s a good answer to the question of how do you finance your ADU, for example, um, to let this, let that after tax liquidity position pile up instead of paying a penalty on the the 401k or Roth, in my view. So I like, I like that answer. That’s 100 grand a year give or take. Um, 8,000 a month times 12 I think is 96, right? So we’re get close to $100,000 a year in liquidity that will begin piling up there. Um, and that’s, that’s a piece of the puzzle over five years, that’s 500k over 10 is a million. So you can think about that in those in those big chunks and say, okay, we’ve got another pile of assets there depending on how long, um, you want to work, that’s going to contribute to this. Plus you’ve probably got another 30, 40 on an annualized basis when all said and done, that’ll be going into your pre-tax or tax deferred account like the HSA, 401k match, those kinds of things. So that sound about right? That’s a that’s a considerable part of the position here that’s going to be more than, you know, a couple percentage points. So I think that’s, I I don’t think it changes the fundamental math about what to do with the house, um, but it’s, I I don’t, I I’m uncomfortable. I’m reacting emotively as maybe not logically here, of pulling out the money from the stock market to double down in Laguna Beach. I mean, that’s that’s a play, but the play is I’m going to put 70% of my net worth on the line for the rest, you know, for the the next 10 years or maybe the rest of my life in this Laguna Beach real estate territory. And that just needs to be a conscious decision that you’re saying that’s the pie chart I would draw if I had five, six, seven million dollars in 10 years if I handed you cash. I would I would recreate that portfolio. And how does that feel? Does that feel right to you?
Ally: Yeah, I mean, I think it’s always good to have diversification, right? I mean, having everything in one basket, especially with all the fires and everything happening, you know, it’s it is that is scary. So it is good to diversify portfolio, I think. And I appreciate that viewpoint because you know, I’m so I’m in Laguna Beach, I love Laguna Beach, so it’s like sometimes you kind of get focused on it.
Mindy Jensen: Mindy, you seem, you seem more on the the train of, yeah, buy the next house and and rent it out there. And what are you what are you thinking about this? Uh about this issue?
Mindy Jensen: Well, I’m thinking that if she can rent her house which costs her $4,000 a month, if she can rent it out for 20, 22, $24,000 a month, that makes a lot of sense because that then that covers that money covers her expenses for the current house plus the expenses if she rents a house at $12,000 a month and she still has money left over for funsies. It covers, I I didn’t run numbers on a mortgage payment on 2.8. Um, and that’s a that’s a thing to think about where would you get the down payment for that? That’s going to be a hefty down payment even if you’re just putting down 10%.
Scott Trench: Remind me again though, the $20,000 is for two months of short-term rentals, right? Which is, which is the limit of the community. Is that correct Ally?
Ally: So, Laguna Beach has a minimum 31 day. and we got 46,000 for two months, so 23,000 a month.
Scott Trench: Okay, do you think and you think year round you could sustain a mid term rental cash flow in that level. Like that is that is the reality you think that get…
Ally: No, I don’t think that. I think those are the summer months, you can get probably a lot more. I think if I were to rent my house out just on a normal, not furnished or anything like that, I could probably get 10 or 11 or 12 maybe. And then if I did Airbnb, furnished, mid-term rental, probably be rented out, I would say maybe 70% of the time at probably 15 grand a month.
Scott Trench: Okay, so 15 grand is a more realistic number for a year-round rents with some of these creative strategies. And that’s still, I mean, these are huge levers and we’ve got a range here that we’ve heard for rent for this property of nine up to really what I’m hearing is 15 on an annualized basis, um, for for this. So that’s a big spread and probably a a big piece of the answer here. If that number’s closer to nine or 10, then your net cash flow on this thing is going to be like 5,000 a month, which sounds awesome for one property, and it is, but it’s not awesome relative to the $1.8 million in realizable equity that you’ve got tied up into the property. And that would be a I would be more inclined to sell at that level. But if you can get 15 if you can get pushing close to 15 or upwards of that, then the simplicity of just having a local owned rental property in one asset might be worth it, um, to a larger degree. Like that’s, that’s 10 grand a month, you’re done, game over. Um, you know, you spend 10 grand a month, that’s it. And you’re you’re you’re you don’t have to touch the rest of your portfolio. So I think that that’s where that’s where I keep going back and forth on it.
