How do you factor Rental Asset in Asset Allocation

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cybertrail
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How do you factor Rental Asset in Asset Allocation

Post by cybertrail »

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?
Last edited by cybertrail on Sat Jul 17, 2021 1:59 pm, edited 1 time in total.
Thesaints
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Re: How do you factor Rental Asset in Asset Allocation

Post by Thesaints »

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?
Future rent flow is kind of speculative, but the property value sure is an asset, keeping in mind its liquidity compared to stocks and bonds.
aristotelian
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Re: How do you factor Rental Asset in Asset Allocation

Post by aristotelian »

Pretty sure no religion is one of the forum rules.

I would not count rental asset in asset allocation unless you plan to sell. I would calculate a reasonable net income which would reduce the amount of income needed to be covered by the investment portfolio.
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cchrissyy
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Re: How do you factor Rental Asset in Asset Allocation

Post by cchrissyy »

The asset or its cash flow is not part of the asset allocation but its existence could inform your need/ability/willingness to take risk.
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Watty
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Re: How do you factor Rental Asset in Asset Allocation

Post by Watty »

cybertrail wrote: Sat Jul 17, 2021 12:59 pm 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?
Not a landlord but it is a separate asset class so you would be looking at stock/bond/investment property.
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Re: How do you factor Rental Asset in Asset Allocation

Post by countmein »

It's definitely an asset with risks and returns. However, it's kind of inconvenient to try to include in your AA. So here's a trick: your basic rental property risk/return profile is somewhere inbetween that of stocks and bonds. So, if your stock bond AA is relatively close to 50/50-- say from 35/65 to 65/35-- you can assume that your rentals are a hybrid asset that has the same risk/return profile as your stock/bond AA and therefore can be considered subsumed into your AA / ignored.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

I view directly held real estate as a separate asset class. A tricky point is that how much leverage is used affects the appropriate allocation level to bonds in the remaining portfolio.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: How do you factor Rental Asset in Asset Allocation

Post by JackoC »

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?
Rental properties like stocks are worth what somebody else is willing to pay for them. The answer is less transparent for rental properties, but you aren't actually operating in a vacuum where you have to estimate and discount future rental flows and expenses to the horizon to get the value. That might actually be true for some types of small business, but real estate prices aren't *that* opaque. You should have a general idea what comparable places sell for in terms of simple metrics like $/sq-ft, cap rate ([rent-expense]/value, not considering finance expense)), etc. And you absolutely should include that in asset allocation, because it *is* there whether you include it or not. :happy If rental RE is 50% of your assets and there's a big downturn in asset markets, you are absolutely going to care that your properties went down 30% in value even if you care more that your stocks went down 50%, even if you plan to 'ride it out' with regard to both, no matter what you say now.

By which I mean I consider my allocation to be X% stock, Y% real estate, Z% safe (bonds, CD's, cash). Ignoring the RE would make no sense that I can see. If OTOH one feels compelled to somehow convert the RE % into an equivalent stock and bond %, so it comes back to just X/Z then people can argue about that all day long. But I can't see how anyone could argue that any properties they'd ever buy would have absolute zero impact on their stock risk appetite, or an argument I'd be likely to buy anyway. An adjacent thread talked about 'white collar' RE investors putting 'too much emphasis on theory'. Perhaps, and it's true that if you have weird ideas about risk management but do the hands on part of RE (choosing and dealing with properties and tenants) well you'll likely be better off than if you have a finely tuned concept of risk management but do the hands on part poorly. But if just talking about the risk management part, I think one is better off thinking of it correctly.
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Re: How do you factor Rental Asset in Asset Allocation

Post by dstac »

While I track the value, it’s going to be off.

I don’t include it for asset allocation as I’m not planning on liquidating it as spending money.

Instead, I’m more interested in the income it produces. This net income I count like an annuity that reduces my need for additional spending $ in the future.

eg: I project a need of $100k/yr and have $25k in rental income and $25k in SS, my remaining unmet need is $50k. Then for retirement assets, I’m saving to cover that at say 25x… $1.25M.

It is possible that the income stream could change or get converted to a pure asset, but this works better for me than something else. Is there a risk of being over-weighted in RE by ignoring the %, yes; but shifts in allocation would be very lumpy and incur significant transaction costs to the point where it’s unlikely to my change course.
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Re: How do you factor Rental Asset in Asset Allocation

Post by ChrisC »

JackoC wrote: Sat Jul 17, 2021 4:25 pm
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?
Rental properties like stocks are worth what somebody else is willing to pay for them. The answer is less transparent for rental properties, but you aren't actually operating in a vacuum where you have to estimate and discount future rental flows and expenses to the horizon to get the value. That might actually be true for some types of small business, but real estate prices aren't *that* opaque. You should have a general idea what comparable places sell for in terms of simple metrics like $/sq-ft, cap rate ([rent-expense]/value, not considering finance expense)), etc. And you absolutely should include that in asset allocation, because it *is* there whether you include it or not. :happy If rental RE is 50% of your assets and there's a big downturn in asset markets, you are absolutely going to care that your properties went down 30% in value even if you care more that your stocks went down 50%, even if you plan to 'ride it out' with regard to both, no matter what you say now.

