BiggerPockets Money Podcast - Finance Friday: Middle-Class Trap on Steroids ($3.8M but CAN'T Retire!)

Episode Date: November 29, 2024

There’s a “middle-class trap” that can keep anyone from FIRE—yes, even high-income earners. Today’s guest has a sizable nest egg that should allow her to retire early, but there are a few roadblocks in her way! At forty-seven, Allie has already built a net worth of $3,800,000. She would like to retire, and most people would assume she has enough to retire, but there are two problems. First, she lives in Orange County, California, one of the most expensive areas in the U.S., and has no plans to leave. The other issue? She has no cash! All of her money is tied up in home equity and retirement accounts. To retire, Allie has a BIG bet to make—one that could have a multi-million-dollar impact on her portfolio! Using Scott’s “Keep or Sell Your Home” worksheet, we’ll look at whether it would make more sense for Allie to keep or sell her Laguna Beach property. Will turning this home into a rental property give her the cash flow she needs, or is selling it and investing in the stock market the better long-term play? Tune in as we attempt to thread the needle and provide Allie with the best roadmap for a long, early retirement! In This Episode We Cover What Allie should do to reallocate her $3,800,000 nest egg and achieve financial freedom What to do with money locked up in home equity and retirement accounts Keeping your home as a rental property versus selling it and investing elsewhere Creative ways to improve your cash position so that you can retire early Building wealth with short-term rentals, live-in flips, and other real estate strategies Escaping the “middle-class trap” of earning high income in a high-cost-of-living area And So Much More! Links from the Show Mindy on BiggerPockets Scott on BiggerPockets Listen to All Your Favorite BiggerPockets Podcasts in One Place Join BiggerPockets for FREE Email Mindy: [e-mail] Email Scott: [e-mail] BiggerPockets Money Facebook Group Support Today’s Show Sponsor, Connect Invest, the Alternative Way to Earn Passive Income Through Real Estate Buy Scott’s Book, “Set for Life” Find an Investor-Friendly Agent in Your Area Finance Friday: How the “Middle-Class Trap” Stops Your Early Retirement (00:00) Intro (01:00) Allie’s Money Journey (03:36) Money Snapshot (13:50) Retiring in Laguna Beach (19:01) Keeping vs. Selling Her Home (26:06) The BIG Bet on Real Estate (34:01) Growing Cash & Renting Her Home (43:41) Real Estate vs. Stocks (52:02) What Should Allie Do? Check out more resources from this show on BiggerPockets.com and https://www.biggerpockets.com/blog/money-585 Interested in learning more about today’s sponsors or becoming a BiggerPockets partner yourself? Email [e-mail] Learn more about your ad choices. Visit megaphone.fm/adchoices

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 Bigger Pockets Money community, because Allie 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. Thanks, Mindy, great to be here and looking forward to creating a complete picture of Alley's financial situation here. Bigger Pockets has a goal of creating one 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 Alley, we want to thank this episode sponsor Connect Invest, Real Estate Investing simplified and within your reach. Now let's get into the show. Allie, we're so excited to have you on Bigger Pockets money today. Welcome. Thank you for having me. excited to be here. Allie, can you share where your journey with money began?

My journey with money. So I came from, my parents were very frugal. I was one of four. An example of my dad's frugality would be we would go to go out to lunch at Wendy's. And he would order one large soda, no ice and six cups. So that is a sort of background that I came from. He always said, no dad, pay for everything. in cash, everything, you know, we always were saving money from a young age.

And that's carried on as I become an adult. I, you know, right now I have a 1999 car. Always been saving since I was little. My first car I bought only went in reverse. So we were able to get a good deal on that. Did you fix it? Or did you just drive backwards? I feel like I feel like that's inviting a.

My dad fixed it. Yeah, my dad was an engineer. He fixed it. We got it for $400. It was a BMW. I only went in reverse. So yes, lots of fun stories like that. But made it interesting.