Ally: Well, and the thing is it’s different, right? So if you do the long-term lease and you need to rent it out fast, that would be 9 grand unfurnished. But if you want to do the extra work, put it on Airbnb, furnish it, which is already all done. We already have all that done, right? But the problem with the 15 grand a month is you’re not going to have it rented out the whole time, right? Someone will probably rent it out for six months for a remodel, then there’ll be a month and a half vacant, then, you know, then another three months. So, in the end if you averaged it out, it would probably be, you know, 11. But there’s different strategies that all create that those different numbers. That’s why there’s such a difference between the numbers.
Scott Trench: Mindy, how do you feel about this? Was if if if the annual rent if if the average monthly rent is going to be $11,000. What do you think? Does that change things for you?
Mindy Jensen: Uh, yeah, kind of, because 11,000, her expenses are going to be $4,000, just for the house. So now we’re down to seven and she’s got to have she’s going to have to find a rental for $7,000 a month or less in order to break even, and that’s going to be difficult in Laguna Beach based on my very quick, very cursory Zillow search while we’re talking. But I mean, do you think you can find something for less than $7,000?
Ally: If I was renting, yes, I do. Uh, if I was buying, no. I mean, what we’ve done in the spreadsheets for buying another house, it was like, okay, my husband’s always like, okay, so we’re gonna move into this horrible little house that needs a ton of work and we still have to pay $8,000 a month. Where are we getting that $8,000? You know, so my husband’s a bit more skeptical than I am. I’m a little more gung ho.
Mindy Jensen: Well, and then you could, you know, after you’ve lived in this other house, let’s say you buy another house, you’ve lived in it for a few years, your kids are continuing to go to school, you’re continuing to make a ton of money off of this current house, you could move back into the current house if you don’t sell it. Have your $4,000 expenses. So you move out and try it. I mean, if it doesn’t work out, maybe you do rent for the first year. If it doesn’t work out, you just move back in. Oh, it was really hard to get renters all the time. Or, oh my goodness, I have 27 people that are looking for a rental at any one time, so it’s super easy to to charge 20,000 a month and it was a good idea, then you go and and buy.
Ally: Yeah, that’s a good idea. Kind of experiment with renting before I, uh, risk my entire everything.
Mindy Jensen: What I see from Scott running his spreadsheet is that there’s no clear, absolutely sell it, this is a terrible idea to keep it, answer. Which is good because if there was, then that would be like, okay, don’t even bother, just sell it and move on. But there is the opportunity to work.
Scott Trench: The answer is super clear though. The answer is super clear. It’s if you believe the assumptions I had for the stock market at 10% and long-term appreciation in Asia free, 3%, 3.5% for prices and rents, it’s an absolute sell decision. It’s a $10 million decision over the next couple of decades. If you believe what Ally believes, that Laguna Beach is going to appreciate at 6% a year, and rents are going to go at 6%, it’s an absolute uh, keep decision. I think we would have very different viewpoints on those assumptions, but that’s the point of the model. You can now, now you know that if you believe those things, you have a clear answer around it. But I think that’s the, that’s the fun, that’s the fun part about financial modeling is those assumptions make such a difference in terms of what to do.
Mindy Jensen: But you’re assuming Denver appreciation and she’s saying this is what Laguna Beach appreciation is. So I like running the numbers at different places. Um, this, I think this is a great homework opportunity for Ally because, uh, what I meant was there’s no, it’s it’s like when you run the numbers according to her numbers, it says keep it. So if both ways said sell, then I we wouldn’t be having this conversation. So now is a great time to go and really dive deep into what is the historic appreciation rates in Laguna Beach? What is the historic uh, rent appreciation in Laguna Beach? and what is the historic returns in the stock market? It’s 10 point something percent. I closed the tab, but it’s 10% historic from the time, you know, all the way back to the beginning. But there’s also some years that it went negative. So, you know, there’s I would I would be more in line with Scott’s 10% on the stock market, but I’m also not betting that I can, you know, I I can say that from here. Um, but I I think that you should be really comfortable with the numbers that you’re putting in, Ally, and I think that you should be, uh, comfortable with them because they’re the historic average. And past performance is not indicative of future gain. We should always say that. But I do think that, um, there’s an opportunity there as opposed to both times we run it, it says, no, sell it.
