401k vs Real Estate
Caio Ferreira TorresPro Member
Rental Property Investor · Danbury, CT · Member since 2020 · 12 posts · 18 votesI just graduated and got a job as a structural engineer (starting this month). I accepted a salary offer of about 70k a year with a 401k match plan available. However, I want to invest aggressively in real estate. Specifically BRRRR single/small multi family properties. I'm going to continue living with my parents and minimize my bills for at least a year to save up as much as possible. After that I plan to house hack, begin investing in BRRRR deals, and grow a portfolio quickly but cautiously. With that being said, should I put money into the 401k or keep all my money available for me to begin my investing career?
I'd do both up to the match if possible. Do not turn down free money.
Do the right thing and invest in your 401k / get tax benefits/ get company matches / get tax deferred gains. Then invest the balance in RE. Whatever you do, don't follow youtube gurus who will tell you not to invest in 401k. That is a nice way to get and stay poor quickly.
@Caio Ferreira Torres,
You can use BOTH your 401k AND your income to invest and there are many people who leverage their 401k’s to do just that.
I can introduce you to several or send you videos (or you can and should) research that on YouTube as self-directed IRAs are a great investment tool if done right, with minimal risk.
Good luck on your new job and learn as much as you can and get your PE license! Congratulations as being an engineer can be stressful AND even a little boring at the same time, depending upon which route you take in this field. (I worked for engineering firms in TX for almost 14 years altogether…)
Best regards,
John Banaski
@Caio Ferreira Torres at least put aside the amount that the company will match. Its free money.
Never turn away free money. Contribute up to the company match.
Check your company's policies for lending and withdrawal so you know your parameters. Also understand the consequences for each. Most likely a loan from your 401K could be limited to half of your balance or $50K, whichever is less. Also, if you are ever severed from the company (fired, laid off, or quit) the balance is required to be paid back immediately, or taken as a withdrawal with penalties applied.
If you withdraw from the 401K, there is a 10% penalty if you are not retirement age. The funds are also taxed. So, whatever your tax bracket is, will be applied to the withdrawal. This usually isn't applied at the time of the withdrawal, but will apply come tax time.
Some people will tell you that the costs or penalties associated with these options for using your 401K funds for Real Estate will not make it worth doing it. Only YOU will be able to determine that for yourself based on the proposed investment. I would argue that sometimes the cost for taking the hit on a penalty can be just another cost of business when you factor in the proposed gain on the Real Estate investment. So, you have to run the numbers and figure out if it is a good tool for you to use for your real estate purchase, or not. That's what they are....tools. Use them as they make sense.
Also, as a side note, if you ever leave your current company, consider rolling your 401K into a self directed IRA, or even a self directed 401K (if you ever become self employed, or get to the point where your real estate has become a business). This will allow you to purchase Real Estate with the funds, and have more control over what you invest in. This will NOT be an option for anything you intend to occupy as these are intended for investments only. However, you can use them to make purchases for rental properties or long term holds.
A balanced approach makes sense @Caio Ferreira Torres
You want to be diversified across equities and RE.
1. Max out your Roth IRA - that gives you the most flexibility and the best tax benefits
2. Fill the 401k up to the company match
3. Use RE money to BRRR via FHA - this scales your equity most effectively
Here’s a bit more about me:
Im 25 (turning 26 in September). I have a 750 credit score. I have 40k debt in student/auto loans. My plan is to start house hacking by September of next year with a FHA 203k loan (already pre-approved for the price range I want). Based on my plan of living frugal, I'll have 40k saved up by September 2022. I will work 40-50 hour a week and I'm willing to dedicate another 20-30 hours each week towards all things real estate. My structural engineering firm works on commercial/residential properties among others. I've read 10 BP books and watched tons of podcast. With that being said, I know there's a lot more for me to learn once I actually start investing (I'm expecting to be humbled haha).
5 year goal (short term): financial freedom. 15 properties cash flowing 54k a year (300$ a month each).
5-15 year goal (medium term): find my niche. Create a unique strategy that I can excel at. Find a way to mix my structural engineering skills into the niche. For example, offer to be part of a clients deal by adding a residential floor to their building (I’m shooting in the dark here but I’ll figure it out).
15-35 year goal (long term): create an empire. Grow exponentially by starting a syndication to fund those deals and more.
Ultimate goal: a million a year in cash flow. Start a non profit and create a small ripple of good in this world.