I was always very embarrassed. But, you know, today I understand why he taught us that. 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 of the kids. just went in reverse. My dad was always working on them because they were so old and so breaking down. So I am, I am right there. We are soul sisters. Where are you based? And let's talk about your career. Sure. So I reside in the lovely Laguna Beach in Orange County. So it's 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, put a down payment and buy a house where I could never afford it right now. My job is I do sourcing for a facilities management company for a big tech client, so I do find cost savings for a living. Do you enjoy that? Yes, very much so. Yeah, no, I really enjoy my job and my job has a lot of benefits. They let me work from home since 2008.

So I was able to raise my children, and I've never had an expensive. of 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. Allie, 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. Debts are just a $600,000 mortgage at 2.75%. I consider that to be good debt. And a helock for 440,000 at 8%, which we'll talk about in a bit. I see that you are Airbnb being your property, your primary residence for two months out of the year.

Is that every year that you do that? 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 run it, but it always rents. And it's, we get, I think last year, someone paid 46 grand for two months. Holy cats. Yeah, I would do that again. I mean, is that like your entire mortgage payment for the whole year? Our mortgage is 2650 a month. Yeah, so I'm doing quick math. Is that just P&I? Yes, she's in California. That's not taxes or insurance. Yeah, that doesn't include. So everything all summed up with our mortgages around 4,000, 4,000 total with taxes and home insurance.

And I see a small pension and Social Security options for you. What is your retirement goal, numbers, timeline, et cetera? Last month. Living in Lagoon, Beach, nobody talks about retirement. Everyone has like a Bentley or a, you know, a Ferrari or a cyber truck. 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 plan or creative planning that would meet with us once a year and they'd say, when do you

want to retire? And they had a little spreadsheet they put up. And I remember saying, well, if I move that number up, how much more money do I have to save? 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 Mr. Money Mustache and Scott, I read your book. And I was like, you know what? I don't have any of these.

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 transportation, which I don't really have, and food, which my husband cooks. So we always eat in. It's better eating it than eating out. So 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. 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? 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 pursuing that as well. I think the most important thing here, it's so glaringly obvious. It's the problem that you came

with us, you know, to him does with today, I think is the, you know, this concept of like the middle class trap with, you know, your net worth is $3.8 million. You're rich. I feel so poor. 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 correct? Yes, that's correct. 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 could also do. Yeah. And this problem is starting to come out of the woodwork. Like, 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? And what have you thought about in the context of this housing decision or how to access this housing as you were putting all these numbers together and thinking about coming on the show here? 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, run 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 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 who really said, you know, you don't want to tap into that 401k. We've got some exciting news. Today is November 29th, which is the very day of the Bigger Pockets Black Friday book sale. Want to be set for life? Just like Allie, you can grab my book and tons of other books for up to 60% off. Head over to BiggerPockets.com slash Black Friday. This offer does an apply to all books and ends on December 2nd. Happy shopping. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing.

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for me over over 10 years. Kickstart your well-being journey with your first audiobook free when you sign up for a free 30-day trial at audible.com slash BP money. Welcome back to the show. Have you read the mad fientist article called How to Access Retirement Funds Early? Yes. 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 401. 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. And this would be after you 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. But there is the Roth conversion ladder. There is the 72T.

there is the just taking it and paying the penalty, although I would do that 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. 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? Yeah, this is an issue. So when I have like a contractor come out and bid me, they say it's going to be minimum a million bucks to build an ADU. But then you see

these pre-built ones online, right, that are like $80,000, so like $150,000. So I think I'd go for the pre-fabbed 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. What would that do to the value of your home? Yeah, I 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, if I spent a million dollars on it, would probably go significantly more than if I bought a prefab. 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 aside. Has anybody done that in the local area? And how did their property translate?

because like, you know, there's always rent and cash flow and income stuff. Like if you could spend $150,000 and make a million back in one year, then there's no, there's no other, like 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 from this. And in that case, then I would be like, yes, how do we finance? How do we finance that? Is it an E-Lock?

