June 30, 2021

JF2493: From $800K in Debt to Full Financial Freedom | Actively Passive Investing Show

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In a recent article, an anonymous writer tells us how he achieved financial independence through passive investing. Today we’re talking about the FIRE movement and what it truly means to be financially free. Theo Hicks & Travis Watts go in-depth on the 4 levels of FIRE, as well as 4 steps to get started and succeed with the FIRE movement.

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Theo Hicks: Hello, Best Ever Listeners, and welcome to the Best Real Estate Investing Advice Ever Show. Today, we’re doing another episode of the Actively Passive Investing Show, so I’m Theo Hicks, joined today with Travis Watts.

Travis, how’s it going today?

Travis Watts: Hey, Theo. Doing great, man. Excited for this episode.

Theo Hicks: Yes, we’re talking about the FIRE Movement today. So the title, as you can see is How To Achieve Financial Independence Through Passive Investing. And we’re going to focus on how you can use the concepts from the FIRE Movement, apply it to real estate investing to achieve your financial independence, financial freedom, or as Travis calls it, your time of freedom.

So Travis, let’s jump into it.

Travis Watts: Awesome. This one’s going to be a little bit different. I know we’ve covered FIRE Movement, we’ve for sure talked about it a lot, but we had an actual episode about this in 2020. This one’s different though; this was actually a blog post on joefairless.com. This was a real individual who used the FIRE Movement philosophy or strategy, if you will, and combined that with multifamily investing and real estate investing.

So we’re going to share highlights from that, as to how this anonymous individual did that. And of course, it’s my passion point, too. I’ve used it as well; didn’t know about the FIRE Movement years ago, I was just going through the same steps and motions, had I understood what the whole thing was. So I’ve used similar strategies myself to achieve financial independence, so that’s what I want to share, are just some tips, some strategies, explain how exactly this worked, and again, highlight thoughts off the blog and things like that.

So really, what this is about is how to build a life on your terms. That to me is the essence of what FIRE movements is all about. We’ll explain that a bit more, but that’s what this episode is about, so thanks for being here, thanks for listening. Anything before I jump in, Theo?

Theo Hicks: No, let’s jump right into it.

Travis Watts: Cool. Let’s start real quick on the basics. So if you’re not familiar with what FIRE means, it’s an acronym; it stands for Financial Independence, Retire Early. It’s a way to create either net worth or passive income that in turn allows you to create the lifestyle of your choice. So that’s my definition of it, but in essence, that’s what it is.

So what I thought was very inspiring about this blog – I just read this the other day; I don’t know when this was posted, but this anonymous individual here… bow this is so cool  – nearly 40 years old, nearly $800,000 in debt when he started this, and was able to achieve financial independence through using this.

So I can’t say the same for myself; I certainly didn’t have 800K in debt, and I’m not 40 yet, so I’ll give you two sides of it. And hopefully, this isn’t one of those, “I have to subscribe to this wholeheartedly, this movement or whatever.” There just might be a couple tidbits that you pull out of this episode and go, “Hey, I might be able to do that in my own strategy.” And that’s cool. As we talked about it a lot, it’s about pulling tidbits from your mentors and from podcasts and from seminars; if you just pick up one or two things just here and there, then those all add up to where you have 100 new ideas in your head, and you go out and just do your thing.

So with that, I guess, Theo, I’ll let you explain before I dive into the “How to” and the strategy – do you want explain the four levels of FIRE or the FIRE Movement?

Theo Hicks: Yes, I will. I want to say one thing following up on what you just said about the inspiration behind this, the 40-year-old who was 800k in debt… A lot of times I’m sure people will think — maybe they’re in their mid-20s, late 20s or early 30s say, “I wish I would have started investing earlier; I’m behind, I’m not going to be able to achieve financial freedom at a certain timeframe because I’ve started so late.” Well, here’s one example, but there’s many other examples of people who are in their 40’s. This guy right here was $800,000 in debt. I believe this guy’s a doctor of some sort. So obviously he has a pretty high active income, but still 40 years old, almost a million dollars in debt and was still able to achieve financial independence through investing. So as, Travis said – inspiration, and don’t let your age determine whether or not you think you can become financially free or not.

