2023 investment strategy: Index funds with high tax bill or real estate?

[White.Beard.Doc]

I am working on our overall investment strategy for 2023. I am debating between an easy index fund investment path, versus a more labor intensive, but far more lucrative, real estate investment path.

Option 1: Go the simple route and invest all the excess income in the taxable accounts, in index funds. The income tax bill for the year will be around 46% combined effective state and local income tax. What is left after paying all those taxes goes into the taxable investment accounts.

Option 2: Invest heavily in real estate, do cost segregation and bonus depreciation. Perhaps I can reduce the income tax to around 14% effective for the year if the plans are effective, saving and investing an extra 1/3 of annual income.

I am somewhat attracted to option 2. There are problems there though. The commercial RE market is in the midst of a repricing freeze. Sellers want the old cap rates that were achievable prior to interest rates going up. Buyers want discounts based on the new financing reality. A significant minority of commercial RE owners are heading into a squeeze and will likely be forced to sell at discounted prices as the year progresses (due to variable rate financing on their investments). Executing option 2 may or may not pan out. Right now I am sitting on a large pile of cash. I put it into high yield stable investments while waiting things out. Option 2 would potentially allow me to add an extra 5% to our net worth in the form of tax savings due to high business income this year. If you exclude the value of the business I started, option 2 could increase our invested asset net worth by more than an additional 10%.

[CordMcNally]

Honest question but does it matter? You've already spoken about you have more money than you'll ever spend.

[StarTrekDoc]

Agreed. Stop playing the game.

Index and spend/donate/live

[jfoxcpacfp]

Old RLP*/FA’s POV here - what is the purpose of increasing your NW by > 10%, in a “labor insensitive” manner? That may already be obvious to you and your wife or you may want to discuss before you make a decision. I once saw a chart online that you hang on the wall with squares representing your estimated life span. You mark off all the squares up to your age then continuing blacking/x-ing out the squares in real time. The visual representation of the time you have left was interesting and arresting.

Where are you on the chart and how do you want to spend your remaining time left? The answer is not OSFA and requires some reflection, as in going through The 3 Questions that George Kinder drilled into our skulls one week during training. All the best with hopes you get more input on this thread.

*Registered Life Planner

[afan]

From your posts, I thought you were already heavily invested in real estate?
And that you were already taking advantage of the tax savings?

The questions would be Are you perhaps too exposed to this asset class?
Do you want to expand the business you are currently running, or would you prefer to put more of your assets in something truly passive, like index funds?

Or are you asking whether the current economic climate is conducive to buying more real estate now? For that, I assume the answer is that it is more risky, has a wide spread of possible returns, positive or negative, and has the potential for a high payoff if you can buy at a low price.

[zlandar]

Option 2 sounds like a chore to me. If you enjoy doing it fine. Otherwise you are trading your time for money you don't need.

[dennis]

I've previously mentioned NNN commercial properties and these are NOT labor intensive. The only thing you have to do is pay the mortgage, which I don't anyway as it is ACHed by the bank. You can still do a cost seg bonus depreciation study. I note the current Dollar Generals on offer have had a raise in the CAP rate offered so things are moving in a positive direction for buyers. You also don't have to worry about having a target on your back like residential landlords do now. We currently have 6 anti-landlord bills in committee in our legislature and I intend to testify against them when the public comments are scheduled by the committee.

[Larry Ragman]

Interesting choices. A few thoughts.

First, I think the “Bernstein Rule” (I.e., stop playing the game) is misunderstood. No reason to stop per se; just lock away whatever you need to keep your lifestyle somewhere safe. All the rest of the wealth, and I infer that is the category these funds fall under, should be put to work. In fact, you can take more risk with it. So what if you don’t have to. You are good at it and wealth creators should be encouraged for the betterment of society.

As for your choices, given you have the disposable wealth, go option 2. The 80% bonus depreciation will drop again next year so the window is closing. I take your caution about the interest rate squeeze on cap rate hence unrealistic seller expectations; however, it would be fun to search out and find a good deal where the seller needs to refi so you can get a good deal. If you end up waiting a year that will still probably work out.

