How do you factor Rental Asset in Asset Allocation

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phxjcc
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Re: How do you factor Rental Asset in Asset Allocation

Post by phxjcc »

cybertrail wrote: Sat Jul 17, 2021 12:59 pm Question for the landlords out there. Rental assets have an estimated present value after accounting for mortgage and sales cost. Do any of you count that as a component of your diversified asset allocation and if so, does it impact your thinking w.r.t. the stock/bond ratio that you hold in traditional finance accounts? If yes, does age/proximity to retirement factor in?
In another thread I said that I have an NW that includes real estate, BOTH PERSONAL USE AND RENTAL.

My AA target includes investment and income producing RE, so yes I count it.
It does NOT impact my stock/bond ratio.
It is not impacted by age.

As I have said (and screamed) all RE is local.
Unlike fungible investment products you CANNOT make a general rule for RE wrt treating it like a bond or a stock or a preferred or some other widget (like a STRIP or ZERO); consider a Detroit apartment building vs. a Manhattan Beach VRBO.
One is like a bond, one is like a stock (AAPL?).
manuvns
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Re: How do you factor Rental Asset in Asset Allocation

Post by manuvns »

probably like bonds but ability to leverage with mortgage can make it better than bonds !
Thanks!
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Doc
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Re: How do you factor Rental Asset in Asset Allocation

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Northern Flicker wrote: Thu Jul 22, 2021 12:46 pm
Doc wrote: Of course it's an asset in one's asset allocation. It's fixed income. It is no different from an illiquid bond. (Being illiquid it's difficult to accurately determine the RE value just like that illiquid bond.) And both have higher risk than Treasuries.
Real estate has some properties of fixed income assets, but it also has properties that are not bond-like-- real estate generally offers significant, but non-guaranteed inflation protection.
Not unlike IBONDs? :D
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Northern Flicker
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

Doc wrote: Thu Jul 22, 2021 2:46 pm
Northern Flicker wrote: Thu Jul 22, 2021 12:46 pm
Doc wrote: Of course it's an asset in one's asset allocation. It's fixed income. It is no different from an illiquid bond. (Being illiquid it's difficult to accurately determine the RE value just like that illiquid bond.) And both have higher risk than Treasuries.
Real estate has some properties of fixed income assets, but it also has properties that are not bond-like-- real estate generally offers significant, but non-guaranteed inflation protection.
Not unlike IBONDs? :D
Very unlike iBonds or TIPS-- changes in property values can deviate substantially from CPI. You don't have to repaint or re-roof a bond. Bonds don't have sewer backups...
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Doc
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Re: How do you factor Rental Asset in Asset Allocation

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Northern Flicker wrote: Thu Jul 22, 2021 7:54 pm
Real estate has some properties of fixed income assets, but it also has properties that are not bond-like-- real estate generally offers significant, but non-guaranteed inflation protection.

...

Very unlike iBonds or TIPS-- changes in property values can deviate substantially from CPI. You don't have to repaint or re-roof a bond. Bonds don't have sewer backups...
I was addressing the inflation protection you get both from iBonds and real estate. OK it's not perfect but the return from a low quality and/or callable bond is not perfect either. That doesn't make those bond not be classed as fixed income.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Doc »

Historically, there have been three primary asset classes, but today financial professionals generally agree that there are four broad classes of assets:

Equities (stocks)
Fixed-income and debt (bonds)
Money market and cash equivalents
Real estate and tangible assets
https://www.thebalance.com/use-all-four ... io-3141071
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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Re: How do you factor Rental Asset in Asset Allocation

Post by dbr »

Doc wrote: Fri Jul 23, 2021 9:24 am
Historically, there have been three primary asset classes, but today financial professionals generally agree that there are four broad classes of assets:

Equities (stocks)
Fixed-income and debt (bonds)
Money market and cash equivalents
Real estate and tangible assets
https://www.thebalance.com/use-all-four ... io-3141071
Fair enough. But there is still a lot of configuring to see how to own real estate, livestock, timberland, gold, gas deposits, art, antique cars, and so on in a practical way and then somehow relate that to how much one should place in stocks, bonds, and cash.

So, I did hold "shares of beneficent interest" in a gas trust. If you wanted to make the drive you could go over to Hugoton and stand on top of the dome. They paid out pretty well but that particular trust exhausted the reserves, stopped payments, and also no longer exists on the market. I don't know how one should have computed the risk and return to compare to what I hold in a TIPS fund, for example. It was also a pain because I had to file a separate Kansas tax return just for that. I had some stock in one of the related pipeline companies, but they went private and bought back all the shares. The buy back jacked up the prices for a nice gain, but I also got a very unwelcome tax bill that year.

