When I recently read in Joe Fairless’s Best Ever Report about how Lue Chen achieved financial independence (or in his case fatFIRE) at only age 38, I had to reach out to him…and boy am I glad I did!
Because I knew that this call was going to be chop full of great information, I asked if I could record it before hand. Lue graciously agreed and I had it transcribed so I could not only review what I had learned, but so I could also put together the Cliff Notes version for you today.
One of the main reasons I reached out to him was that I wanted to pick his brain a little bit because there’s a lot of physicians and dentists that are looking at ways to either retire earlier (FIRE), or cut back to seeing patients 2-3 days a week.
And by using the methods he’s implemented, this can certainly be done within 5-7 years.
Before we get into specifics, let’s find out a little bit about Lue Chen….
Lue Chen
Lue is an immigrant from China that came to the U.S. when he was 19. He finished college in New York City and then went on to become a computer programmer for about 13-14 years. He’s currently married with three kids and considers himself very fortunate in that both him and his wife (CPA) were raised by very frugal families. This helped them to have a high savings rate during their careers without sacrificing much of their standard of living.
Initially, their retirement planning consisted of investing in index funds and didn’t know much about real estate investing. (He did what I both teach and practice myself, “Don’t invest in anything you don’t understand.”)
Both Lue and his wife maxed out their company-sponsored 401Ks annually and any extra money left over was put into index funds in post-tax accounts. They really started funding the accounts just after the 2008-9 recession in both the Vanguard S&P 500 Index Fund and the Total Stock Market Index Fund.
They were able to experience great returns and grow both their net worth and nest egg due to the fact that the market had bottomed out. Once they started deploying that money towards real estate in 2017, the amount invested in index funds had tripled.
Initial Goals
By the time Lue found out about real estate investing through a podcast in 2007, he had enough savings that he was able to deploy right away into whatever he saw fit.
After learning about being a landlord for rental properties, and all the different asset types in real estate, he realized that they all required quite a bit of work upfront and maintenance.
His goal was to spend more time with the kids and live a fatFIRE life, so he decided to move into a more passive investing instead of the active finding deals, rehabbing, renting it out, managing the tenants.
What is fatFIRE?
I first heard of the concept of fatFIRE from both the Physician on Fire and the Financial Samurai.
This concept stems from the ever popular FIRE movement which stand for:
Financial Independence Retire Early
Fat FIRE simply takes this one step further in that it allows someone to be able to live it up in retirement without having to live like a monk. Lean fire, on the other hand, allows someone to live more frugally during retirement age. Their annual spending tends to be a bit lower vs the fatFIRE crowd.
You can easily survive without a full-time or part time job because your investment income more than covers your best life’s living expenses.
This was one of the goals that Lue and his wife were trying to accomplish.
Self-Directed Solo 401k
Once his goals were set, it was time to take action which involved deploying all of the money in their index funds into passive real estate. But they had to make sure they did it in a way which allowed them to avoid taxes and fees.
They started off by converting their company 401k to a self-directed solo 401k. This is similar to a regular 401k but just for you and your spouse.
He stressed the need to work with a trusted company to help with the conversion to handle the regulatory requirements and documentation. He personally used Sense Financial for the entire process.
Once he received the necessary paperwork, he was able to use it an open an account with Charles Schwab for the solo 401k. Next, he then performed a direct rollover from his previous employer into the new account.
IF he had withdrawn the 401k money, it would have been considered a taxable event. The key in the process was the documentation the company he worked with provided him.
Related Article: 10 Pros and Cons of Using A Self Directed IRA For Real Estate
Join the Passive Investors CircleIRA vs Self-Directed IRA or 401k
For clarification, I asked Lue if he could explain the difference between a Traditional IRA vs a Self-Directed IRA or 401k.
He explained, “When I was with an employer, I was working for a company that allowed me to put my money in either a traditional 401k fund or IRA. I can put into what the company chooses to house the money, they are usually called a custodian.”
“So if a company chooses Fidelity as the company that’s going to hold my 401k, then when I contribute my money into a 401k, it goes to Fidelity. It’s up to Fidelity and the company to offer what kind of investment options I have with my money such as stocks, bonds or funds. Usually the choices offered are very limited.”