So with that out of the way, the four levels of FIRE; so you’ve got CoastFIRE, LeanFIRE, FIR -FIRE (just FIRE_, and then FatFIRE. So what is coast FIRE mean? Coast FIRE means that you still need to work, you still need to rely on your active income to cover your living expenses or anything above those living expenses, but you’re at the point with your investing that you don’t need to continue to invest money. So you might have, from a real estate perspective, a bunch of single-family homes that aren’t necessarily generating you a bunch of cash flow, but you know that by the time you retire, you’ll have enough equity in these homes to retire and live without money, or you know, some other investment like an IRA or something.

So you need to work, you need to live off that money, but you don’t need to invest anymore. It’s just once time goes on, that investment or investments you already have will naturally get you to the point where you can retire. So you can coast to retirement, that’s the point of it being called the CoastFIRE.

The next level above that would be a LeanFIRE. So this is where you get to a point where you’ve calculated what your basic living expenses are, and then you’ve got to the point where you’ve got enough passive income coming in from whatever you’re investing in, real estate or not, to cover those living expenses. So eat and live in a house, things like that. So you don’t have anything above that, you can just cover all of your living expenses. Now, you’re at LeanFIRE.

And then the official FIRE would be if you have achieved LeanFIRE, and then some. So you’ve got enough passive income coming in on your investments to cover all of your living expenses, your basic needs are covered. But then you have a little bit extra out for reserves. That way, you actually have the ability to retire, right? Not just living and that’s it, being able to do nothing else. So that would be the FIRE.

And then above that would be FatFIRE. So this is where you have achieved FIRE. You’ve got your basic living expenses covered, you have reserves, but then you have enough income coming in through your passive investments that you can really do whatever you want, right? This is living in excess, or fat, I guess. So you’re living in luxury, you can go on vacations, you can buy the things you’ve always wanted, but still not having to work. Your passive investments are covering all of those expenses.

So again, just to quickly summarize, we’ve got the CoastFIRE where you can coast to retirement with your investments; the LeanFIRE, where you take it a little bit further and now you’re bringing in enough passive income where you can cover all your basic living expenses; the FIRE, which is where you can cover your basic living expenses, and then a little bit more for reserves; and the FatFIRE, where your passive investments are allowing you to live a life of luxury and excess.

Break: [07:27] to [09:29]

Travis Watts: I want to highlight too with kind of a story, to paint it a little bit differently, but same concept obviously… So I remember hitting LeanFIRE, and again, I didn’t know about the FIRE Movement back then… But I’ll give you an example what that looked like.

When I was at LeanFIRE, I was in my early 20s, I had one full-time single-family rental property; it was cash flowing  400 or 500 a month or something like that, and then I was living in this three-bedroom house, single, no kids, unmarried, whatever… And so I rented out the other two bedrooms. I had a very low mortgage payment; it was $890 a month or something like that. So I was charging each of these roommates $600 per month. And I had some other investments too that were providing some cash flow… So I was just able, barely, to cover my mortgage and my food and my transportation and my bills. But had I said, “Alright, that’s it, I’m done. I’m good.” Think about it. I couldn’t have really, right? Because the minute you start a family or you have kids or things change or you want to upgrade your house or you need a new car, these things pop up in life and all of a sudden, I would have been removed out of LeanFIRE, right? Because now all of a sudden, I couldn’t cover all those expenses.

So that’s the point is, it was a cool epiphany for me, like, “Wow, I’m on the right track. I’m getting there,” but it just wasn’t quite enough.

And yes, regular buyers, to your point – you’ve got some cash reserves, you’ve got excess cash flow, because as we all know, medical expenses, unexpected things, they pop up. And we’ll probably want to, hopefully, increase our lifestyle over time.

