Dear Al,
I have a few rental houses and am wondering how to value them for the purpose of asset allocation and future cash flow. For example, if a house is worth $100K and there is a $60K mortgage on it, would I use the equity difference of $40K as the asset allocation? I understand that real estate is generally considered to be a “safe” risk. So would I consider it like a bond when looking at stock vs. bond investments? Additionally, how does one account for future cash flow when using retirement calculators? I would take a conservative route and assume high expenses/upkeep to arrive at cash flows?
Robert
Dear Robert,
Asset allocation is widely discussed in securities investment, but is less significant in real estate. Income from rental property is arguably bond-like, but its equity may appear more stock-like as investors in both will anticipate appreciation. As to your contention that real estate is “safe,” compared with securities, perhaps a better expression is “more predictable,” at least if well selected and managed. However, to see what can go wrong, consider the locale sixty miles north of the prestigious city of Santa Barbara, California. During the early years of the space race, Vandenberg Air Force base became the West Coast center of the newly developing U.S. missile program. By 1958, immense construction projects resulted in a massive population influx. Nestled alongside the military complex sat the town of Lompoc, official 1950 population of 5,555. With the arrival of the construction crews together with the additional military and civilian employees, the local area experienced inundation. Real estate volume and values escalated, as did rental prices. With such activity, real estate development followed, with tract builders from Los Angeles rushing to participate. Within four years, population exceeded 20,000. As predicted, it couldn’t last. With the missile launchers built and operating routinely, the need for people and newly built houses and apartments ceased to exist. By 1964 the area was clearly depressed, with a record foreclosure volume the only notable event. So much for real estate as a “safe” risk. As to your final question, concerning retirement calculators and the prediction of a property’s future cash flow, I consider such determinations to be mostly idle speculation. I strive to select my rental property with favorable location as the prime consideration and let nature take its course.
Al Jacobs
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AL JACOBS has been a professional investor for nearly four decades. His business experience ranges from real estate, mortgage, and securities investment to appraisal, civil engineering, and the operation of a private trust company. In addition to managing his investments on a day-to-day basis, he is a featured financial columnist for both online and print publications. He is the author of Nobody’s Fool: A Skeptic’s Guide to Prosperity. You’re invited to subscribe to his financial Newsletter, "On the Money Trail," at no cost or obligation by visiting www.onthemoneytrail.com.
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