As you can tell, I believe in the power of real estate. I think of the 401k as a backup plan. I do believe it can give me great returns just not as much as real estate if I’m actively investing (infinite/ridiculously high return with brrrr). If I contribute to 401k I’ll go from 40k saved to about 33k which makes a big difference at the start of my investing career. However, I want that diversification in my investments. I’m looking into taking out loans against the 401k. I’m also considering a delayed start to the contributions. Maybe wait 2 years to before I start contributing. Thank you all for your advice! I’ve carefully read each and every one. And please feel free to add on or comment on my plans! I appreciate it.
Hi Caio, I love your enthusiasm. This is nothing wrong with wanting to change your life and the world for the better. But as a trained engineer, I think you need to fall back on your training with regard to looking at the facts. If people could spend 20 hours a week getting infinite return on BRRRR properties everyone would be doing it. Some thoughts on just the 5 year part of your plan
- The median single family house price in Danbury is 450k. But lets assume for the moment you find properties in the 250k range. You have to by definition, buy with cash because anything you BRRRRR is not financeable. You also need the cost of repair, holding, insurance, etc. So you dont need 40k, you need more like 10x that amount to BRRRR in your area.
- But wait, you say, you will use hard money. Someone with no relationship to you will give a 25 year old with zero experience 400k or more in cash. Totally believable.
- Go to a different area? Of course now the renovation will be managed remotely and you will need to spend 10% on local property management. So you have zero experience and you are going to increase the difficulty and do it remotely.
- 15 rentals means 15 tenet families, with all the associated problems. And remember you bought cheaper run-down properties in less affluent areas, so the tenets are C-D at best. Chasing rent, fights, evictions, property damage, etc. All in 20-30 hours a week
- Oh and you have to source 15 properties. But they cant be any properties, they need to be distressed owners willing to sell at 70% of current value minus repair costs. So you have to compete against every other wholesaler in the area for deals. Every other person who wants to earn infinite returns working 20 hours a week. So to get 15 properties you need to generate a list of about 1500. All distressed, all off market.
Can it be done, absolutely. The podcasts and books have dozens of people who talk about going from 0 to 100 doors in a year. Financial freedom. Dont be a W2 wage slave. You bet, it can be done. That, however, is just selection bias. You don't hear about the tens of thousands of people who tried and failed. If I asked a room of NBA players if "following your dream" is worth it, they would all say yes. But what if I asked a room full of homeless? It can be done, but can you do it?
You will do what you want Caio and that is a good thing. I wish you all the luck in the world. I would only caution you that putting a plan into a spreadsheet is much different than executing it in real life. Good Luck
This is very negative, and doesn't really provide the OP useful info, John.
Winston Churchill once said, "A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."
The question isn't whether you can do it or not, Caio, it's a matter of HOW.
I think you have a good plan. I think you will have an issue with the scale you have planned. It is very aggressive for a beginning investor with little capital. You may find that in the first 1-2 years, you get 1-2 properties under your belt. Maybe your owner occupied and 1 rental. Or maybe you do both as owner occ properties to maximize your down payment funds. Keeping in mind that you must live in the property for 12 months to satisfy your lender's requirement. However, after that, you can convert it to a rental, and not be in trouble with the Lender. So having 2 properties in 2 years that you only had to pay 3-5% down for is a realistic expectation. 15 in 5 years is a bit aggressive without the capital.
Your plan to start with a purchase for yourself is good (House Hack). The FHA 203K or B is a GREAT product! It allows you to wrap your rehab expenses into the initial loan amount. The only caveat is that the appraisal needs to support the ARV (After Repair Value). You also need to find a contractor that will be willing to cooperate with the FHA terms, which require the contractor to wait for payment until the FHA inspector comes out to confirm that the project was completed. You have the ability to use up to 3 contractors. So, make sure that the ones you choose will be able to do all of the work. You cannot do ANY of the work for this program. The funds are held back in escrow, and are released when the inspector verifies and approves the project. Since this is an FHA product, you could get into this home with as little as 3.5% down. You will have closing costs, but those could also be negotiated, or built into the rate. You may also be able to get a down payment assistance as a first time home buyer, so ask your lender about that. You can't just go to any lender for the FHA 203K or B program. Only approved lenders are allowed to offer these. So, go to the HUD site for the approved lender list.
When using hard money lenders, John is not entirely accurate in his statements. Hard money lenders concentrate more on the project than they do you, this is why they are called asset based lenders. They may look at your experience, but this is likely only going to be reflected in your terms (rate and LTV), not in whether they will do the loan or not. Try saving this option for down the road after you have an established project count under your belt.