A relative had a vintage car stolen and got a good insurance payment for the value. He had to pay capital gains tax because the insurance payment was for more than the original cost of the car. Another relative was murdered collecting rents on houses he owned in a dicey neighborhood.
Last edited by dbr on Fri Jul 23, 2021 9:50 am, edited 1 time in total.
broncocountry25
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Re: How do you factor Rental Asset in Asset Allocation

Post by broncocountry25 »

This is a good one for the BH forum. I am surprised most people aren't saying to SELL the real estate and put it in the BH portfolio.

I absolutely look at the equity available in each rental but discount it realistically for costs to sell. Whatever I would net or be able to 1031 into another property is very valuable and part of my overall plan for the future. Stocks are hands off just keep buying and holding. With RE I plan to build up a portfolio of smaller properties and then look to 1031 exchange them into bigger properties down the road for the highest possible cash flow.

They make monthly cash flow today but that is not the most important aspect for us as we are both working FT for the foreseeable future. I think RE can be an amazing business (incentivized by the govt) and I plan on using it as my early retirement and to teach my kids about money with a tangible asset/business vs. just handing them a lump sum in a investment account (those I know who received this don't appreciate it much).
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Re: How do you factor Rental Asset in Asset Allocation

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broncocountry25 wrote: Fri Jul 23, 2021 9:55 am This is a good one for the BH forum. I am surprised most people aren't saying to SELL the real estate and put it in the BH portfolio.

I absolutely look at the equity available in each rental but discount it realistically for costs to sell. Whatever I would net or be able to 1031 into another property is very valuable and part of my overall plan for the future. Stocks are hands off just keep buying and holding. With RE I plan to build up a portfolio of smaller properties and then look to 1031 exchange them into bigger properties down the road for the highest possible cash flow.

They make monthly cash flow today but that is not the most important aspect for us as we are both working FT for the foreseeable future. I think RE can be an amazing business (incentivized by the govt) and I plan on using it as my early retirement and to teach my kids about money with a tangible asset/business vs. just handing them a lump sum in a investment account (those I know who received this don't appreciate it much).
Most of the time comments on this forum are very positive toward people holding rental real estate. That is because owning rental real estate is an obviously feasible option for those who wish to engage in it and will gain the know how and make the effort to do it successfully.

But the question is not about owning real estate. The question is about how to allocate capital across stocks, bonds, and real estate, and that question does not seem to be addressable in the straightforward way that the question how to allocate capital across stocks and bonds in the absence of real estate or in the presence of real estate separate from real estate can be resolved.

I think the best guidance is probably the experience of those who do own assets of all three types and I would pay attention to what they say about it.
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Re: How do you factor Rental Asset in Asset Allocation

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dbr wrote: Fri Jul 23, 2021 10:01 am But the question is not about owning real estate. The question is about how to allocate capital across stocks, bonds, and real estate, and that question does not seem to be addressable in the straightforward way that the question how to allocate capital across stocks and bonds in the absence of real estate or in the presence of real estate separate from real estate can be resolved.

I think the best guidance is probably the experience of those who do own assets of all three types and I would pay attention to what they say about it.
We owned commercial and residential RE in a family partnership for several decades. The management and how much to allocate to this sector was decided by the ladies and they did a very good job of it.

After they reached retirement we sold it all so I don't worry about it anymore.

So the answer to the OP: Ask your spouse? :D

But one aspect that I don't think has been addressed so far is depreciation. That deduction can reduce current taxes on ordinary income and defer it into future taxes at capital gains rates. This makes it a much different type of asset than those we usually discuss here.
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Re: How do you factor Rental Asset in Asset Allocation

Post by halfnine »

Doc wrote: Fri Jul 23, 2021 10:59 am
dbr wrote: Fri Jul 23, 2021 10:01 am But the question is not about owning real estate. The question is about how to allocate capital across stocks, bonds, and real estate, and that question does not seem to be addressable in the straightforward way that the question how to allocate capital across stocks and bonds in the absence of real estate or in the presence of real estate separate from real estate can be resolved.

I think the best guidance is probably the experience of those who do own assets of all three types and I would pay attention to what they say about it.
We owned commercial and residential RE in a family partnership for several decades. The management and how much to allocate to this sector was decided by the ladies and they did a very good job of it.

After they reached retirement we sold it all so I don't worry about it anymore.