By which I mean I consider my allocation to be X% stock, Y% real estate, Z% safe (bonds, CD's, cash). Ignoring the RE would make no sense that I can see. If OTOH one feels compelled to somehow convert the RE % into an equivalent stock and bond %, so it comes back to just X/Z then people can argue about that all day long. But I can't see how anyone could argue that any properties they'd ever buy would have absolute zero impact on their stock risk appetite, or an argument I'd be likely to buy anyway. An adjacent thread talked about 'white collar' RE investors putting 'too much emphasis on theory'. Perhaps, and it's true that if you have weird ideas about risk management but do the hands on part of RE (choosing and dealing with properties and tenants) well you'll likely be better off than if you have a finely tuned concept of risk management but do the hands on part poorly. But if just talking about the risk management part, I think one is better off thinking of it correctly.
I treat it as a separate asset class, with rental cash flow when distributed or taken, and whose fair market value is included, obviously, in my net worth. But since it's illiquid (until I sell it), I don't group it with other investable, liquid assets and don't take it into account for purposes of arranging an appropriate asset allocation for investable, liquid assets of cash and securities (equities and fixed income). If I took my rental real estate into consideration, it could skew my asset allocation for those investable assets, much the same way that monetizing/reducing to present value income streams from a generous pension could have on my asset allocation.

I don't think you ignore the income streams from rental properties as it might be useful in meeting your living expenses, but other than that, I wouldn't bank on it for purposes of determining an appropriate asset allocation for your other assets. That's just me.
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Re: How do you factor Rental Asset in Asset Allocation

Post by JackoC »

ChrisC wrote: Sat Jul 17, 2021 5:20 pm

I treat it as a separate asset class, with rental cash flow when distributed or taken, and whose fair market value is included, obviously, in my net worth. But since it's illiquid (until I sell it), I don't group it with other investable, liquid assets and don't take it into account for purposes of arranging an appropriate asset allocation for investable, liquid assets of cash and securities (equities and fixed income). If I took my rental real estate into consideration, it could skew my asset allocation for those investable assets, much the same way that monetizing/reducing to present value income streams from a generous pension could have on my asset allocation.

I don't think you ignore the income streams from rental properties as it might be useful in meeting your living expenses, but other than that, I wouldn't bank on it for purposes of determining an appropriate asset allocation for your other assets. That's just me.
Yeah, I can't understand that. If RE was a small enough portion of my allocation I might ignore it, because it's negligible. Like where people discuss including their house or not (which I also include). The person whose house is 5% of NW in a market where RE prices haven't done anything much relative to inflation in decades is not making a significant mistake. The person for whom it's 50% in a high cost market that's rocketed in recent decades, is seriously misleading themselves to exclude that from their analysis of risk. Same with rentals. The rental produces income the self-occupied house doesn't, but as to price risk real estate is basically real estate.

I don't see that (or including pension PV, which I also do, though it's much smaller than RE for me) as 'skewing' anything. I see it as recognizing reality for the purpose at hand, asset allocation calculation, for managing risk. If I have a huge exposure to real estate my overall risk is much greater than people with the same amount of stock as I have but the rest in 'riskless' bonds rather than real estate. I can't see why I'd ignore that difference unless it was insignificant, insignificant stuff is by definition not a big problem.

Other responses mentioned 'not going to sell soon', I also don't see what that has to with asset allocation and risk management. I don't plan to sell any appreciable % of my stocks soon, perhaps not in my lifetime. I don't think that would make it reasonable to exclude them from my asset allocation.
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Re: How do you factor Rental Asset in Asset Allocation

Post by ChrisC »

Jacko,

I manage my real estate as a separate asset category with separate management risks. If I included my investment real estate it would be 20 percent of my net worth so it's not something I ignore. And if I booked my home residence, that would increase my real estate holdings to 33 percent of my net worth, And if I monetized the present value of my generous pension income stream and social security retirement benefits, all together that would result in 75-80% of my net worth -- how does that not skew my asset allocation for investment securities?

Reality for me is to manage risks with each appropriate asset class differently.
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cybertrail
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Re: How do you factor Rental Asset in Asset Allocation

Post by cybertrail »

Thank you everyone for the conversation. I asked the question because I am a Landlord of one home (a place I used to live) and it has a relevant level of equity as a percentage of my savings. As others have noted, I can't just ignore it as it does factor into my risk.

I have been considering how to account for this in my AA. The discussion above has helped and I'm starting to think it depends on whether you expect to maintain it as a rental property in retirement or not. If yes, then I agree with the comment above that it is likely best to subtract the expected rental income from the retirement need (like SS) and then work out stocks and bond ratios based on your plan and risk to resolve the balance.

However, in my case, I expect I will sell it at the start of retirement. In that case, it seems like the logical path would be to trace the safe present value (after assumed realtor commission, mortgage and tax) as a separate asset class. Then, since most all rules of thumb and collective wisdom/guidance regarding AA focus on stocks and bonds, I would do my long term risk planning considering the rental asset much like bonds (provided I am conservative in my estimate of it's value). I agree with the commenter above that property value (at least in the case of my particular property) is not a random guess as there are comparable sales to reference.