Is it something else? because you'll be, you'll be able to justify almost any source of capital for that investment. But what's your conviction in that, in that, that value at? 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? So I don't know that I'd be able to find 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 from 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? 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 to make, you'd rather increase the value of property by $3 million dollars with a million dollar outlay, but then a $150,000 dollar outlay to get a million bucks. That's another 1.75 million. That's an enormous play. And there's a possibility of doing like a JDU ADU. So you could do two. You can do two ads here in Laguna. So a junior ADU and a regular ADU. So you could actually do it twice.

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 style maybe in a slightly smaller home nearby. Is that right? Yes, ideally. What is the ideal future home? Home? Yeah. Like what is what is your future living condition look like? 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. It doesn't need to be big, but I do think people need their own space. You know, when they go off to college or move out, I don't, it could be much smaller. just a one bed. 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? Ideally, I'd like to keep it as a rental. What's it cost to rent the house that you want to live in for the next couple of years? 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 normal three-bedroom, nice house would probably be around $12,000 a month. $12,000. Okay. That's higher. So we're in hard territory here. That's $150,000 a year in rent.

And to buy the place, how much would one of the places you're thinking about buying cost? They're usually around $14,000 or $15,000 a month. That's the mortgage payment. How much is the price point? You can't get anything under 2 mil here. So what I've been doing, so say a house is up for a long time, I'll sort it by length. Then I'd offer 1-8. And every once in a while, they'll say, okay.

And then they get a couple other bids and somebody outbids me. I mean, that's kind of what's been happening. I wouldn't pay more than 1.8, but you're getting not a very nice house at all. Yeah, I don't see a lot of $1.8 million property. Yeah, you have to create the 1.4. eight million. 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 could rent it out for a lot more. 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 will write me because I used to just have 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. 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, 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 by accessing your retirement funds early. Scott, do you think that $3.8 could get her some $3,000 a month? I think that's the big question here 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 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 with $2.4 million in cash or after tax, I've calculated the equity you would realize to $1.863 million on this. at least, if you could sell it there. We can generate a lot of cash flow with $1.8 million in cash in a number of buckets. I think that's the big question here is what do we do? How does it feel to even talk about selling the place? 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. And 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? Well, let's walk through the long-term rental case real quick. I nerded out and I did a spreadsheet here. Right now, Scott is using his should I sell or rent spreadsheet to run the numbers for Alley.

Go over to our YouTube channel, YouTube.com, slash bigger pockets money to see Scott in action. It's fascinating. And I'd love to just kind of walk through and see how this feels at the highest level and say like, here's, this is a value. You think it's about $3 million today? Yes. We don't have to worry about the original purchase price in, well, actually, yeah, what was the original purchase price for this? It was 940. 940. Okay. And you bought that 10 years ago, but we don't need that date right now. When did you get your current mortgage? You know, I refinanced back when everything was really cheap. So I would say during COVID.

So like probably around this time, September, 2021 kind of deal? Yeah, that sounds perfect. And your mortgage balance was $6.50-ish? You know, we 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. So I need this number to do the population. But what was it?

Is it close to $650? Yes. Okay, great. And then this, does this look reasonably close? We have 2,400 in P&I, 12,000 in annual property taxes, and 2200 in annual insurance? Yes. 3,600 a month in mortgage payments. It's around 4,000, yeah. Okay, I'm going to bump this up to 3%. That's probably a little closer. What is the interest rate in the mortgage? 2.75, I think. All right. So I'm getting close here, right? We're not exactly right, but we're pretty close. for the 30? Yeah, yeah. I said if you sold the place, you'd have a 5.5% agent 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 net sale proceeds of $1.8 million. 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? capital gains rate for California? No. I'm going to put that at 9%. Probably high. All right. How about 0.08%? 8% sound right? No, I just mean it's probably a lot if it's California. That means you're going to pay 267-ish in federal and potentially about 120 in California taxes to be verified here. And that leaves you with this number in terms of what you could invest in the next thing. This model was built around deploying that towards your next house, but you could also invested in stocks or something else there.

