I had a real estate discussion with a family member (at a funeral, from all possible occasions) who is well into his retirement age and is still pinching pennies and living very frugally because they use every dollar they can spare to pay off his rental properties and he is almost there. He was making some comments on our frequent travelling and how he is saving. It made me think about my own exit and I want to share this, because we basically arrived at an exit strategy that is almost too good to be true and I never see it on BP, so tell me what you think about what I ended up suggesting to him.

They have a medium-sized portfolio mix of duplxes, a couple quads and some singles, a typical mom-and-pop operation. Plan is to pay it all and then live off the cash flow, which is great, but at this point in his career (over 20 years in) his portfolio is fully depreciated so he is paying a lot of income tax. But he has a fairly large amount of equity (and a terrible RoE). And he does not want to sell anything.

So we did some quick math. He could do a 200k cash-out refi which would be less than 3% of his portfolio and we are currently running high single-digit appreciation. At 7% interest, amortized commercially over 25 years that's $1,414 for principal and interest. Taxes and Insurance he has to pay anyway. To make up for the loan he would have to increase rents $23 per door, which is low for Milwaukee. The $200,000 from the cash-out refi are tax free, because they are a loan - and not income. So he can just pocket the money, spend it on toys and travel without paying income tax. And also keep his cash flow the same. You are basically living off your equity gains. 

My argument is that this approach is very conservative. It's basically the same as the standard advice that every financial advisor will give you for your 401k. If your expected return is 6% per year, take out 4% a year to live off and you will never have to worry about touching your principal and running out of money. You still pay taxes on that though. 

The beauty of real estate is you don't pay any income tax of a cash-out refi, neither federal nor state. And the cash flow of a low-leverage portfolio is still strong and acts as a safety net, or pay for PM, if things get uncertain or real estate does not appreciate, you can fall back on cash flow, because you have to cut into it.

This also makes it really clear that the name of the real estate game is equity and NOT cash flow! Why would you not do that??