Does that make sense? Any major drivers I might be overlooking? (This assumes of course one is conservative in estimating a safe sale price).
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Re: How do you factor Rental Asset in Asset Allocation

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FYI - I modified a few post titles due to a typo by the OP in the thread title. The typo was fixed.
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Re: How do you factor Rental Asset in Asset Allocation

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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?
R/E residential or commercial assets + rental income , etc. = business financial investment = business finance.

Personal investment finance = personal assets, income, portfolio, etc. = personal finance.

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Re: How do you factor Rental Asset in Asset Allocation

Post by spectec »

I do two calculations on my spreadsheet. The first one calculates the purchase price of the rental property as a percentage of my total asset allocation. Then just below that line I allocate 40% of its purchase price to equities and 60% of its purchase price to fixed income, with nothing allocated to the real estate value. This recognizes that it has some residual value (such as in a distress sale situation) and thus impacts fixed income, but it is also capable of increasing in value, so it can affect equity allocation. Why 40-60? It just seems realistic to me.
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Re: How do you factor Rental Asset in Asset Allocation

Post by SGM »

I do not use rental assets in any calculation of AA. We have very little residential income, but we do have a variety of income streams associated with a farm.

AA is only applied to stocks, bonds and cash equivalents.
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Re: How do you factor Rental Asset in Asset Allocation

Post by spectec »

SGM wrote: Sat Jul 17, 2021 8:55 pm I do not use rental assets in any calculation of AA. We have very little residential income, but we do have a variety of income streams associated with a farm.

AA is only applied to stocks, bonds and cash equivalents.
I calculate my AA based on anything that comprises my net worth, exclusive of home equity and value of personal belongings.
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Re: How do you factor Rental Asset in Asset Allocation

Post by AerialWombat »

I do view the equity in my rentals as an asset class that I track in relation to my other investments. My target is a 50/50 ratio between real estate equity and “everything else”. Due to appreciation the last couple years, it’s very out of balance. Thus, I am not purchasing a new property this year and am “rebalancing” with new money.

What I exclude from my AA calc is private corporation equity.
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Re: How do you factor Rental Asset in Asset Allocation

Post by dstac »

I think you nailed a key distinction: long term income stream v. asset to be converted. Depending on how one is approaching it makes sense to treat it differently. If I were planning to use the asset value itself, I think it becomes very bond like, though because of the correlation between interest rates and RE values it will move differently than a bond (and possibly more in sync w stocks?).
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Re: How do you factor Rental Asset in Asset Allocation

Post by GMCZ71 »

cybertrail wrote: Sat Jul 17, 2021 6:53 pm
However, in my case, I expect I will sell it at the start of retirement.

Does that make sense? Any major drivers I might be overlooking? (This assumes of course one is conservative in estimating a safe sale price).
I would sell shortly before retirement if you need to have low income/agi for the health care subsidy.
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

We would probably treat cash from selling our rental (net of fees, taxes, other costs) as a windfall and invest according to our asset allocation at that time. Our rental's approximated value does affect our overall net worth, but that's just a number to track progress. Its mortgage also affects our net worth calculations but also our asset allocation because it acts like a negative bond effectively making the net asset allocation riskier than the gross allocation. Its income also affects our asset allocation because it acts like an annuity allowing our asset allocation weighted more towards stocks than otherwise.

In practice, this means our liquid assets get rebalanced to more stocks as the gross asset allocation becomes more aggressive as we also aggressively pay down the mortgage so that our net asset allocation is maintained. Eventually when the mortgage is paid off, there will be no difference between net and gross asset allocation, and we'll return towards increasing bonds glide path for retirement. (I.e., we pay down more mortgage principal in a year than a 1% bond asset allocation increase for following (age - offset) in bonds.)
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Re: How do you factor Rental Asset in Asset Allocation

Post by ZWorkLess »

Thank you for starting this interesting conversation.

I track the net value (after mortgage and 6% sales commission) in my net worth tracker. I do track the net value of our principle residence, but I am not really counting it towards retirement goal $ since I plan to have a paid off house for retirement. I.e., my retirement goal $ is $house plus $retirement investments.

Likewise, I track the net value of our business.

For projections, I use a conservative 2-3% appreciation for RE, and I include the amortization schedule/mortgage payoff n projections as well.

I don’t project an income stream from our main investment property into retirement, as we won’t decide whether to sell it at retirement or hold it indefinitely until we retire/sell our business that resides on part of the property.

Since fairly diversified real estate (commercial and residential) and our main business represent most of our wealth, I do consider that when deciding how comfortable I am with risks in our AA. Personally, RE has been the most reliable wealth builder in my life (maybe six or eight properties in total, generally not more than three at the same time, across 5 states and 30 years), I probably feel more comfortable with a higher risk AA than I might otherwise. I,e., I’m happy at 80/20 in our 50s, because the downside risk on stocks is fairly small for us since our stocks/bonds are a lot less than half our assets. If they were the large majority of our assets, I’d probably be more like 70/30.