And then to your point of FatFIRE, that could be to use an excess, like a billionaire, like a Mark Zuckerberg or something, obviously, has basically unlimited money. So it doesn’t have to be unlimited, but it’s like if you were living on $10,000 per month, but you had $40,000 per month rolling in. That’s fat FIRE, right? It’s like no matter what happens, you’ve got excess, you got cash reserves. So anyway, a couple visuals.

I want to get into the actual strategy, though, both in this blog and then personally. So the guy from the blog, he started investing in REITs. REITs are something we’ve talked about a number of times on the show, it stands for Real Estate Investment Trusts. They can be private or they can be publicly traded; most people refer to REITs as the publicly-traded REITs that are in the stock market… And they hold real estate; you could buy a multi-family REIT, you could buy a self-storage REIT, a mobile home park REIT, things like that. So REITs can pay monthly dividends, they can pay quarterly dividends, but I think by law, they’re required to pay out something like 90% of their earnings to their investors. So sometimes there’s not a ton of equity upside. They’re just paying out basically all the cash flow and revenue, for the most part. So they’re liquid, which is great. If you put money in them and you say, “Hey, I want that money back” you can sell them if they’re publicly traded.

And this is what I’ve talked about in previous episodes, that I got my nephew started with REITs because you can start with literally a free brokerage account. These days, often there’s no trade fees and some of these REITs are $10 per share. So you can literally get started for $10 on this journey. So it’s a great budget way to toe-dip into the real estate world, if you don’t want to go buy single-family homes or do the syndications which we’ll talk about here in a minute.

But a big con, the reason I don’t do a lot in the REITs space is that they’re subject to market volatility. When the stock market’s up, it’s great; your cash-flowing and your building equity, all is good. But when we had like the crash last year, and the stock market falls apart, 30%, so do these REITs. So a lot of the REITs I held were down, and then I bought some as well at a discount. So kind of pros and cons there. So that’s how he got started.

I on the other hand, I got started with single-family homes, as I’m sure a lot of the listeners know. So house-hacking was first step, renting out the spare bedrooms, like I just talked about for LeanFIRE, fix and flips, vacation rentals… That was the only way I knew how to get started; I didn’t understand what REITs were. So when someone said, “Be a real estate investor,” the only thing I could think was single-family home, so that’s what I did.

And I also had a high-paying job; probably not quite like a doctor, perhaps, but I worked a lot of hours, 100 hours a week, so I made some decent money in overtime… So I was saving 70% of my paychecks basically, is what I was doing. And that gets back to that frugality mindset and the FIRE Movement concept. Again, not even knowing what that was at the time.

So real quick, my four things that I subscribe to that worked was earn as much as you can earn using your highest and best potential, whatever that is for you. I did a lot of side hustles, real estate, worked a high-paying W-2 job, that was my highest and best at the time.

Two, live on as little as possible for a period of time, not your whole life, but more like 5-or 10 years, get serious about building yourself financial independence. So that’s step two.

Three, invest in something; you’ve got to invest in something. So for me it was single-family real estate in the beginning and nowadays, it’s multifamily syndications, multifamily real estate, and I like cash flow. But to your point earlier, I guess we were talking before the show, but a lot of people in the FIRE Movement are investing in the stock market, like in the index fund that holds a bunch of S&P stocks or whatever, and that works for some. Again, for me it was real estate.

And then last but not least, avoid bad debt; credit card debt. If you have student loan debt, really evaluate that, try to pay that off. If you have personal loans, car loans, stuff like that.

So those are the four things that kind of sum up and summarize the FIRE Movement for the most part. You’ll hear different takes on it depending on who you listen to, but that’s more or less it.

And the key thing I found in this blog – and I’ll tie it all together now… We started in separate areas of real estate, but we ended up investing in the same asset class, the same asset type, the same business model, which is private placements. Real estate syndications is what we inevitably thought was or still think is the right asset class for us, and the right strategy.