Scott Trench: Another component of this that makes it just so complex and such a great challenge. Thank you for bringing this today. I mean, it’s this is something people are going to be struggling with this, is if you just want to simplify it and go back the other way, you know, a completely different way of looking at this. You say, okay, the price of of retiring comfortably in Laguna Beach is tying up $3 million in a house, uh, and having the expense for the mortgage payment be zero, because your taxes and insurance are nothing on a property that size, um, for it. So if this mortgage is paid off, which is something we’ve talked about in the past, you know, you know, at 2. 2.75, so that’s going to be hard to pull to swallow. But if the mortgage is paid off, then your expenses go from 10, $9,900 a month to 7,300 a month on there. And you’re pretty, you’re within a stone’s throw of $7,300 a month from your current portfolio, um, if you can accumulate a little bit of cash outside of that and bridge to traditional retirement age, you’re not that far off on that front either. And so that’s an option to think about here is like, you know, do you keep this place, rent it out for a couple of years, do a live-in flip or two? I love the live-in flip in areas like a Laguna Beach because of the tax-free capital gain. Um, that ties up some money, but you’re paying interest on a much lower interest than your flipping competitors, and you get the first 500,000 tax-free. If you want to do that two or three times between now and the time your kids go up to college or leave the house, that would probably completely end the game, um, for you. And now you have your, you can you can think about it in much simpler terms. I have a paid off property that I can live in in Laguna Beach and about two and a half, $3 million in the portfolio outside of that, um, from these live and flip capital gains. How’s that one for a complete different spin on the situation that says go all in on just paying the thing off and tying up with $3 million in equity.
Ally: I like the idea of paying off my, my husband would like that because he likes not having any debt. But now are you saying now go back out and buy some houses in Laguna and flip them? Is that what you were saying there?
Scott Trench: I’m saying move into the next house in Laguna, which is they can move into the next house and you buy it. Yeah. And but treat it as a live and flip. You’re going to own it for two, it’s a slow flip. You’re going to own it for two years, and then you’re going to flip it, and then you’re going to sell it like what Mindy does here and I imagine the spreads there are super high on that front because I imagine super wealthy people buying $2 million homes do not want to spend six months refurbishing the place.
Ally: I see a lot of success with people doing that. They’ll buy it for, you know, under two mil, flip it for four and a half within a year.
Scott Trench: Then, then you’re going to have to pay tax if you did that.
Mindy Jensen: No, no, no, no, no. Put both kids on title when you buy it. And then they’re there for two years, it’s their primary residence too, then you get a million dollars of tax-free capital gains.
Ally: Yeah, I would have to live in it because I’d have to rent out my house to to pay for it.
Scott Trench: $500 of which doesn’t go to your retirement, it goes to your, your, you know, um, the kids’ Bentleys. Um, but but I think that’s, you know, if you if you say if you take that math and you say, okay, I’m going to do a live-in flip, um, I’m going to buy one of these properties for 1.7 or whatever, whatever that is, that’s really bad shape. We’re going to fix it up with our ourselves. Now you rent out the primary, and if you can get that 12 to 15 range, you’re probably going to cover the lion’s share of the new mortgage while you live in there. It’ll be slightly more expensive, you’ll save slightly less. But that’s not a, that is a, that is a approach that would be reasonable in your situation since you have 8,000 a month in savings, um, on top of your expenses right now.
Ally: I like that idea. Just gotta talk my husband and two kids in.
Mindy Jensen: I would find a real estate agent. If you don’t have one that you’ve been working with in the past, biggerpockets.com/agents is a great place to find an investor-friendly agent and even though you’re going to be moving into it, you’re looking for an agent who understands investments as well. So they can say, hey, this one is going to, if you fix this one up, it’s going to yield a whole lot more than this one for the same price.
Scott Trench: And you could definitely lose and that’s my, that’s my my my worry about the the plan to go all in on a good of age real estate uh in your situation, but that’s there’s a good way that it’s it’s a significant derisking of the investment process.
Ally: If you choose want to partner with me. That would help, uh, mitigate the risk too. We can get third.
Scott Trench: Hard money lenders love California, um, because they’re big loans on these properties, um, and they make a lot of a lot of interest in points. So you’ll have no trouble finding lenders, um, if you can bring some, if you can bring a material amount of cash down.