“Now, in a self-directed IRA or solo 401k, you have total control of what you can invest in. For example, you can invest in stocks, bonds, gold, real estate and several other asset classes too. The idea of self-directed is that you tell it where your money goes.”
“If you have a good rental property you want to invest in coming up in your pipeline, then you can simply write a check out of your self directed solo 401k or self-directed IRA account and invest in that rental. That certainly would not be an option if you are working with Fidelity or any other custodians that work with your company/practice.”
How To Deploy Funds
After Lue set up a self-directed 401k with Charles Schwab that Sense Financial assisted with, he next began deploying that money to fund the real estate deals to help him reach his financial goals.
He was able to accomplish this by using the check writing option that was available on the account. For instance, after researching his options, he chose to begin to reinvest the money in index funds into multifamily syndications.
After connecting with several sponsors/syndicators of these deals, he identified the ones he wanted to invest in and simply wrote a check from the Schwab account. Most of these deals were for accredited investors only and were a minimum of $50,000 to invest with.
After this process, the investment was under the solo 401k plan and not Lue Chen. The individual that invested with the deal, Lue, will be the solo 401k plan.
How Lue Chose His Real Estate Investments
When Lue initially started researching options regarding real estate investing, he thought he’d have to be a landlord and wasn’t too keen on having to collect rent and fix toilets on the weekends.
But the more he learned about real estate, the more he realized that to scale quicker you can buy multi-family apartment complexes that makes everything a little bit easier in terms of per unit.
Being in a syndication allow you to have your own team to:
- manage the building
- fix the toilets
- market the property for new tenants
But the problem for him and many others (such as myself), that in order to go into multi-family, most don’t have the bandwidth, connections and capital to go out and buy an apartment complex.
That’s when the multifamily syndication deal comes along. This is when a sponsor or syndicator has a connection, knowledge and expertise to go out and find great deals like an apartment complex in a growing area such as Dallas (which is where several of my investments are located).
Now most don’t have $40 million dollars laying around so syndicators are able to underwrite a deal and then present it as an offering to people out there who’s interested to contribute a small portion of the equity.
For instance, I could put in $50,000, Lue could invest $50,000, and John Smith goes in for $100,000. With a lot of investors, the property can now be purchased.
Then the syndicator, let’s say his name is Joe, would go out and buy this property and form an LLC. The LLC would exclusively own the property. We as investors would own a small percentage of the LLC that owns the property.
Joe, the sponsor is in charge of managing the properties, putting renters in it, renovating it, and basically doing all of the work that most doctors and other high-income professionals want to avoid.
How To Find Deals
Most of the deals that both Lue and I invest in are not publicly advertised. You first have to establish a personal relationship with a sponsor that puts a deal together.
The first step will be to look for a good, trust-worthy sponsor. There are multiple ways to find one such as:
- word of mouth
- internet research
- podcasts
Lue is big on contacting the sponsor directly ( I am too) to find about their goals and the types of properties that they invest in. Lue would also discuss his personal goals as an investor and if it’s a good fit, the sponsor then would put them on their mailing list.
Once Lue receives a potential deal, he starts his due diligence process that includes:
- the track record of the company
- how long have they been investing in syndications
- how many deals have they acquired and exited
- talking to their other investors (very important)
If they pass his test then he starts looking at the deal itself. Some of the criteria he’s evaluating are:
- the numbers provided
- location
- are people moving in or out of the area
- job market
- business plan (i.e. value-add)
- preferred rate of return (PRR)
- cash flow
Then after that, there’s usually a split between investors and the operators. If the location is good, the business plan looks solid and reasonable, and numbers align with what Lue’s seen with other deals, and he thinks it’s a good deal compared to putting money into the stock market, then he pulls the trigger and invests.
So the best advice that both Lue and I can give someone is to first, before investing in money, find a sponsor that you can trust.
Investment Locations
Lue currents has 10 multi-family syndication deals going on through four different sponsors in different areas in Texas, Atlanta, and Tampa. He invests $50,000 per deal because that’s the minimum.
He’s able to sleep better at night knowing that he has spread out his investments over multiple properties that provide him the diversification he’s looking for.
He thinks about his money in buckets. One is a cash account bucket that he uses to invest in syndication deals. These investments spin off either monthly or quarterly distributions that are usually paying 7-8% per year. He then uses that money to pay his mortgage, buy groceries, and basically anything else he needs to live on.