And then so what 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 10, I have it plugged in at 10%, you could be conservative and put it at 9. 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? I'd probably be conservative and say eight or nine. 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 on this. I have assumptions around vacancy and all that stuff and gets you have cash flow of 5,500 a month if you keep it. What do you think Laguna Beach Beach is going to appreciate in terms of rent and price drug? Do you think it's going to be historical average or higher or lower? Higher.

I mean, I think I heard some stat that house prices double every eight years. That's close to an eight year or one. So that's a very aggressive assumption. But, and that will, if you believe these things. you're likely to want to keep the place. And do you think that same is true for rent growth? Yes. And I'm going to put expense growth lagging a little bit behind that,

hopefully because you can still buy your roof shingles from Kansas City, even as rents go up in Laguna Beach. Does that feel right? Yes, that feels right. Yes, it's all what you believe here. You're going to see that keeping it is going to produce a lot of cash flow. And 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 onto 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 am much more conservative with my assumptions for real estate. And I would, I plug, I plug in a default of 3.4% because you never know what's going to happen in the future there. And 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 a 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 tool that can help you think through it. And then one other consideration I'd pose for you that I was reacting in is you're going to be very heavily weighted to real estate. If you hold this thing, especially if you buy more compared to the stock market because of your starting position. 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 on the right track. And I just sidetracked us unnecessarily. But hopefully that was at least a little helpful. Stay tuned after one final break. And we'll be back with Allie after this. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing. And if you're like most folks, it can be a little eye-opening. That's why I like Monarch. It helps you see exactly where your money is going, and more importantly, where your taxed refund can make the biggest impact. Because the goal isn't just to look backward, it's to actually make progress.

Simplify your finances with Monarch. Monarch is the all-in-one personal finance tool designed to make your life easier. It brings your entire financial life, including budgeting, accounts and investments, net worth, and future planning together in one dashboard on your phone or your laptop. Feel aware and in control of your finances this tax season and get 50% off your Monarch subscription with the code pockets. What I personally like is that Monarch keeps you focused on achieving, not just tracking. You can see your budgets, debt payoff, savings goals, and net worth all in one place. So every decision actually moves the needle. Achieve your financial goals for good with Monarch, the all-in-one tool that makes money management simple. Use the code pockets at

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They never sell your data. And all services are handled in-house because privacy by default is their pledge to all customers. Visit Northwest Registeredagent.com slash money-free and start building something amazing. Get more with Northwest Registered Agent at Northwest Registeredagent.com slash money-free. Let's jump back in my alley. 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. I'll send that to you, Allie, as well. Yeah, so you can start playing with it too and, you know, throw in different numbers and see what happens. 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, 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. Laguna Beach is awesome. I, like, I've been there at Sam Clemente, and it's like, oh, my gosh, you can live anywhere in the world. One of those two places, you know, is right as somewhere along that coast. It's so often. I'm from Philadelphia, so I can appreciate the beauty and the weather. and everything. But yeah, no, it's been a, it's, it's an amazing spot. Yeah, it's really gorgeous.

Yeah. People from Texas are the ones that always rent my house. Another question you had was about your pension and should you be cashing that out right now? It's $27,000 if you cashed it out and you'd get 477 a month if you waited until 2042 to start taking your pension. That's, I did the math really quickly. That's like just what, four and a half years, almost five 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? Put it towards my house in Laguna Beach, my second house. What 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 do have a lot of Roth.

in my 401k. And can I use that? 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?