I think the risk of RE can be moderated by diversifying your RE holdings. I.e., I’d rather have four $250k properties from various areas/types than one $1M property. That’s not always possible, especially at the start, but it’s something to consider.

I also think RE risk can be moderated by not being excessively leveraged. I know RE investors who maximally leverage every property with 30 year loans and refinancing, etc. I prefer less risk, so I minimize leverage.
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Re: How do you factor Rental Asset in Asset Allocation

Post by phxjcc »

I am very appreciative of BH.com.

HOWEVER, my real world AA does not match the BH ideal—nor will I reveal that AA as it would just start a bunch of non-actionable discussions.

Short answer: I count my property in my net worth and keep an eye on the AA of all holdings.

The issue in the present day is that with low fixed income rates it is difficult to translate an R.E. Cash flow into a bond equivalent.

What I do keep an eye on is the TOTAL RETURN for each asset class….and then compare and contrast each class that I hold against each other.


I also do WHATIF’s….
So, if—for example—the rental was sold and the funds put into Wellesley, would the total return had been better?
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Re: How do you factor Rental Asset in Asset Allocation

Post by dbr »

Asset allocation is a portfolio theory concept. That theory says that individual assets have a set of annual returns and the variability of that return over time is the risk. It is assumed that those terms are defined and calculated in a commensurate way for all the assets. From that one can compute the expected return and the risk (variability) of the return for the portfolio. The inputs are the means and standard deviations of the asset returns and the correlations among the asset returns. The output is the mean and standard deviation of the periodic portfolio returns.

It does not seem straightforward to assemble an appropriate data set for real estate that can be combined with stock and bond returns to get whole portfolio statistics. Therefore rental assets are not included in the asset allocation to stocks and bonds. That said, I have seen a paper or two where exactly the required portfolio theory is attempted. The result is a three dimensional display of risk and return on the axes of stock/bond/real estate and there is an efficient portfolio surface rather than an efficient portfolio line.

A major problem is that in portfolio theory risk is assumed to contain no diversifiable component. An individual property or a set of a few properties in one community would have so much diversifiable risk I don't know how your would implement the theory.

I suspect that in practice most individual investors are better off running their rental real estate as a business that requires investment than trying to allocate that investment alongside stocks and bonds. As a prior poster eloquently pointed out the result does inform your need, ability, and willingness to take risk. For some people real estate value so far dwarfs other holding that it can be doubted that a stock and bond portfolio even exists. Probably the portfolio is just a cash reserve for the business. In other cases it is the other way around and the real estate is just an entity that might be converted to liquid assets someday or that supplies an income stream.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Aged Maduro »

Rental Real Estate should be considered a separate asset class than your stocks and bonds and just classified as "Investment Real Estate".

In practice, within a portfolio leveraged rental property is more similar to stock and paid off rental property more similar to a bond.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Oddball »

Our RE equity is ~50% of our net worth but I don't include it in our stock/bond AA, nor do I do any type of re-balancing between RE and stocks/bonds.

RE for us is used for monthly cash flow i.e. after rental income - mortgage/expenses, we pay ~$500 a month out of pocket for our unit which would rent for $3200; and the mortgage pay down we view as retirement savings. We have $X in the Roth account, we have $Y in the 401k, we have $Z in equity in property 1, we have $A equity in property 2, etc.

As mentioned above by another poster, since we have good amount of equity in RE we are more risky with our stocks/bonds, at 90/10 now in our early 40's and have no plans to change that as we get older.
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Re: How do you factor Rental Asset in Asset Allocation

Post by KyleAAA »

The equity is part of the portfolio in the "real estate" asset class. Yes, it influences how much goes in stocks vs bonds.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

cybertrail wrote: Sat Jul 17, 2021 6:53 pm Thank you everyone for the conversation. I asked the question because I am a Landlord of one home (a place I used to live) and it has a relevant level of equity as a percentage of my savings. As others have noted, I can't just ignore it as it does factor into my risk.

I have been considering how to account for this in my AA. The discussion above has helped and I'm starting to think it depends on whether you expect to maintain it as a rental property in retirement or not. If yes, then I agree with the comment above that it is likely best to subtract the expected rental income from the retirement need (like SS) and then work out stocks and bond ratios based on your plan and risk to resolve the balance.

However, in my case, I expect I will sell it at the start of retirement. In that case, it seems like the logical path would be to trace the safe present value (after assumed realtor commission, mortgage and tax) as a separate asset class. Then, since most all rules of thumb and collective wisdom/guidance regarding AA focus on stocks and bonds, I would do my long term risk planning considering the rental asset much like bonds (provided I am conservative in my estimate of it's value). I agree with the commenter above that property value (at least in the case of my particular property) is not a random guess as there are comparable sales to reference.

Does that make sense? Any major drivers I might be overlooking? (This assumes of course one is conservative in estimating a safe sale price).
You could hire a management company to take care of all of the property management. Then it is more or less a passive asset. You could choose to do the property management work yourself. This is a part-time job for which you receive imputed compensation. So I think it has to be an asset in your allocation.

