Author Topic: Asset Distribution Help  (Read 763 times)

T Bone

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Asset Distribution Help
« on: July 25, 2018, 01:29:28 PM »
Hi MMM team,
Iím looking for your thoughts on my asset allocation, specifically a rental house that is fully paid off in Seattle.

I am 42, recently divorced and either FIRE or between jobsónot totally sure yet.  Iíve had a bit of a rough time so just sorting myself out.  I quit my well-paying job that I found dreadful and am taking the summer off, kinda, and working a little bit of consulting (20-60 hours per month) for some cash flow.  Iím not working enough to save money but Iím not having to dip into savings for all this summer free timeówhich is great.

When married, we bought the house for $250,000 in 2003 and lived in it for 10 years.  In 2013, we moved and rented out the house.  I received the house as part of our divorce asset distribution, and instead of refinancing it, I just paid it off completely using other assets. Here are the data points about the house:
Gross Rental Income: $2,200/mo; $26,400/yr
Taxes, Insurance, Utilities, Maintenance: $6,400/yr
Net Rental Income:  $20,000/yr
House Value: $615,000 as per appraisal for divorce. 
I live in a small rented apartment and pay $1,450/mo.
As a % of my total assets, the house is a lot.  Hereís the breakdown.
58% Seattle Rental House
31% 401K
11% Cash/Checking, Peer Street, Individual Stocks, HSA, ESPP, and a 2005 Toyota Matrix.
My question is how best to think of this house. Itís nice to have the rental income but am I maximizing my return here or do I have too much sunk in one illiquid asset?  Would it be better to sell the house and buy another property (potentially multi-family) in a lower cost market?  Or sell the house and put the money in a variety of other assets (some to a stock account, some to peer street, or other)?  How do I think about (do the math/calculate ROI) on the return Iím getting on the house vs other opportunities (stocks ~7%, peer street ~7%). 
I might also mention that house values in Seattle are crazy bananas.  Zillow forecasts 8.8% growth per year for my house.  Can I think about the house like itís a dividend paying stock portfolio that appreciates 8% per year and pays out $20,000 in dividends?

Thanks so much for your thoughts and feedback!

Bicycle_B

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Re: Asset Distribution Help
« Reply #1 on: July 25, 2018, 02:47:22 PM »
Let me start with a non-expert opinion. My strength as an initial commenter will be being non-partisan among different options. I don't know the real answer, I just suspect you will get several opinions eventually. Below I will guess what common schools of thought will say.

1. "Seattle real estate is too expensive, dump the rental". There is a school of thought about rentals that, to overstate slightly, the ratio of rent to cost is the key. A high cost city like Seattle provides the landlord with too low of a return. This school suspects that you are not correctly accounting for costs because they will be higher than you anticipate. They may refer to the 50% rule of thumb (with no mortgage, all other costs eventually add up to 50% of rent), which implies that your profits are really $13,000/year in the long term vs $615,000 value. That's about 2% return on equity, a terrible performance. Get out while the getting is good.
2. Sure, double down on 1. Take the money from selling the house and learn to buy/manage remote properties in cheap areas that fit the 50% standard.
3. Similar to 1, but focused on your appreciation question. The bubble in your town could pop, do not count on appreciation.
4. Agree with 1 and 3's analysis of the rental, but prefer financial investments (stocks/bonds) as the alternative. Using 4% return above inflation (6% to 7% nominal return) compared to the 2% on the rental, you double likely real return by going this route.

Personally I lean a little towards 4.

ZMonet

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Re: Asset Distribution Help
« Reply #2 on: July 25, 2018, 03:41:31 PM »
I'll vote towards #4. 

You need to diversify.  The last thing you need, after the divorce, is a bubble pop.  Simplify by diversifying into stocks and then figure out what you want to with your personal and professional life.  You have a whole nother half+ of your life to live.

T Bone

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Re: Asset Distribution Help
« Reply #3 on: July 25, 2018, 10:21:50 PM »
ZMonet and Bicycle_B thanks so much for your thoughts and feedback.  I've got some research to do, now, on the tax implications of selling.  Cheers!

Finances_With_Purpose

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Re: Asset Distribution Help
« Reply #4 on: July 25, 2018, 11:48:44 PM »
If I read it right, you make 20k on 615k of value on the house, so your return is barely above 3%. 
Plus you have management and maintenance stuff on top of it.

You could just go buy a CD that would return almost that much.  Appreciation may help you some too - you didn't say what that has been historically - but that rental return leaves a lot to be desired.