But again, there’s pros and cons. Unlike REIT that’s publicly traded, you can’t invest in private placements with $10 or $100 or $1,000. Now, you’re on a different scale. Now you’re talking about deploying $100,000, let’s say, into one or two deals, or something like that, depending on the minimum.

But the pro is they’re not tied to the volatility of the stock market. So my portfolio when we had the market crash last year, in the private placement space, was steady and consistent. Dividends just kept coming through either monthly or quarterly. On paper, you really wouldn’t have seen too much of an impact or difference. But had I had it all in REITs, I would have been down 30-40 percent. So to me, that’s a huge pro, a big reason why I’m in private placements.

So they’re passive investments, they produce monthly or quarterly income, like I said, those are some of the highlights.

So that kind of covers the “what” and the “how to”, our two different stories merging together. But Theo, can you talk about burn rate? I think this is a good time in this segment to kind of discuss that. That’s a critical element to living on investment income and how much you spend in the FIRE Movement.

Theo Hicks: Exactly, you’ve kind of already hinted at this earlier, when you were talking about the FatFIRE, so it’s kind of the opposite. So let’s say that I’m generating $10,000 per month in income. In Travis’ example, if I’m only spending $4,000 per month, and then with FatFIRE, no matter what I do, I’m always going to have more money coming in than is going out. So your burn rate is how much money you’re spending.

So in that example, the burn rate would be $4,000. So if I’m generating $10,000 per month in passive income and I’m spending $4,000 per month as my burn rate, then I’m okay. Now, if those were flipped, so if I’m spending $10,000 per month and I’m only generating $4,000 per month in passive income, my burn rate is too high, $10,000. So I need to either bring my burn rate down or I need to bring my passive income up. It’s kind of applying this to the four different levels. In a sense, when you’re at the buyer, your burn rate is equal to your income rate. So if your living expenses and your reserves you want is a $4,000 per month and you’re generating $4,000 in passive income per month, then you’ve achieved FIRE. Below that, you’re at LeanFIRE or CoastFIRE, above that you’re at FatFIRE.

So what’s the ideal ratio or what’s the metric you can put on this to know what your burn rate needs to be compared to how much money you need to have?

So in the FIRE Movement, the idea is that you need to save 25 times your annual expenses or 25 times your burn rate. So if your annual burn rate is going to be $60,000 per year, then 25 times that would be $1.5 million. So you’re gonna have $1.5 million in the bank in order to cover your burn rate of $60,000 per year.

Break: [18:14] to [18:50]

Travis Watts: The whole 25x thing, just so everybody understands, is if you subscribe to that idea in this Movement, it’s based off the 4% rule, which is a more common way to explain it. So a lot of people who are doing stock investing, specifically because of the nature of stocks being liquid, a lot of people are selling 4% of their portfolio value to live on… Because if you think about it, an S&P index fund, for example, an index fund isn’t really a cash-flow vehicle; it’s got a small dividend that they pay out, but not enough to live on, unless you’ve got $100 million or something. So what that is it can be set either way – 25x your expenses or what you intend or want to live on, or 4% of your portfolio value.

So to your point, if you withdraw 4% of a $1.5 million stock portfolio, for example, that gives you $60,000 per year. So if $60,000 is your number, those are your numbers. And they’re trying to be conservative with that, they’re trying to say there’s inflation and sometimes the market’s up 20% one year, but sometimes it’s down 20% one year… So they’re trying to find a little conservative number, which they came up with 4%, to account for these things.

And I forget all the stats, I used to look into this stuff when I was first learning about, I kind of geeked out. They’ve ran all these 100-year scenarios off 3%, 4%, 5%. 4% is kind of the sweet spot; you have a very high probability of being able to survive and always have money if that’s the kind of “rules” quote unquote, that you’re following.

But I will give you an alternative perspective, because I don’t like the 4% rule. I’m mostly in real estate; I’m mostly in value-add multifamily syndications. For me, personally – I’m not telling anyone else what to do, but for me, I use the 8% rule. And I’ll tell you why and I’ll show you how.