There is one place where it really matters that you include the rental property, and that is when considering the level of risk in your asset allocation. Not including the asset in your asset allocation is both a missed opportunity and a potential source of error in assessing risk.

One school if thought is that real estate is a risky asset and should be part of the risk asset allocation, with the percentage of assets in bonds not changing after inclusion of the real estate. I consider that to be a reasonable, but conservative approach. I take the view that residential real estate has a moderately low correlation with equities, and in the absence of leverage, is both bond-like and stock-like. As leverage is increased, a real estate holding becomes more stock-like.

With leverage limited to moderate levels with positive cash flow, I think a bond allocation level can be lower, but not lower in proportion to one's stock allocation than you would have without the real estate, and probably higher than that.

For instance, if you are 70/30 stocks and bonds and then acquire a rental property that is 20% of assets, then you might choose 60/20/20 stocks/bonds/RE, which if leverage on the RE is moderate, may have a similar risk level to, or even lower risk than 70/30. By comparison, the conservative approach would be 50/30/20 i.e. not lowering the bond allocation. Both are valid approaches, and the amount of leverage is an input to that decision.

We of course can't predict with confidence how different assets will behave in future times of economic duress, but I also believe that residential real estate probably is more correlated with US small-caps and mid-caps than US large caps due to the REITs, homebuilders, and regional banks in the small/mid sector. This may be exploitable when considering less conservative allocations that depend on reduced correlation of equities and residential RE.

You probably know that (unless it has changed) the owner-occupied cap gain exclusion requires having lived in the house 24 of the previous 60 months. A due diligence task is to confirm the 24 out of 60 month rule. Then after about 2.5 years as a rental, you should either sell for the exclusion or decide that you are comfortable with and confident that you will hold it long term.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

Northern Flicker wrote: Wed Jul 21, 2021 1:11 pm
Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
Why? Are you going to rebalance your AA based on the value of your home equity estimate on Zillow?

Not trying to mock but trying to understand the purpose of including it in your AA.
dbr
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Re: How do you factor Rental Asset in Asset Allocation

Post by dbr »

Marseille07 wrote: Wed Jul 21, 2021 1:16 pm
Northern Flicker wrote: Wed Jul 21, 2021 1:11 pm
Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
Why? Are you going to rebalance your AA based on the value of your home equity estimate on Zillow?

Not trying to mock but trying to understand the purpose of including it in your AA.
I would assume the idea should be that an asset allocation is not just a list where you add up the value of a bunch of different assets and divide by the total to get pie chart. It isn't an asset allocation unless the result informs the investor in some meaningful way what the investment properties of the whole are, meaning the expected return and the standard deviation of the returns of the whole and how those statistics might be affected by what distribution of assets is involved. I think rebalancing might be a red herring. You don't have to rebalance to do the portfolio analysis. It is not a red herring in the sense that if you can't adjust to market changes, it might not be useful.

This question has a lot in common with the sometimes asked question of whether net worth is different from asset allocation, and the answer to that has to come from the person asking. I am not sure what the OP actually wants to know.
Marseille07
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

dbr wrote: Wed Jul 21, 2021 1:27 pm I would assume the idea should be that an asset allocation is not just a list where you add up the value of a bunch of different assets and divide by the total to get pie chart. It isn't an asset allocation unless the result informs the investor in some meaningful way what the investment properties of the whole are, meaning the expected return and the standard deviation of the returns of the whole and how those statistics might be affected by what distribution of assets is involved. I think rebalancing might be a red herring. You don't have to rebalance to do the portfolio analysis. It is not a red herring in the sense that if you can't adjust to market changes, it might not be useful.

This question has a lot in common with the sometimes asked question of whether net worth is different from asset allocation, and the answer to that has to come from the person asking. I am not sure what the OP actually wants to know.
I tend to consider NW as everything minus liabilities, and AA for liquid assets, which RE is not. But you're right that people might define NW and AA differently.
halfnine
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Re: How do you factor Rental Asset in Asset Allocation

Post by halfnine »

Marseille07 wrote: Wed Jul 21, 2021 1:16 pm
Northern Flicker wrote: Wed Jul 21, 2021 1:11 pm
Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
Why? Are you going to rebalance your AA based on the value of your home equity estimate on Zillow?

Not trying to mock but trying to understand the purpose of including it in your AA.
To me AA is a misnomer. It should have really been called portfolio allocation. Similarly currency risk should have been called currency diversification. And FIRE should have just been FIFU. But now I digress.

Anyway back to why it should be included into an asset allocation. To diversify risk. That is the main point of an AA. Hard and fast rebalancing on very narrow ranges is an option. However, alternatively, one could simply have a range. This is what I do. Property 15-40%, Stocks 40%, Fixed Income 20-40%, Gold 5-10%. If they are in that range, it's good enough. I am not bearing too much or too little risk in any one asset class. Technically I also include human capital and it's inverse correlation with social security as it's own separate entity when analysing risk. Try rebalancing that!

