Raid 401K to Buy Investment Property?

Question

Hi All,

Just out of curiosity. Would it be advised to borrow from 401K to buy a second investment property? I'm in the process of buying my first rental, but would love a little more cushion to purchase a second. I'm 32 years old and would like to build more wealth and lower my overhead. I also plan to stick with the 1% rule and projecting a cash flow of $450-500 per unit.

Thanks.

Nick Noon · Answer

@Ha Dang

Great read.  Great for motivation.

I think what @Jesse T. is trying to say is that #1: your time is worth something so you should factor that in.  Although it may not hit your bottom line, it should still account for something.  #2 you should figure it in because you may eventually want to hire a PM firm to run the property for you when you start building up your portfolio.  It's a good idea to make sure the property would still cashflow if you had to at some point hire a PM firm to run your property.

Best of luck.

Owen Dashner · Answer

@Ha Dang - that is exactly what I thought you meant (using leverage).  You are not accounting for any expenses other than your mortgage, which is a common mistake for new investors.  Cashflow is what is leftover after all expenses.  You have forgotten maintenance/repairs, vacancy, CapEx, advertising costs, evictions, taxes, insurance, management, etc., etc.

Factor in ALL of the costs associated with operating a rental property and you will be nowhere close to $450...

Derek Etzel · Answer

This is good information. I was actually thinking of tapping in to my 401K as well. Better hold off for awhile since I have no experience in Real Estate yet.

Jesse T. · Answer

I agree with this advice.  Get your first property performing before acquiring a second and/or taking a 401K loan.  While a 401K loan is handy source of cash, it really should be used for short-term emergencies.  The longer you have the loan outstanding the worse the tax/performance impacts on your retirement.

Steve Vaughan · Answer

PM is an expense seasoned investors account for even if self-managing @Ha Dang.

Just want to point out that all 401k loans are due in full within 60 days of separation from that employer.  Picture this - you borrow from your 401k and stick into the not-liquid investment of a rental house.  You get laid off.  Now you have to pay back the loan within 60 days or pay the taxes and penalties on what equates to a withdrawal.  Or you quit.  Or you die and your heirs now have to deal with it.  Plus you lost tax-deferred growing power while you 'paid yourself interest'. The house barely cashflows.  You need $42,000 quick, but have no job.  It's all tied up in the house.  What do you do?

Nick Noon · Answer

I personally plan on using my 401k for my first investment.  There is no penalty or taxes taken out to take the loan and I pay back the loan and interest to myself.  So no matter what I will replenish it.  I would ideally getting a better rate of return on an investment property than I would by just market fluctuation on my 401k.  Yes, its a risk....but so its a 401k.  Half of your money could disappear into thin air if the market fluctuates bad enough, so there's always risk in every investment.

No matter where you are thinking about getting the money from, you should definitely do some more researching on what makes a good real estate deal.  I would read a couple books on real estate...there are plenty of good suggestions on this site.  You need to make sure you are looking at the deal all the way through including CapEx, vacancy rate, utilities, normal repairs, evictions, property taxes....every real estate deal is different and you need to factor everything in.  As others have said, that is why most people fail.  They have a mortgage of $500 and rent coming in at $1,000 and they think they are cashflowing $500/month when it is far from it.

Good luck in the future and keep reading on this site!  It has helped me more than words can describe.

Jordan Decuir · Answer

@Ha Dang Some good advice above, also consider that generally any loans borrowed from a 401k are due for full repayment if when you are no longer employed by the company, in the event you voluntarily leave or are let go (knock on wood).

I would think using the 401k loan could be a good source of short term funding if needed to tap into to snap up a good deal, but waiting until you have more experience under your belt is a good notion.

Jesse T. · Answer

Since 1% is gross and the $400 to $500 figure is net, they aren't mutually exclusive.  If you are paying pure cash and expenses are 50% a 100K property should meet that definition.

If you are highly leveraged it will be tough to make the $400 to $500 figure since you net income(rents minus non-interest expenses) will typical end up around 6% on a 1% gross rents property which isn't much margin from typical investor interest rates(basically none once you factor in principal payments).

Owen Dashner · Answer

I would echo the advice above.  But I would also like to point out that you will never cashflow $400-500 per unit using the 1% rule.  It's not mathematically possible over time.

Ha Dang · Answer

No problem! I guess I will wait to see how my first rental goes to determine if acquiring a second would be a good idea. By then I may not even need to raid the 401K for extra funds. Definitely a thought and welcome all opinions.

Thanks

Raid 401K to Buy Investment Property?

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