Ally: Good to know.
Mindy Jensen: Okay, Allie, this was a really fun set of circumstances and interesting financial, I don’t want to say problems because these are all really great problems to have. I have so much money but it’s tied up in my retirement accounts. Yeah, but you have so much money. Um, but this was, this was a fun exercise and I am super excited to see where all your research leads you to. So please keep us up to date. Um, it might even be fun to have you come back after you’ve determined what you want to do and we can, we can run through some different numbers and scenarios then.
Ally: Yeah, no, thank you. This has been super helpful and I really appreciate your feedback. I listen to your show all the time, so I’m really happy.
Scott Trench: Thank you so much for coming on and congratulations on your awesome problems. I’ll be really interested to see how you untangle all this. It’s a really tricky situation and a good thing like congratulations. I hope you’re feeling, you know, very excited about the future.
Ally: Yes, well thank you again.
Mindy Jensen: Thank you, Ally and we will talk to you soon.
Ally: Bye bye.
Mindy Jensen: All right, Scott, that was Allie and that was a really interesting set of problems. And I wish I was a little more knowledgeable about the Laguna Beach area just because, uh, you and she had different assumptions on the returns, the historic returns and the, or not the historic returns, the forward-facing returns for Laguna Beach and, like, I can see both of you being right, but only one of you will be right.
Scott Trench: So, I think it’s really hard for me to wrap my mind around this problem and I’d love to get input from the BiggerPockets Money community on this because this is the middle-class trap on steroids right here. I also, you know, just in responding to it, I I thought of something after we finished recording, I wish I would have thought of it when we were there, around the 1031 exchange applies here because I’m so used to dealing with so many such smaller dollar values on primary residences, um, where the capital gains exclusion applies. But when you have a $2.2 million gain and only the first 500,000 is excluded, well, now we got to talk about how to shelter the other three or 400,000 dollars. Another option I threw out there for Ally is to consider a 1031 exchange. Can she sell that property and move that into other higher yielding, cash flowing investments somewhere else, um, as part of that portfolio because that’s going to be more, you know, that that may, that may be a way to shelter that tax benefit if she decides to sell the property. Um, she kind of busted my model with how big the numbers are on this property and I have to go revisit a few assumptions in there and make sure that those are tailored, um, to these types of situations.
Mindy Jensen: Well, a 1031 is for investment property. So she would have to turn this into a rental for a while, I believe. And what I don’t know about the 1031 exchange is quite a lot. Uh, but I do know that it’s for a rental property. Um, so I’m wondering how that would how that would work.
Scott Trench: I think that that’s, that’s a great accounting question for our community actually. I believe you can do it if you rent it out for two years. But let’s hear from the community and ask that question out there. How can you 1031 a primary residence if you turn it into a rental? I believe the answer is yes.
Mindy Jensen: Yeah, and if that’s the case, then absolutely that would make so much sense because then you can kick that tax can down the road and she’s saving, uh, what did you say? $300,000 on taxes, almost $400,000 on capital gains taxes if she does that.
Scott Trench: Yeah, and depending on what the California marginal rate will be for that, which she’ll be in a high tax bracket between her income and the gain on this one. I calculate my crude math that’s certainly incorrect, but ballpark a 387,000 in capital gains. So that’s a material part of the decision here. You can get another 400 grand by deferring it into real estate if you plan to keep real estate for the long, long, long term. That could be pretty powerful there. You are giving up the primary residence exclusion though. So something, there’s a, there’s a tax angle to this that should definitely be explored, and she should probably talk to a real estate friendly CPA.
Mindy Jensen: Probably. She should definitely talk to a real estate friendly tax provider or tax planner who can help her figure out what is her best play. They can run these numbers for her. Um, but yeah, this was fun problem to try and and figure out.
Scott Trench: We’d love your thoughts on it. This is a new problem for Mindy and I at this scale. So any feedback or thoughts are appreciated.
Mindy Jensen: Scott and I want to hear from you. What advice would you have given to Ally that differs from what Scott and I said? We would love to hear from you below.
Scott Trench: Should we get out of here Mindy?
Mindy Jensen: We should, Scott. That wraps up this episode of the BiggerPockets Money podcast. He is Scott Trench. I am Mindy Jensen saying, Cheerio Mistletoe.
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