I find this board has way too much of an emphasis on portfolio allocation and rebalancing and can't see the forest for the trees anymore.
harikaried
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

Oddball wrote: Mon Jul 19, 2021 12:35 pmsince we have good amount of equity in RE we are more risky with our stocks/bonds, at 90/10 now in our early 40's and have no plans to change that as we get older.
Curious, what would your asset allocation be if you had no RE, and would it also not glide?
Marseille07
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

halfnine wrote: Wed Jul 21, 2021 2:06 pm To me AA is a misnomer. It should have really been called portfolio allocation. Similarly currency risk should have been called currency diversification. And FIRE should have just been FIFU. But now I digress.

Anyway back to why it should be included into an asset allocation. To diversify risk. That is the main point of an AA. Hard and fast rebalancing on very narrow ranges is an option. However, alternatively, one could simply have a range. This is what I do. Property 15-40%, Stocks 40%, Fixed Income 20-40%, Gold 5-10%. If they are in that range, it's good enough. I am not bearing too much or too little risk in any one asset class. Technically I also include human capital and it's inverse correlation with social security as it's own separate entity when analysing risk. Try rebalancing that!

I find this board has way too much of an emphasis on portfolio allocation and rebalancing and can't see the forest for the trees anymore.
Is the "Property" allocation only for rental properties or do you include your primary residence? To me, AA is something you *invest* your money in, and imo primary residence isn't an investment.
gougou
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Re: How do you factor Rental Asset in Asset Allocation

Post by gougou »

The equity value of your rental assets should be considered similar to very illiquid stocks. Rental asset is very similar to rental real estate funds or REITs. It is a business that carries some debt. Stocks are also businesses that carry some debt.
BrooklynInvest
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Re: How do you factor Rental Asset in Asset Allocation

Post by BrooklynInvest »

dstac wrote: Sat Jul 17, 2021 4:57 pm While I track the value, it’s going to be off.

I’m more interested in the income it produces. This net income I count like an annuity that reduces my need for additional spending $ in the future.
This. I don't look at the property as part of my AA (about a third of a 2-family house so a little nonstandard and more illiquid than a pure investment property) but the "annuity-lite" income stream helpfully reduces the need for me to accumulate as much. Granted, I'm paying a larger mortgage so two paths. Me, I like the stability of the rental income stream in combination with my 70-30 portfolio.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

Marseille07 wrote: Wed Jul 21, 2021 1:16 pm
Northern Flicker wrote: Wed Jul 21, 2021 1:11 pm
Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
Why? Are you going to rebalance your AA based on the value of your home equity estimate on Zillow?

Not trying to mock but trying to understand the purpose of including it in your AA.
The primary purpose is to manage portfolio risk by considering all the assets together as one portfolio. Rebalancing may be limited for a variety of reasons, such as holding stock and fixed income in separate account locations. One might rebalance in such a situation by directing stock dividends and net rental income into fixed income assets (or mortgage prepayments on a rental property).

Rebalancing is important but is just one piece of the puzzle. The primary purpose of an asset allocation is to manage portfolio risk, and all investment asset classes held need to be included in the portfolio to do that.
Last edited by Northern Flicker on Wed Jul 21, 2021 3:45 pm, edited 1 time in total.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
dbr
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Re: How do you factor Rental Asset in Asset Allocation

Post by dbr »

Northern Flicker wrote: Wed Jul 21, 2021 3:33 pm
Marseille07 wrote: Wed Jul 21, 2021 1:16 pm
Northern Flicker wrote: Wed Jul 21, 2021 1:11 pm
Marseille07 wrote: Home equity of RE (rental or primary residence) is part of NW but not part of AA. It doesn't make sense to count RE in AA as stocks or fixed income.
It may not be a stock or fixed income, but it makes sense to include it in one's asset allocation as its own asset class.
Why? Are you going to rebalance your AA based on the value of your home equity estimate on Zillow?

Not trying to mock but trying to understand the purpose of including it in your AA.
The primary purpose is to manage portfolio risk by considering all the assets together as one portfolio. Rebalancing may be limited for a variety of reasons, such as holding stock and fixed income in separate account locations. One might rebalance in such a situation by directing stock dividends and net rental income into fixed income assets (or mortgage prepayments on a rental property).

Rebalancing is important but is just one pirce of the puzzle. The primary purpose of an asset allocation is to manage portfolio risk, and all investment asset classes held need to be inckuded in the portfolio to do that.
Exactly. In my mind the point of talking about the term asset allocation is that the financial properties of the total depend on financial properties of the components in a way such that one can make sense of what it means to have so much allocated to one thing and so much allocated to another. There is nothing in there that says management techniques such as rebalancing have to be practiced. On the other hand one does have to have some way of coming up with numbers, or at least some sort of description, of the risk and return of the whole where one can show what changes if one selects a different allocation across the parts. I am not sure that is so simple for a RE/Stock/Bond portfolio. As I said I can recall seeing one or two papers that apply some sort of modern portfolio theory to a set like that.