So the answer to the OP: Ask your spouse? :D

But one aspect that I don't think has been addressed so far is depreciation. That deduction can reduce current taxes on ordinary income and defer it into future taxes at capital gains rates. This makes it a much different type of asset than those we usually discuss here.
From a risk diversification standpoint it certainly would seem valid to sell rental properties when one reaches retirement age. Instead of being diversified across stocks-bonds-property one would now be diversified across stocks-bonds-social security. So it would still be a multi-legged stool approach. Even more valid if one continued to own a primary residence as that further diversifies one against rental inflation.
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Re: How do you factor Rental Asset in Asset Allocation

Post by halfnine »

dbr wrote: Fri Jul 23, 2021 10:01 am
broncocountry25 wrote: Fri Jul 23, 2021 9:55 am This is a good one for the BH forum. I am surprised most people aren't saying to SELL the real estate and put it in the BH portfolio.

I absolutely look at the equity available in each rental but discount it realistically for costs to sell. Whatever I would net or be able to 1031 into another property is very valuable and part of my overall plan for the future. Stocks are hands off just keep buying and holding. With RE I plan to build up a portfolio of smaller properties and then look to 1031 exchange them into bigger properties down the road for the highest possible cash flow.

They make monthly cash flow today but that is not the most important aspect for us as we are both working FT for the foreseeable future. I think RE can be an amazing business (incentivized by the govt) and I plan on using it as my early retirement and to teach my kids about money with a tangible asset/business vs. just handing them a lump sum in a investment account (those I know who received this don't appreciate it much).
Most of the time comments on this forum are very positive toward people holding rental real estate. That is because owning rental real estate is an obviously feasible option for those who wish to engage in it and will gain the know how and make the effort to do it successfully.

But the question is not about owning real estate. The question is about how to allocate capital across stocks, bonds, and real estate, and that question does not seem to be addressable in the straightforward way that the question how to allocate capital across stocks and bonds in the absence of real estate or in the presence of real estate separate from real estate can be resolved.

I think the best guidance is probably the experience of those who do own assets of all three types and I would pay attention to what they say about it.
Those posts where most people are positive to rental real estate I must have missed. My recollection is the advice is typically SELL, SELL, SELL. Although, with bonds at such low rates, it does appear that the voices have quieted down a bit.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

Doc wrote: Fri Jul 23, 2021 9:24 am
Historically, there have been three primary asset classes, but today financial professionals generally agree that there are four broad classes of assets:

Equities (stocks)
Fixed-income and debt (bonds)
Money market and cash equivalents
Real estate and tangible assets
https://www.thebalance.com/use-all-four ... io-3141071
So real estate is not fixed income.
harikaried
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

Marseille07 wrote: Wed Jul 21, 2021 4:08 pmWhich doesn't mean the impact of properties is 0 though. Like you, a lot of people go more aggressive in their stock/bonds AA knowing they can sell rental properties when their budget gets tight.
Hmm… I don't think we've thought of our AA being more aggressive because we could sell the rental property. Similar to how we've adjusted our asset allocation to be riskier with imputed rent from our home, while our rental is producing income, we have more ability and willingness to invest our liquid assets in equities. How much would we adjust our AA if that rental income stopped -- we haven't really thought about it but maybe from 15% bonds to 30%? I suppose similarly, our home is about half the value of the rental, so proportionally without the imputed rent, we would shift from 15% bonds to 25%.

But now this has got me thinking if the magnitude of the AA change should depend on total amount of liquid assets relative to the rental income, which at a high level is somewhat based on the rental property value (assuming some market value and cap rate, which excludes financing/debt)…
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

Oddball wrote: Thu Jul 22, 2021 9:19 amWhen we first set up our AA we were at 80/20, but given the amount of mortgages we have (3, one on each property) it didn't seem to make much sense to have a large bond portion.
You seem to have associated moving from 80/20 to 90/10 because you had the mortgages -- as in if you had even more debt, you would have reduced your bond allocation even more? If I'm understanding that correctly, in other words because you decided to take on risk by having loan payments, your asset allocation should match that willingness for risk to be consistent?
Oddball wrote: Thu Jul 22, 2021 9:19 amEquity in the properties is about 1/2 our NW, so a large dip in the market doesn't affect our NW too drastically.
This sounds like as you pay down the debt to increase your equity in the properties, a smaller portion of your net worth would be in the stock market, so that also gives the ability for your liquid assets to be allocated more aggressively? Did I get that right?