Well, if it's the principle, you should be able to withdraw the funds. The gains will be subject to penalty. from the Roth. So you'll pay a penalty for withdrawing those early. Your Roth position, let me go back to this. Well, the Roth position is in total 243,000, and you actually put out for us the contributions of 160.

So you could pull out the 160 to use toward that purpose. I'm still a little hung up, though, here on the should we, right? Because what you're doing, and this is fine. 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 $2 million in Laguna Beach real estate by using the stock market funds, which is, which is a like, maybe you win. I, like, you know, maybe if you believe it's going to appreciate 6% a year and you lever up on

the Laguna Beach real estate and hold on for a few decades, you're going to get real rich. But I already have you projected to a $20 plus million net worth over the next 30 years, whether you keep or sell the first home. 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 net worth level, if I just handed you up a pile of cash, would it would feel we'd be like,

okay, I'm done. 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, in five years, could I sell it, make a profit? And then I have that extra money to retire on. I don't think I need a lot of money to retire. I would look into, like I would start like find an agent that can help you in Laguna Beach and start looking for. for an amazing property, a dumpy property that you can make beautiful, or 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's a great deal. Get it under contract and then 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 $10,000 a month, it kind of doesn't make a whole lot of sense to say, no, you shouldn't do that.

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. 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. 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, that could absolutely be the right choice. But then it's like why? Like what is that in 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 from there? And that's what's, that's where I continue to get hung up here. This is like, I'm not, I'm not, I'm not, I'm not sure how that, how that translates into the goal of retiring early, quite as clearly. Could you maybe explain that to me, Ali, what the, like, maybe is that what I'm missing there? 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 have till I retire, I really don't have that much cash. 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 next 13 years, right, with the cash that I have? So I guess in my mind I think, well, I need like another property or something, providing income for me or another property I could sell that would provide income to get me to that retirement.

Yes. Okay. So 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. And you need to generate,

you need something else to generate the $120,000 per year that you spend, right? Some other, some other asset situation to do that. But what's happening in reality is you have $2.6 million dollars in assets locked up in order to in order to have this expense profile right here. So you're really like in some ways we can think about it as like what's six, like that's you, you're you're locking up $2.6 million to keep your expenses $7,500 to, you know, $9,000 below what they would otherwise be for your housing. And 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 were to rent, you'd be spending that amount of money. Or you'd need about $2 million at least in a paid

off property, or a very lately levered property, to have the same expense profile. And so that brings me back to how do we unlock this $2.4 million in equity in the house and use it to fund retirement? Or what else can be used to get there? One other. question we haven't talked about in 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. Will you accumulate 50K a year or 100K a year? Well, I think before I 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, depending 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, but this is just brand new. But that's what I can probably work to save $8,000 between $7 and $8,000 a month. Awesome. And are you, are you, also contributing somewhat down that stack of retirement 401K, the Pentec, all that kind of stuff.

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 401K. HSA, I heard Mindy say you always should max out the health savings. If you have a high deductible plan, yes, because you can either use it to have tax-free expenses for your, 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. Yeah. So that's what I did. So I just signed up last

Friday, but that's what I did. So I think I put $8,000 in that and then 5% 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. And I think I've changed it like three times since like going back up. and down. But I think I want more cash. It's a good answer to the question of how do you finance your ADU, for example, is to let that after-tax liquidity position pile up instead of paying a penalty on the 401k or Roth, in my view. So I like that answer. That's $100,000 a year, give or take, 8,000 a month times 12, I think 96, right? So that we're getting close to $100,000 a year in liquidity that will begin piling up there.

And that's a piece of the puzzle. Over five years, that's 500K or 10 minutes a million. So you can think about that in those big chunks and say, okay, we've got another pile of assets there depending on how long you want to work. That's going to apply to this. Plus, you've probably got another 30, 40 on an annualized basis when all said and done. That will be going into your pre-tax or tax deferred accounts like the HSA, 401K match, those kinds of things.

