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How to account for real estate in asset allocation?

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  • Larry Ragman
    replied
    Originally posted by Dont_know_mind View Post
    To me, there's a big discrepancy in how real estate investors view their AA and stock investors. RE investors seem to not really care too much about AA and mainly focus on their LVR and cashflow.
    I'm not really sure how to make them consistent.
    To me it indicates that risk tolerance is possibly largely a psychological thing and maybe AA is too.
    I agree with this observation. My rental real estate is ~10% of my investments, and ~15% of my net worth if I count my residence, but I usually ignore both in considering my investment asset allocation as well as year to year measures of wealth. I’m not saying this is a good thing, just a fact. I suspect it is a reflection of the reality that net worth metrics are just not that important to me. Like many here I save and invest a lot, and since I am neither actively buying more real estate nor relying on the income from real estate yet, I concentrate in the areas I have current goals (for saving, etc).

    I could easily pick a value for the real estate and count it in the totals and percentages. But setting investment goals against 10% real estate/60 stocks/ 30 bonds or 65/35 stocks to bonds is effectively meaningless. The stock/bond totals are the same. And besides, it is simply easier to track the stocks and bonds (at Vanguard) without the real estate numbers. It would be different if I were buying more real estate, or trying to increase real estate ROI, or cash flow, but I am not because I am set on those factors.

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  • Dont_know_mind
    replied
    To me, there's a big discrepancy in how real estate investors view their AA and stock investors. RE investors seem to not really care too much about AA and mainly focus on their LVR and cashflow.
    I'm not really sure how to make them consistent.
    To me it indicates that risk tolerance is possibly largely a psychological thing and maybe AA is too.

    Leave a comment:


  • hillaj1
    replied
    I personally do not include my rental units in my asset allocation (age 35; 90/10 equity/fixed), to keep rebalancing easy. I include the REITs I own in my equity bucket at a fixed percent rebalanced twice per year with everything else.

    I don’t think there is a perfect answer to your question. I’m simple minded, so keeping it separate makes my life easier.

    Leave a comment:


  • GogglesandScarf
    replied
    Originally posted by wawot1 View Post

    So imagine I have a net worth today of 1million. 10% of that is 100k to put into my direct real estate bucket. I could buy a $100k house outright, and get much lower returns, but have much lower risk. Or, on the other hand, I could put down $20k each on 5 different houses, each worth $100k, for a total of $100k invested, expect to get higher returns, but now I owe the bank $400k for those 5 properties.

    In both of these scenarios, I have $100k of my assets tied up in direct real estate, but in 1 case I have low risk and low expected returns, and in the other case, I have high risk and high expected returns.

    As I'm typing this, I'm seeing more clearly that this just boils down to what my risk tolerance is....thanks for helping me think through this.

    Live long and prosper -
    The scenario with 5 houses is an accumulation phase play. If home prices appreciate your gains are multiplied by 5. If rent appreciates your gains are multiplied by 5. Your tax writeoffs are x5 as well.

    Meanwhile, your renters are paying off the mortgages.

    Downside is making your nut and risk of vacancy. You will have to pay the mortgage if renters dry up, which means you have to 1) have a large emergency fund and/or 2) have a large income (keep working).

    Leave a comment:


  • Bev
    replied
    I do not count real estate as part of our asset allocation. There are obviously different ways to look at this one.

    Leave a comment:


  • wawot1
    replied
    Originally posted by StarTrekDoc View Post

    Welcome to Direct Real Estate investing! Good questions and real hard answers and really depends on the question you're trying to answer.

    Risk -- it's the dollars invested. Say that 100k house is your 20k (probably closer to 30-40k in reality as no bank will let you in at 20k). That's YOUR risk. If it tanks and you walk away - the bank holding the note is at risk. The bank can absolutely go after you for the balance and that's where the structure of the investment is important and holding personal guarantees also true.

    NetWorth -- it's the investment worth - liability (loan) = equity. That's what should represent the contribution to your portfolio balance. Just like any investment, nothing realized until it's cashed out -- so all paper gains. That Picasso maybe worth $10M but until cashed out, it's all technical on the NetWorth and can become $0 if your dog eats it.