Estimate the appreciation (since it's paid off), including averaged over down years, and then look at the return.

The others make a good point about diversifying: most of your net worth is in a single asset, so there's always the bubble risk.  But you still have a large chunk outside of the house, so it's not as significant as if it were 70% or more, and you can do some things to diversify away from the house. 

Sounds like you have a handle on things.

T Bone

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Re: Asset Distribution Help
« Reply #5 on: July 27, 2018, 09:12:52 AM »
Yes, thanks Finances_With_Purpose.  In terms of historical appreciation, we bought for $250K in 2003 and in 2018 it appraised for $615K.  Honestly, I'm not sure if I'm doing the math right, so correct me if I get it wrong.  But (615-250)/250=146% growth over 15 years (including the down time during the recession).  146/15 years=9.7% yoy growth--is my math right?

Finances_With_Purpose

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Re: Asset Distribution Help
« Reply #6 on: July 27, 2018, 09:29:56 AM »
Yes, thanks Finances_With_Purpose.  In terms of historical appreciation, we bought for $250K in 2003 and in 2018 it appraised for $615K.  Honestly, I'm not sure if I'm doing the math right, so correct me if I get it wrong.  But (615-250)/250=146% growth over 15 years (including the down time during the recession).  146/15 years=9.7% yoy growth--is my math right?

It's fairly close, but no, because the rate compounds - you stack return on return every year, you don't just keep adding a fixed amount to the original base amount.  Your actual return rate will be a little less than 9.7%.  For your purposes, though, that may work, especially if the timeline were short (e.g. 3-5 years).  Over shorter time periods, that math is close to correct.

The absolute way to calculate it would be this:
615 = 250(1 + X)^15 

In that equation, X is your rate of return on the investment.  15 is the number of years - the number of times you received that rate of return, compounded. 

Using that equation, you get X = 0.061848, so a return of 6.18%.

Bicycle_B

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Re: Asset Distribution Help
« Reply #7 on: July 27, 2018, 09:47:53 AM »
In understanding return, it's also wise to factor out inflation.

From 2003-2018, inflation was about 2.17%.

(I got total inflation of about 38% using January 1 2000 to January 1 2018 in the govt CPI calculator:
https://data.bls.gov/cgi-bin/cpicalc.pl

Then I used Excel formula for calculating nth root to calculate 15th root of 1.38)

Subtracting that from 6.18%, your real annual return on equity was about 4%.

Had you also been netting 2% rent after operating expenses, that would have been a total return in the past of about 6% annually. But will the increases in equity last forever? You call the shots...
« Last Edit: July 27, 2018, 09:49:45 AM by Bicycle_B »

Finances_With_Purpose

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Re: Asset Distribution Help
« Reply #8 on: July 27, 2018, 05:06:48 PM »
In understanding return, it's also wise to factor out inflation.

From 2003-2018, inflation was about 2.17%.

(I got total inflation of about 38% using January 1 2000 to January 1 2018 in the govt CPI calculator:
https://data.bls.gov/cgi-bin/cpicalc.pl

Then I used Excel formula for calculating nth root to calculate 15th root of 1.38)

Subtracting that from 6.18%, your real annual return on equity was about 4%.

Had you also been netting 2% rent after operating expenses, that would have been a total return in the past of about 6% annually. But will the increases in equity last forever? You call the shots...

Good point, @Bicycle_B .  You always have to count inflation.  So what seems like 9.7% is actually 4%...ah, the power of compounding.  Then the 4% diminishes farther once you discount for ongoing/input costs: maintenance, repairs, taxes, so on (all things you don't have to pay with actual passive investments).

T Bone

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Re: Asset Distribution Help
« Reply #9 on: August 03, 2018, 11:00:29 AM »
This is awesome, thanks for the math help and the thinking on this.  Another consideration--the house wasn't always an investment property--it was my primary residence for 10 years, so that somehow--mathematically or otherwise, factors into the overall scheme. The real question is what to do going forward, which seems clear with the math--sell the house and go with passive investments.  Thanks for all the input!

Finances_With_Purpose

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Re: Asset Distribution Help
« Reply #10 on: August 03, 2018, 12:01:37 PM »
Any time, @T Bone.  I wasn't necessarily arguing to buy index/mutual funds or any particular alternative, by the way, though there's no problem with that, and it's certainly more passive.  Just helping you count the cost of what you're actually invested in.