So does that sound about right? 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 don't think it changes the fundamental math about what to do with the house. But it's, I don't, 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 next 10 years and 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 had you cash, I would recreate that portfolio. And how does that feel? Does that feel right to you? 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 Laguda Beach. I love Laguna Beach. So it's like sometimes you kind of get focused on it. Mindy, you seem more on the train of, yeah, buy the next house and rent it out there. And what do you think about this? About this issue. 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 then 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 fundzies. It covers, I didn't run numbers on a mortgage payment on 2.8. And 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%. Remember me again, though, the $20,000 is for two months of short-term rentals, right? Which is the limit of the community? Is that correct, Dowell? So Laguna Beach has a minimum 31 day.

We got 46,000 for two months, so 23,000 a month. Okay. Do you think, and you think year-round you can sustain a midterm rental cash flow in that level? Like, that is the reality you think that could. 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-year-old. term rental probably be rented out, I would say maybe 70% of the time at probably 15 grand a month. Okay. So 15 grand is a more realistic number for 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. for this. So that's a big spread and probably a big piece of the answer here. If that number is 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 50, 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 to a large degree. Like that's that's 10 grand a month. You're done. Game over.

You know, you spend 10 grand a month. That's it. And you don't have to touch the rest of your portfolio. So I think that that's where I keep going back and forth on it. 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 nine 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 rent it out the whole time, right? Someone will probably run it out for six months for a remodel, then it'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 will probably be, you know, 11. But there's different strategies that all create those different numbers. That's why there's such a difference between the numbers. Mindy, how do you feel about this? If the annual rent, if the average monthly rent is going to be $11,000, what do you think? Does that change things for you?

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 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? If I was renting, yes, I do.

If I was buying, no. I mean, when we've done the spreadsheets for buying another house, it was like, okay, my husband's always like, okay, so we're going to move into this horrible little house. It needs a ton of work. And we still have to pay $8,000 a month. Where are we getting that $8,000? So my husband's a bit more skeptical than I am. I'm a little more gun-ho. 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 charge $20,000 a month. And it was a good idea. Then you go and buy. Yeah, that's a good idea. I kind of experiment with renting before I risk my entire everything. 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. 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, it's a 3% and a 1%, 3.5%. three and a half percent for prices and rents. It's an absolute sell decision. It's a $10 million net worth decision over the next couple of decades. If you believe what Allie believes that Laguna Beach is going to appreciate it,

six percent a year and rents are going to go at six percent. It's an absolute keep decision. I think we would have very different viewpoints on those assumptions, but that's the point of the model. Now you know what if you believe those things, you have a clear answer around it. But I think that's the fun part about financial model. Those assumptions make such a difference in terms of what to do.

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. This, I think this is a great homework opportunity for Allie because what I meant was there's no, it's like when you run the numbers according to her numbers, it says keep it. So if both ways said sell, then 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 rent appreciation in Laguna Beach, and what is the historic returns in the stock market? It's 10. something percent.

I closed the tab, but it's 10 percent 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 be more in line with Scott's 10% on the stock market, but I'm also not betting that I can, you know, I can say that from here. But I think that you should be really comfortable with the numbers that you're putting in, Allie, and I think that you should be 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 there's an opportunity there as opposed to both times we run it. It says no sell it.