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Sign up for my newsletterTaxes
I’ve always read about how taxes can be avoided in a big way when investing in syndications but was excited to ask Lue about his own personal experience.
He’s currently NOT putting any money aside to pay taxes on the monthly distributions he’s receiving. He stated that at the end of each year, each deal sends him a K-1 return to file with the IRS as he’s a member of an LLC with other investors.
One of the benefits is that he’s able to capture some of the properties’ annual depreciation which helps to offset taxes via a cost-segregation analysis.
He informed me that on the K-1, because of the cost segregation analysis, it usually shows a loss on the property.
In essence, his share of the company is usually losing money. So he’s able to report that because of the depreciation shown on the K-1. He’s not making money so he doesn’t pay any tax on the income.
Now when the deal exists in roughly five years, there’s going to be a capital gain. So the capital gain and the recapture of the depreciation will require taxes to be paid at that time.
Usually then there’s a 15-20% tax rate on that money gained for the deal, because for capital gain, the tax rate is much lower than your ordinary income. Remember, while receiving the distributions, he’s not pay tax on those monies.
1031 Exchange
A 1031 Exchange (Like-Kind Exchange) is defined by the IRS as:
Like-kind exchanges — when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or “like-kind” — have long been permitted under the Internal Revenue Code.
Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031.
I asked Lue when a deal exits, instead of paying taxes on the profit gained, would he consider taking that money and buying another property via a 1031 Exchange. Here’s his answer:
“Yes. That would be my first choice to 1031 that profit into the next deal so that I can delay paying tax on them. The problem and the big concern on the 1031 is now you remember I don’t own this property outright, so it’s not just my decision. All the investors in the deal have to agree to 1031 into the next deal, otherwise, the entity that owns the property will not be able to buy another property.“
How Do You Know If You Can fatFIRE?
I don’t know about you, but I don’t want to work my whole life and then have to live like Scrooge pinching pennies always worried I’d run out of dough. That’s NOT what I picture retirement to be like.
So I was excited to both hear other people were able to retire sooner but also live a great life too (fatFIRE).
I was curious to find out how he knew he had invested in enough real estate deals to continue providing for his family (remember he has three little kids) while still living it up.
Here’s what he told me:
“We were in New Jersey while we were working so the cost of living was high. We were making okay salaries between both of us and when our income was high, our expenses were too.
When we decided to retire, we looked at our numbers and our real estate investment income was nowhere near what we were spending a month in New Jersey.
The decision was made to relocate to North Carolina where cost of living is low. I did the math based on the cost of living in North Carolina where we continue a great lifestyle but still have our expenses covered by the passive income.
During this time, my wife was very supportive as she really likes the early retirement lifestyle and spending time with the kids, because ultimately, that’s what’s important to both of us while we’re still young.
That was the ultimate driving force to make all these changes be more doable. Yes, it was a lot of work. It was a lot of planning. It was a lot of things that could have gone wrong. But ultimately, we decided to do it. We went for it full speed ahead, and it worked out so far.“
401k Early Withdrawal
The last question I asked him was, “How are you using the money in your self-directed solo 401k?”
He stated:
“Our plan was to use some of that money and perform a Roth conversion. The quick version for that is that let’s say I take $50,000 out of my 401k account. In the eyes of the IRS, it’s a taxable event, but I’m not doing a withdrawal. What I’m doing is just like quitting any job. I take the money and I roll into a traditional IRA. Once I get it in the traditional IRA, I can then convert it into Roth IRA”
“Converting from a Traditional IRA to Roth IRA is a taxable event, but I don’t get penalized. Now because our income is low, remember the K-1 showing losses, so we basically have zero income from those investments on our taxable account.”
“I’ve been working with several CPAs to go through the numbers to make sure everything is being done correctly. But ideally, we will be able to convert some of the 401k money out into a Roth IRA without paying any federal tax.”
My Thoughts
We all know there’s more than one way to skin a cat and Lue has provided one of them for those of us that are aspiring to get to fatFIRE.
Whether you love what you do and are looking for ways to continue working while making more on your hard earned money or you want to retire earlier, consider looking into multifamily syndications.
If you want more information, feel free to contact me to set up a brief call to discuss your investment goals.