[LIFO]

What's different between "passive" real estate and bonds? Assuming no debt, a stable 4 cap property is going to pay the same as a 4% bond does. With interest rates where they are, debt may deteriorate earnings yield. Don't borrow at 6 to get 4, etc...

My understanding of cost segregation/bonus depreciation is that it is typically helpful when you want to lever up as it frees cash upfront to reinvest. Don't you have the opposite problem where you're trying to get your cash to work?

Are you looking to become a real estate guy? Buy distressed, rehab, or use your marketing prowess to bring rents up and fill vacancy? IMO, that's a career change, not an investment strategy.

[pit.alumni]

Don't let the tax tail wag the dog. Not sure what your market is like, but in mine there are not any good options for RE investment currently, at least by my criteria. My criteria is pretty simple. Cash on cash return of >6% tax free, market rents significantly above my carrying costs so I don't have to worry about negative cash flows even with downturn, renter demand for the property and location and properties that are in my current area. I suppose there are other parts of the country where the deals may be better but I prefer to stay local where I know the intricacies of the market. I guess RE is fine if you can find a good deal, but the emphasis is on good.

[The White Coat Investor]

I am working on our overall investment strategy for 2023. I am debating between an easy index fund investment path, versus a more labor intensive, but far more lucrative, real estate investment path.

Option 1: Go the simple route and invest all the excess income in the taxable accounts, in index funds. The income tax bill for the year will be around 46% combined effective state and local income tax. What is left after paying all those taxes goes into the taxable investment accounts.

Option 2: Invest heavily in real estate, do cost segregation and bonus depreciation. Perhaps I can reduce the income tax to around 14% effective for the year if the plans are effective, saving and investing an extra 1/3 of annual income.

I am somewhat attracted to option 2. There are problems there though. The commercial RE market is in the midst of a repricing freeze. Sellers want the old cap rates that were achievable prior to interest rates going up. Buyers want discounts based on the new financing reality. A significant minority of commercial RE owners are heading into a squeeze and will likely be forced to sell at discounted prices as the year progresses (due to variable rate financing on their investments). Executing option 2 may or may not pan out. Right now I am sitting on a large pile of cash. I put it into high yield stable investments while waiting things out. Option 2 would potentially allow me to add an extra 5% to our net worth in the form of tax savings due to high business income this year. If you exclude the value of the business I started, option 2 could increase our invested asset net worth by more than an additional 10%.

How does more money change your life?

[Zaphod]

Maybe hold in short duration bonds for now, earning a nice coupon and wait to see if a truly great commercial real estate environment becomes available, could be more than 5% then. No need to rush, wait and pick a great spot, if not, move on and index.

[abds]

You're probably approaching 9-figure net worth at some point in the near future... you have said you don't need more money... you said or implied on some thread that you've never flown private... so does more money make your life better in any way?

If you actually enjoy the real estate beyond making money in it, option 2. If you want to get to a certain NW before you buy a fractional share of a jet (or some other expensive lifestyle-enhancing thing), option 2. If you want to relax and have enough money, option 1.

[White.Beard.Doc]

Honest question but does it matter? You've already spoken about you have more money than you'll ever spend.

I continue to consider increased net worth equals increased financial security, but there comes a point.....

We currently spend on the things we want and do not deprive ourselves of anything, the grandkids education is taken care of, and the travel plans are taken care of. Still, this inflationary environment could get more ugly, and if there is a long horizon ahead, what then?

Not always logical, but personal finance is very much a psychological game.

[White.Beard.Doc]

Old RLP*/FA’s POV here - what is the purpose of increasing your NW by > 10%, in a “labor insensitive” manner? That may already be obvious to you and your wife or you may want to discuss before you make a decision. I once saw a chart online that you hang on the wall with squares representing your estimated life span. You mark off all the squares up to your age then continuing blacking/x-ing out the squares in real time. The visual representation of the time you have left was interesting and arresting.

Where are you on the chart and how do you want to spend your remaining time left? The answer is not OSFA and requires some reflection, as in going through The 3 Questions that George Kinder drilled into our skulls one week during training. All the best with hopes you get more input on this thread.

*Registered Life Planner

Yes, it is good to ask those life goal questions, and ask them again. This is a good start to a discussion with my spouse.