Another component to this that makes it just so complex and such a great challenge. Thank you for bringing this today. Some of 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 retiring comfortably in Laguna Beach is tying up $3 million in a house. and having the expense for the mortgage payment be zero because your taxes and insurance are nothing on a property that size for it. So if this mortgage is paid off, which is something we've talked about in the past, it's $2.75, so that's going to be hard pill to swallow. But if the mortgage is paid off, then your expenses go from $10,900 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. 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 rented out for a couple of years? Do a live in flip for two. I love the live in flip in areas like a Laguna Beach because of the tax-free capital gain. That ties up some money, but you're paying interest on a much lower interest in you're 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 out to college or leave the house, that would probably completely end the game for you. And now you can think about it much simpler terms. I have a paid off property that I can live in in Laguna Beach and about $2.5, $3 million in the portfolio outside of that from these living 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 inequity. 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 that? I'm saying move into the next house in Laguna, which is like move into the next house, buy it. Yeah. And but treat it as a living 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 are super high on that front because I imagine super-gobble people buying $3 million homes do not want to spend six months refurbishing the place. I see a lot of success with people doing that. They'll buy it for, you know, under 2-mill, flip it for four and a half within a year. Then you're going to have to pay talent if you do that. 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. Yeah, I would have to live in it because I'd have to rent out my house to pay for it. It's $250,000 per person on title, not just $250, if you're single and $500 if you're married. So then you get a million dollars of tax-free capital gates. And there's like rules involved, of course.

500 of which doesn't go to your retirement. It goes to your, you know, the kids bent least. But I think that, you know, if you take that math and you say, okay, I'm going to do a living flip. I'm going to buy one of these properties for 1.7 or whatever, whatever that is, that's in really bad shape. We're going to fix it up with 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 approach that would be reasonable in your situation since you have 8,000 of money. in savings on top of your expenses right now. I like that idea.

Just got to talk my husband and two kids in it. I would find a real estate agent. If you don't have one that you've been working with in the past, BiggerPockets.com slash 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. I mean, you could definitely lose. And that's my,

that's again my worry about the plan to go all in on the Gouda Beach real estate, uh, in your situation. But that's there's a good way. It's, it's a significant de-risking of the investment process. If you two want to partner with me, that would help, uh, mitigate the risk. You know, we can go thirdies. 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 fund and lenders. If you can bring a material amount of cash down. Good to know. 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. But this was a fun exercise, and I am super excited to see where all your research leads you to. So please keep up. us up to date. It might even be fun to have you come back after you've determined what you want to do and we can run through some different numbers and scenarios then. Yeah. 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. Thank you so much for coming on and congratulations on your awesome problems. I'll be really interested to see how you untangle and it's a really tricky situation and a good thing. Like, congratulations. I hope you're feeling, you know, very excited about the future. Yes. Well, thank you again.

Thank you, Allie, and we will talk to you soon. Bye, bye. 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 you and she had different assumptions on the returns, the historic returns and 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. I think it's really hard for me to wrap my mind around this problem. And I'd love to get input from the Bigger Pockets 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 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 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've got to talk about how to shelter the other $400,000 or $400,000. Another option I throw out there for Allie is to consider a 1031 exchange. Can she sell that property and move that into other higher yielding cash flowing investments somewhere else as part of that portfolio? Because that's going to be more, you know, that may be a way to shelter that tax benefit if she decides to sell the property. She kind of busted my model with how big the numbers are on this property, and I have to go revisit a few assumptions and there make sure that those are tailored to these

types of situations. 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, but I do know that it's for a rental property. So I'm wondering how that would work. I think that 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 a community and ask that question out there. Can you 1031 a primary residence if you turn it into a rental?

I believe the answer is yes. 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, what did you say, $300,000 on taxes, almost $400,000 on capital gains taxes if she does that. Yeah, 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 are $387,000 in capital gains.

So that's a material part of the decision here. You can get another $400,000 by deferring it into real estate. and plan to keep real estate for the long term, that could be pretty powerful there. You are giving up the primary residence exclusion, though. So there's a tax angle to this that should definitely be explored, and she should probably talk to a real estate friendly CPA. 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.

But yeah, this was fun problem to try and figure. out. 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. Scott and I want to hear from you. What advice would you have given to Allie that differs from what Scott and I said? We would love to hear from you below. Should we get out of here, Mindy? We should, Scott. That wraps up this episode of the Bigger Pockets Money podcast. He is Scott Trench. I am Mindy Jensen saying cheerio, mistletoe.