    So example: 1M portfolio with 950k in stocks, 50k in 100k house with 50% loan

    RE Risk 50K <--- use this scenario during growth and accumulation phase
    Net worth 1M (950k+100k-50k loan)
    Portfolio balance 950k:50k

    Take 50k stocks and move to RE
    RE Risk 100k <<------- use this once achieved IPS goals of DRE and shift to cashflow state)
    Net worth 1M (900k+100k)
    Portfolio balance: 900k:100k
    Thanks Star Trek Doc -

    So I think the real question I'm wrestling with - I can expect a higher return on investment the more leveraged I am, but that obviously exposes me to more risk.

    So imagine I have a net worth today of 1million. 10% of that is 100k to put into my direct real estate bucket. I could buy a $100k house outright, and get much lower returns, but have much lower risk. Or, on the other hand, I could put down $20k each on 5 different houses, each worth $100k, for a total of $100k invested, expect to get higher returns, but now I owe the bank $400k for those 5 properties.

    In both of these scenarios, I have $100k of my assets tied up in direct real estate, but in 1 case I have low risk and low expected returns, and in the other case, I have high risk and high expected returns.

    As I'm typing this, I'm seeing more clearly that this just boils down to what my risk tolerance is....thanks for helping me think through this.

    Live long and prosper -

    Leave a comment:


  • StarTrekDoc
    replied
    Originally posted by wawot1 View Post
    Hi all -

    I'm buying my first investment property. My question is how to account for this in my asset allocation.

    My investment policy statement says that 10% of my assets should be in real estate; easy to figure that out when it was a REIT, but now that I'm venturing into directly owning a property, not sure what makes sense.

    Let's say I put down 20k on an investment property worth 100k and the property appreciates to 110k. Curious what people would count towards my asset allocation - 20k, because that's what I put in? 30k, because that's the equity I have in the property?

    And how to account for the risk that the leverage introduces into my asset allocation? Seems to me that it's a different level of risk to buy 20k worth of a REIT or index fund - max potential losses are 20k - than to put down 20k to buy a 100k house. If the house gets trashed by a tenant (or hit by an asteroid or whatever), I'm at risk of losing my 20k investment and still owe the bank 80k.

    Seems like that added leverage risk ought to figure into the asset allocation somehow, but not sure how to navigate.

    Thoughts?

    Thanks everybody.
    Welcome to Direct Real Estate investing! Good questions and real hard answers and really depends on the question you're trying to answer.

    Risk -- it's the dollars invested. Say that 100k house is your 20k (probably closer to 30-40k in reality as no bank will let you in at 20k). That's YOUR risk. If it tanks and you walk away - the bank holding the note is at risk. The bank can absolutely go after you for the balance and that's where the structure of the investment is important and holding personal guarantees also true.

    NetWorth -- it's the investment worth - liability (loan) = equity. That's what should represent the contribution to your portfolio balance. Just like any investment, nothing realized until it's cashed out -- so all paper gains. That Picasso maybe worth $10M but until cashed out, it's all technical on the NetWorth and can become $0 if your dog eats it.

    So example: 1M portfolio with 950k in stocks, 50k in 100k house with 50% loan

    RE Risk 50K <--- use this scenario during growth and accumulation phase
    Net worth 1M (950k+100k-50k loan)
    Portfolio balance 950k:50k

    Take 50k stocks and move to RE
    RE Risk 100k <<------- use this once achieved IPS goals of DRE and shift to cashflow state)
    Net worth 1M (900k+100k)
    Portfolio balance: 900k:100k

    Leave a comment:


  • wawot1
    started a topic How to account for real estate in asset allocation?

    How to account for real estate in asset allocation?

    Hi all -

    I'm buying my first investment property. My question is how to account for this in my asset allocation.

    My investment policy statement says that 10% of my assets should be in real estate; easy to figure that out when it was a REIT, but now that I'm venturing into directly owning a property, not sure what makes sense.

    Let's say I put down 20k on an investment property worth 100k and the property appreciates to 110k. Curious what people would count towards my asset allocation - 20k, because that's what I put in? 30k, because that's the equity I have in the property?

    And how to account for the risk that the leverage introduces into my asset allocation? Seems to me that it's a different level of risk to buy 20k worth of a REIT or index fund - max potential losses are 20k - than to put down 20k to buy a 100k house. If the house gets trashed by a tenant (or hit by an asteroid or whatever), I'm at risk of losing my 20k investment and still owe the bank 80k.

    Seems like that added leverage risk ought to figure into the asset allocation somehow, but not sure how to navigate.

    Thoughts?

    Thanks everybody.
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