So I’ve used this ever since I went full-time passive with these syndications in 2015, and it still applies today. So I live on cash flow; that’s my income. But I don’t bank or count on equity upside, even though historically speaking, it’s usually there. Sometimes it’s there in even greater numbers than what we hope for. But I don’t bank on it. I like to be conservative, I subscribe to under-promise and over-deliver even for myself personally, when I project my forecast. So the equity upside piece, which I’ll explain in more detail here in a minute, covers dips in my portfolio, things that may not go as planned, inflation, taxable situations that pop up, there’s a lot of miscellaneous out there; it’s hard to really forecast, so I kind of used that cushion to cover all of that and then I just try to live on straight cash flow. That’s kind of my thing.

So let’s take a deal, for example. Let’s say I’m going to invest today in a multifamily value-add syndication. Let’s say it’s a 5 year home and it’s got a 16% IRR, Internal Rate of Return. So if 8% of that is the cash flow that I’m collecting year after year, and the other 8% is equity upside – we’re going to hopefully buy low and sell for a higher price, right? Because we’re renovating and we’re raising rents and we’re increasing net operating income… So again, I use the 8% rule, and I say, “I’m going to make 8%.” That’s what I say to myself anyway, and that’s what I live on. And whatever happens above that is used to offset the miscellaneous in my portfolio; sometimes it works out well, sometimes that upside isn’t there.

You’ve got to remember, everybody listening, these are projections. When you go into these types of deals, it’s anyone’s guess really about the equity upside 5 years down the road. Do you really know what the government’s going to be doing? Do you really know what the Federal Reserve’s going to be doing? Or the US dollar? Or inflation? Or interest rates? No. Nobody can know, nobody does know, not even the Fed knows. Nobody knows. So they’re a guess. So my guess is, I want to go very conservative on that, and that’s something that we talk about a lot on this show.

So with that said, I’m not a financial planner, so please seek licensed advice. I’m not telling anybody what to do, I’m explaining what I do personally, and what’s worked for me. And that’s just one version of the FIRE Movement. I’m sure there’s a ton of people out there that would disagree with some of that, and again, a lot of people are our stock-focused, so maybe all of that may not make sense. And certainly, there’s investments where this would not apply, the 8% rule, because you don’t have approximate equal upside in equity compared to cash flow, right? Maybe it’s only cash flow or maybe it’s only equity. So this whole thing may not make sense.

But to the point of our show, talking about being a passive investor in multifamily syndications, I thought I would share that. I don’t think I’ve ever shared that before. So that’s all I got on that topic, on the “How to” and the strategy. I shared my four rules that I follow; hopefully, take some notes on that, if that helps anybody. And like I always say, it’s simple, but it’s not easy.

So do you have anything to add, Theo, before we sign off?

Theo Hicks: Obviously, I really enjoyed that you’ve shared, that because you’ve not shared that before, your cash flow 8% upside strategy to be conservative and not necessarily focusing on the upside, just focusing on that cash flow. It really comes back to that one point you talked about a lot when you’re analyzing deals and taking a look at that cap rate that people are using on the exit; because you move that cap rate up and down a little bit, and it’s sometimes multiple percentage points difference in the upside you’re going to get. So in essence, Travis lives off of that cash flow; since the whole concept of the FIRE Movement is that cash flow coming in, it’s better to base your calculations on that cash flow, and then that other equity upside being the cherry on top, so that if that does happen, it kind of dip it into that FatFIRE side of things, where if you project the FatFIRE and you don’t hit it, you might be a little bit below where you want to be. So I really appreciate you sharing that. That’s all I have to add.

So if that’s all you have Travis, Best Ever Listeners, thank you for tuning in. If you have any questions you’d like us to answer on this show or we do a 60-second question segment that we post on YouTube, make sure you submit a question to me, theo@joefairless.com. Thanks for tuning in, have a best ever day and we’ll talk to you tomorrow.

Travis Watts: Yes, thanks, everybody. Thanks, Theo. See you later.

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