Real Estate



I think I must still be missing the point. If you have a traditional bond (corp, muni, treas., etc) that matures in 30 years to $1000, but is currently selling at a discount (suppose $900) do you consider yourself to have a $1000 or $900 bond position? Maybe these are not the same, but I am having difficulty separating the two in the old noggin. A mortgage does indeed mean what you and JOE say, but it can only be realized AT THAT INSTANT as the equity value. To do so otherwise seems to suggest that we base asset allocation on what we expect to have in 30 years.
Again, I apologize for my thickness and am by no means firm on my position. If you will bear with me, could you please explain further.
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kastnna wrote:

Don't get too drawn into the bond analogy. Rich helped me out by calling it a 30yr sinking fund, which better describes its nature, but even that may be throwing you off.
In the big pie chart of asset allocation, as I previously posted, why would debt cancel real estate equity? You hold $250K of house and do so regardless of the mortgage attached. The impact to your net worth if the house goes up or down 20% is +/- $50K, again, regardless of the mortgage. To put it a different way, say I have a banker friend who would offer me a personal line on my signature, instead of the mortgage. Does my position change because my loan is not secured by the house?
I'm guessing you are thinking "equity" as in I have a $250K house, but $200K mortgage, so I have $50K in equity. Well, I'd not keep too many friends if I felt compelled to offer, "no, you really have $250K equity as that's the value of your house, and you are short a X-yr sinking bond."
If I pie-ed my worth to include the house, the mortgage cancels my cash positions, not the home equity. (even to the point of showing negative cash).
To your question on the actual bond - it depends. I'd be inclined to "mark to market" and treat a bond at its current value. You have a bond that can sell today for $900, that's what it's worth.
I hope this helps. (hey, I'm still dense on a series of issues, no problem) JOE
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That's why I'd use the term "exposure" not equity. As in: You have $50k equity in the house (meaning the amount you'd net if you sold it off today), but you have $250k *exposure* to real estate - meaning that if real estate goes up by 10%, your net worth due to that move goes up by 10% * 250k = $25k.

Pie charts kind of stink when there are potential negative values included!
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joetaxpayer wrote:
[...]

Hmm, I'm not so sure that makes sense. Back when I learned some accounting theory, I was taught that short-term (current) assets should be matched to short term (current) liabilities, and long term to long term.
On my personal balance sheet, I list assets in decreasing order of liquidity, ditto for liabilities. Therefore, while credit card debt, accrued property tax, insurance, and anything else that I expect to pay off in a year or less, "cancels" my cash positions, my mortgage clearly "cancels" my homeowner's gross asset value (market value of my house) -- they are both long-term.
In other words, I see the mortgage canceling (offsetting) the house value not because it is secured by the house, but rather because they are both long term. Perhaps 12 month's worth of mortgage payments would "cancel" my cash position, because 12 month's worth of payments could be considered short-term (current). But the remaining 0 to 29 years worth of mortgage payments (assuming 30-yr term) are clearly long term, I don't have to worry about paying them for at least a year and probably much longer!
If I borrowed against my home equity to purchase a rental property, same thing: long term liability matches long term asset. If I borrowed against my home equity to buy-and-hold stocks, same thing: long-term liability matches long term asset.
-Mark Bole
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Mark Bole wrote:

I see your point, but this thread started asking if a house which had a 100% mortgage was less a real estate asset allocation than a full paid house and I'd think not. If I read you correctly, you'd not agree that a 30yr bond and cash both should be treated as cash. We can split hairs over short vs long term, and perhaps agree that the pie chart can take on all the granularity one chooses.
In terms of timeline, you are right, but I still am not convinced that the owner has any less house in his portfolio due to the mortgage (the reverse mortgage aside, since its nature isn't that of a standard loan, but the more I think about it, it's like a put option for the homeowner. I still need to sleep on that thought) JOE
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Renting vs. 0% equity are *very* different. 0% equity means you have a real-estate position equal to the value of your house, plus a *negative* position in loans/bonds. Renting really does mean you have a zero position in real estate. If you are a renter and real estate goes up in value, all that happens is your rent probably goes up. If you are an owner with zero% equity and real estate goes up, your loan doesn't get any bigger, but your portfolio's value (and your equity!) go up a lot - the magic of leverage.
Similarly, if you rent and real estate values go down, well, your rent probably doesn't go down. Such is life. But if you own with 0% equity and real estate values go down your portfolio actually goes negative.
Before the move in real estate values, yes, the renter and the 0% equity guy have portfolios worth the same - zero. But one's portfolio is *highly* exposed to movements in the value of real estate and the other is not exposed at all.
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joetaxpayer wrote:

Well, you can via a reverse mortgage. Whether that's a cost-effective method is another question.
Brian
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Default User wrote:

But that still doesn't change the amount of house in the portfolio, as selling a stock would. As I drew down at the magic 4%, over time the 'real estate' portion would be a much larger piece of the pie. It just creates a loan against the house. JOE
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Kast,
I agree. But I think the 5%-10% guideline is based only on the capitalization of real estate versus the capitalized securities universe. It is not necessarily the "best" amount to allocate to real estate. That depends upon desired risk/reward and certain assumptions.
Let's say that you have a portfolio that is 60% stocks, 30% bonds, 10% real estate. If the stock market tanks - your portfolio pretty-much tanks. A larger investment in real estate may help to better support a portfolio during a bear market in stocks, such as we saw in 2000-2002, while still supporting excellent long-term returns.
-JJ
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snipped-for-privacy@yahoo.com wrote:

JJ, without knowing specifically what you're looking at it's hard to say, but I'd be wary of any rules of thumb about asset allocation. Some people don't even consider REITs to be a separate asset class, for example, so they might say 0% is appropriate. Others might be relying on historical models over time periods where REITs performed extremely well, and weren't highly correlated with other asset classes, using that as a justification for a high investment in them. Just looking at the numbers you can find periods that would justify allocations higher than 20%...they've outperformed US stocks over quite a few time periods.
One rationale for keeping it small is that it is, as another poster mentioned, a relatively tiny part of the public equities market, based on total market capitalization. It's a small subset of the Russell 2000, really. Commercial real estate may have a lot of value associated with it, but a small percentage of properties are owned by REITs. So I question the capacity of existing US REITs to absorb a 20% allocation by the "typical investor"...that'd be too much money chasing too few stocks. There was some commentary about this after REIT gains earlier this year; some blamed institutional dollars that were tied to investments in the 200-odd public REITs that are members of the major US REIT indices.
I don't know how relevant home ownership is to a REIT allocation -- as you said, they're really different things. To some extent there may be correlations in value but even that strikes me as tenuous. And as you said, one's an investment, the other is the place you live.
-Tad
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In general, I like equity REITs. They have a simple business model of owning property and paying out rent after expenses as dividends. They benefit from not paying corporate income taxes, and CEOs are forced to be disciplined in allocating capital because of the limited ability to retain earnings. Of course, at a low enough price they are attractive as an asset class and at a high enough price they are unattractive. I think investors and especially the financial planners who advise them need to have basic valuation models for the various asset classes rather than suggesting a fixed x% allocation at all times. "Everyone knows" that market timing is BAD, but I think buying things without some conception of fair value is worse.
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