Our current plan is to pay down the debt while also making our gross asset allocation more aggressive, so that does seem to match up with the above. I don't have a good intuitive explanation of why other than to maintain a net asset allocation, but maybe we should be thinking more about the equity portion of net worth.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Oddball »

harikaried wrote: Tue Jul 27, 2021 5:24 pm
Oddball wrote: Thu Jul 22, 2021 9:19 amWhen we first set up our AA we were at 80/20, but given the amount of mortgages we have (3, one on each property) it didn't seem to make much sense to have a large bond portion.
You seem to have associated moving from 80/20 to 90/10 because you had the mortgages -- as in if you had even more debt, you would have reduced your bond allocation even more? If I'm understanding that correctly, in other words because you decided to take on risk by having loan payments, your asset allocation should match that willingness for risk to be consistent?
Oddball wrote: Thu Jul 22, 2021 9:19 amEquity in the properties is about 1/2 our NW, so a large dip in the market doesn't affect our NW too drastically.
This sounds like as you pay down the debt to increase your equity in the properties, a smaller portion of your net worth would be in the stock market, so that also gives the ability for your liquid assets to be allocated more aggressively? Did I get that right?

Our current plan is to pay down the debt while also making our gross asset allocation more aggressive, so that does seem to match up with the above. I don't have a good intuitive explanation of why other than to maintain a net asset allocation, but maybe we should be thinking more about the equity portion of net worth.
We moved from 80/20 to 90/10 because 1) we have several mortgages and I have read enough on here about "negative bonds" to see that having a large bond portion at a low interest rate while also carrying mortgages doesn't make much sense (note that over 90% of our mortgage debt is at 2.9 or 3.0%) and 2) since we have growing equity in our properties we can be more risky with our stock/bond allocation because we are not reliant on that alone for our retirement. Having rentals makes our overall portfolio LESS risky, imo. As outlined below, we have a separate way to increase our NW than just stocks/bonds. If we took on more debt, we won't change the 90/10. Should we be 100/0? Should we be 50/50? Are we at 500/-400 or whatever with "negative bonds"? Who knows. We are happy with 90/10 and that is what we plan to stay at.

Right now, with our 5 rental units over 3 properties (plus another unit we live in at one of those properties) we, really the tenants, pay down $3400 a month on the mortgages, that is $3400 increase in NW per month, $40,800 per year increase in NW. In 5 years, assuming no refi on the properties, we will be up to ~$48,000 per year in principle recapture, and so on due to the mortgage amortization schedule. In 15 years we will have $1.2 million in equity across the 3 properties in today's dollars, and I assume the properties will appreciate at the rate of inflation so at 2.5% the value in 15 years will be closer to $1.7 million.

Our NW is ~50% property equity and ~50% stocks/bonds but that is not a target. We don't have a target for that ratio. If we end up with 75% equity and 25% stock/bonds or 75% stocks/bonds and 25% property equity, it doesn't really matter and it does not affect how aggressive we invest. We invest 90/10 stocks bonds, and we buy property when we need or want move; each of the 3 properties we own has been our primary residence at one point, and have lived in 4 out of the 6 units we own.
freckles01
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Re: How do you factor Rental Asset in Asset Allocation

Post by freckles01 »

Rental property and net worth did not factor in determining my AA. If I didn't have rental income or sold the property, my AA would remain the same but would be larger.

I consider rental income as an additional income stream. Once retired, adding pension, SS,retirement and taxable funds- I will have safe stable retirement incomes to tap into.

My AA is roughly 70/30, if I factored pension and rental income as cash, AA is probably less aggressive.
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

Oddball wrote: Wed Jul 28, 2021 12:55 pmIf we took on more debt, we won't change the 90/10.
Thanks for all the details. It seems like we have ended up at the same target 90/10 allocation as you where at a high level, I think we're following Vanguard's target date glide path and adjusting to a "younger age" due to having rental income and imputed rent, so we end up with a "minimum 10% bonds" asset allocation for our liquid assets.
Oddball wrote: Wed Jul 28, 2021 12:55 pmRight now, with our 5 rental units over 3 properties (plus another unit we live in at one of those properties) we, really the tenants, pay down $3400 a month on the mortgages, that is $3400 increase in NW per month, $40,800 per year increase in NW.
Curious, do you end up directing cash flow as extra principal curtailment to increase the rate of rent building equity? From your numbers, seems like a $100k principal curtailment (from rental income or other sources) improves the $41k NW/year by roughly $4k or 10% in the first year (basically moving forwards on the amortization roughly 2 years). Or I suppose that extra cash could potentially be better deployed purchasing additional rentals or shifted to the liquid asset allocation.
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