It is true that there are great success stories, and also great failures. However, having a realistic plan, good reserves to fall back on, and an exit strategy will be your key here. Don't grow beyond your comfort level or leverage yourself to thin. I think in researching the big failures, you will find that they strayed from their plan, leveraged themselves to thin, and didn't have a pivot plan or exit strategy. Just like any investment, if you aren't strategic, you can and will get burned.
After further research, I’ve decided to delay the real estate investments a bit and max out the 401k company matched contributions. I will delay the real estate investments until 2023. This way I can save up 50k before I begin investing.
For those interested, here’s my plan on achieving 15 properties in 5 years (kind of). I was thinking of year 1 as the first year I start investing and not so much 5 years from now.
I think of brrrr as 2 deals a year. Giving myself 6 months to refinance each deal. Also, I want to invest in single family homes in New Britain, CT. After buying and rehabbing, the cost should be no more than 200k. For each deal I would of course run the numbers to make sure it makes sense.
Year 1: House hack in Naugatuck, CT (about 35 mins from my job) with a 203k rehab loan. If I’m able to wrap the closing cost into the loan I should be able to house hack for 10k leaving me with 40k. Later that year I’ll invest in my first brrrr deal with a private money lender. I’ve already spoke to 2 that are willing to work with me. It’ll be expensive since I don’t have experience but they’re more focused on the deal itself. Since they only require 10% of the cost, I’ll spend 20k and have 20k for reserves. By then end of the year I’ll refinance the property. I would have rental income after the rehab, my personal income, and 20k reserves in case it’s not a “perfect” brrrr (and other costs).
Year 2: Buy two more deals (similar numbers) using the brrrr strategy (one after the other appraises and I’m able to refinance).
Year 3: Refinance out of the 203k loan and house hack a new property. Brrrr my way into 2 more deals. Total of 6 rental properties.
Year 4: With income saved from my job, cash flow, and taking a loan out against my 401k if needed, I’ll buy a second “rotation” of brrrrr properties. Meaning I can obtain 2 properties, brrrr them, and obtain 2 more. Total of 10 properties.
Year 5: Similar to year 3. New house hack, brrrr into 4 more properties. Total of 15. Also, instead of turning the old house hacks into rentals, I could sell them. I would have lived in them for 2 years which gives me the tax benefits. And I could use the capital to fund more deals.
This sounds far fetched but at the same time it sounds simple enough for a person that willing to put in the work. I’m still inexperienced so right now this is just a dream I’m working towards. I will always make sure to get the comps, run the numbers, and be as diligent as possible. Plans can change of course. I know I’ll have to adapt to a lot of situations as they come. As of right now this is where my head is at. I’m motivated and dedicated to accomplishing this goal. And please, let me know if and why this is unrealistic!! I probably won’t listen haha but I want to know the reasons why it wouldn’t work so I could figure out a way around it.
@caio, I'm also in the early stages of my investment career and I happen to live in Naugatuck--currently house hacking a 3-family.
I see you're looking to begin your house-hacking journey in Naugatuck. I'm also a real estate agent with an office in town and would be happy to help you find a property.
Feel free to reach out to see if we could help each other out.
Something else that I personally have been contemplating is that with all the debt that the govt has been accumulating; they’re going to need to do something at some point. I would think that large 401k balances are an easy to see target. I would not be surprised to see them tax large balances more upon withdrawal. Really nothing they do would surprise me as far as collecting tax from people who actually saved/invested for retirement.
Find a way to do both... but the match is free money, so take it first.
Then adjust your spending habits to make the real estate happen as well!
@Caio Ferreira Torres I hope your job is in the govt, where you can sit on your *** with no consequences for underperformance (that is what will happen when your focus is elsewhere). Maybe that’s the reason you don’t see any growth in focusing on your career and therefore seeking validation via real estate investing. I started with a 6 figure salary and doubled it in 6 years by focusing on my career, while the money dumped into 401k quadrupled with zero effort. Started investing in real estate 2 years ago, and am realizing now that real estate will never give the return that my career and stock investments will.
https://www.biggerpockets.com/...
But I may still put ~15% of my investments in real estate for the sake of diversification. You are here on a forum with big bias on real estate and still majority of the feedback is to utilize the benefits of 401k - doesn’t that tell you something? Your assumption is that it will be easy to find good deals and make profits, while your cash flow from your job will be secure. Good luck!