In any case just adding up all the values of the components and listing them in a table is not asset allocation; it is just a report, of net worth perhaps.
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Re: How do you factor Rental Asset in Asset Allocation

Post by harikaried »

Marseille07 wrote: Wed Jul 21, 2021 2:30 pmIs the "Property" allocation only for rental properties or do you include your primary residence? To me, AA is something you *invest* your money in, and imo primary residence isn't an investment.
At least for us, I think we're similar to your view. In our net worth spreadsheet, we track Liquid, Property and Debt to calculate Net worth. Liquid assets are invested according to our asset allocation. Property for us includes primary residence, rental and vehicles (but maybe that's just so buying an expensive vehicle doesn't show up as a drop in our net worth :wink: ). All debt is combined (except credit card which gets paid off each month anyway), so one could view Property - Debt as equity or Debt ÷ Liquid as something related to leverage.

Before buying our rental, Liquid was roughly double Property while after buying that ratio flipped, but our Net worth was relatively unchanged. We didn't really think about adjusting our asset allocation when purchasing, so we ended up just maintaining our original asset allocation glide path for a few years. This was even in the context of Debt getting close to Liquid, so our net asset allocation was effectively heavily leveraged with a negative net bond allocation. Maybe we should have done something differently, but we've been aggressively paying down Debt with income while Liquid continued to grow. And more recently realizing that we had been more risky and okay with it, we've been updating our gross asset allocation to be more aggressive as we continue to reduce Debt, which has gone from 90% of Liquid to now 20%.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

I don't view this as even remotely definitive, but here you can see one example where correlation of a residential equity REIT with small caps is increased, with small value increased even more (more regional banks and homebuilders on the value side), but not as much with AVUV that filters out the real estate sector (but has a higher allocation to regional banks than IJS):

https://www.portfoliovisualizer.com/ass ... &months=36
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Marseille07
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

harikaried wrote: Wed Jul 21, 2021 3:48 pm
Marseille07 wrote: Wed Jul 21, 2021 2:30 pmIs the "Property" allocation only for rental properties or do you include your primary residence? To me, AA is something you *invest* your money in, and imo primary residence isn't an investment.
At least for us, I think we're similar to your view. In our net worth spreadsheet, we track Liquid, Property and Debt to calculate Net worth. Liquid assets are invested according to our asset allocation. Property for us includes primary residence, rental and vehicles (but maybe that's just so buying an expensive vehicle doesn't show up as a drop in our net worth :wink: ). All debt is combined (except credit card which gets paid off each month anyway), so one could view Property - Debt as equity or Debt ÷ Liquid as something related to leverage.

Before buying our rental, Liquid was roughly double Property while after buying that ratio flipped, but our Net worth was relatively unchanged. We didn't really think about adjusting our asset allocation when purchasing, so we ended up just maintaining our original asset allocation glide path for a few years. This was even in the context of Debt getting close to Liquid, so our net asset allocation was effectively heavily leveraged with a negative net bond allocation. Maybe we should have done something differently, but we've been aggressively paying down Debt with income while Liquid continued to grow. And more recently realizing that we had been more risky and okay with it, we've been updating our gross asset allocation to be more aggressive as we continue to reduce Debt, which has gone from 90% of Liquid to now 20%.
Yeah, while I understand there are multiple views on NW and AA, my view remains that properties (to be exact, just home equities) are part of NW but not AA.

Which 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.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

Marseille07 wrote: Which 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.
This is including it in your asset allocation qualitatively whether it not you choose to describe it that way.

The reason you can have a somewhat more aggressive stock/bond ratio is the potentially reduced correlation of stocks and residential real estate. If both stocks and your rental are down at the same time, being able to sell the rental at that time does not help you any more than selling the stock.

Correlations can be tricky. The low liquidity of real estate and lack of an efficient market to price it means that some of the perceived lower correlation may be an illusion from not having the true market value at different points in time.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
halfnine
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Re: How do you factor Rental Asset in Asset Allocation

Post by halfnine »

Marseille07 wrote: Wed Jul 21, 2021 2:30 pm
halfnine wrote: Wed Jul 21, 2021 2:06 pm To me AA is a misnomer. It should have really been called portfolio allocation. Similarly currency risk should have been called currency diversification. And FIRE should have just been FIFU. But now I digress.

Anyway back to why it should be included into an asset allocation. To diversify risk. That is the main point of an AA. Hard and fast rebalancing on very narrow ranges is an option. However, alternatively, one could simply have a range. This is what I do. Property 15-40%, Stocks 40%, Fixed Income 20-40%, Gold 5-10%. If they are in that range, it's good enough. I am not bearing too much or too little risk in any one asset class. Technically I also include human capital and it's inverse correlation with social security as it's own separate entity when analysing risk. Try rebalancing that!

I find this board has way too much of an emphasis on portfolio allocation and rebalancing and can't see the forest for the trees anymore.
Is the "Property" allocation only for rental properties or do you include your primary residence? To me, AA is something you *invest* your money in, and imo primary residence isn't an investment.
Yes, I include primary residence but we are talking meta level here. And at the meta level I don't play the "AA" game. And I don't play the "investment" game. These semantics are only relevant to let someone know we are essentially talking about stocks and bonds. So at the meta level, let me you ask you a question. You own a home. You take a job abroad for 2-3 years and rent out your home while you are gone. Are you telling me that your "asset allocation" (whatever that means) really went form 0/75/25 to 40/45/15 and then back to 0/75/25. And are you telling me your risk level really changed over that time frame and that substantially. If your answer is "yes" it did then we will just have to agree to disagree. If your answer is "no" nothing really changed then any model that gives those results is invalid and needs to be modified accordingly.

That said, a primary home has the same "investment" (whatever that means) features as a rental house albeit with significant changes in taxation (and a frequent desire for many to spend money on it). But if we want to put in financial terms it might look something like:

3-15% nominal return (3% multiplied by existing leverage) (tax free to 250/500K)
3-8% dividend yield (imputed rent)(after tax yield)
2-7% ER (some of which is pre-tax, some post-tax, and some which can offset capital gains).
6% selling fee

The fact that some people's homes have a higher ER than others (largely by personal spending choices) doesn't mean that a house is now a consumption item. Although if you chose to view it like that your heirs will thank you.
Marseille07
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Re: How do you factor Rental Asset in Asset Allocation

Post by Marseille07 »

halfnine wrote: Thu Jul 22, 2021 1:05 am
Marseille07 wrote: Wed Jul 21, 2021 2:30 pm
halfnine wrote: Wed Jul 21, 2021 2:06 pm To me AA is a misnomer. It should have really been called portfolio allocation. Similarly currency risk should have been called currency diversification. And FIRE should have just been FIFU. But now I digress.

Anyway back to why it should be included into an asset allocation. To diversify risk. That is the main point of an AA. Hard and fast rebalancing on very narrow ranges is an option. However, alternatively, one could simply have a range. This is what I do. Property 15-40%, Stocks 40%, Fixed Income 20-40%, Gold 5-10%. If they are in that range, it's good enough. I am not bearing too much or too little risk in any one asset class. Technically I also include human capital and it's inverse correlation with social security as it's own separate entity when analysing risk. Try rebalancing that!

I find this board has way too much of an emphasis on portfolio allocation and rebalancing and can't see the forest for the trees anymore.
Is the "Property" allocation only for rental properties or do you include your primary residence? To me, AA is something you *invest* your money in, and imo primary residence isn't an investment.
Yes, I include primary residence but we are talking meta level here. And at the meta level I don't play the "AA" game. And I don't play the "investment" game. These semantics are only relevant to let someone know we are essentially talking about stocks and bonds. So at the meta level, let me you ask you a question. You own a home. You take a job abroad for 2-3 years and rent out your home while you are gone. Are you telling me that your "asset allocation" (whatever that means) really went form 0/75/25 to 40/45/15 and then back to 0/75/25. And are you telling me your risk level really changed over that time frame and that substantially. If your answer is "yes" it did then we will just have to agree to disagree. If your answer is "no" nothing really changed then any model that gives those results is invalid and needs to be modified accordingly.

That said, a primary home has the same "investment" (whatever that means) features as a rental house albeit with significant changes in taxation (and a frequent desire for many to spend money on it). But if we want to put in financial terms it might look something like:

3-15% nominal return (3% multiplied by existing leverage) (tax free to 250/500K)
3-8% dividend yield (imputed rent)(after tax yield)
2-7% ER (some of which is pre-tax, some post-tax, and some which can offset capital gains).
6% selling fee

The fact that some people's homes have a higher ER than others (largely by personal spending choices) doesn't mean that a house is now a consumption item. Although if you chose to view it like that your heirs will thank you.
My answer to your question of going abroad & back is no. We're safe here :beer
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Re: How do you factor Rental Asset in Asset Allocation

Post by Oddball »

harikaried wrote: Wed Jul 21, 2021 2:09 pm
Oddball wrote: Mon Jul 19, 2021 12:35 pmsince we have good amount of equity in RE we are more risky with our stocks/bonds, at 90/10 now in our early 40's and have no plans to change that as we get older.
Curious, what would your asset allocation be if you had no RE, and would it also not glide?
We were landlords before we took over our investments from an advisor, I actually found Bogleheads from being on the BiggerPockets website, so hard to say for sure.

When 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. Also, the fact that in our NW calculations the value of our properties rarely changes as I only change it manually since zillow has a hard time getting an actuate value for our properties. And I only update it manually when I have a solid data point like a new appraisal. Equity in the properties is about 1/2 our NW, so a large dip in the market doesn't affect our NW too drastically.

We are 15+ years from retirement so maybe down the road we will be more conservative with our stocks/bonds.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Doc »

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?
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.

And your age is irrelevant. Five, ten years before you die just sell it if you will spend the money or leave it to your kids.

While most "normal" FI has a relatively constant value, investment RE tends to increase in value due to inflation. So do bonds if long term interest rates decline. So what it's still not a stock.
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Re: How do you factor Rental Asset in Asset Allocation

Post by Northern Flicker »

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.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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