It's a just fine asset allocation if the individual understands all the risks, accepts them, mitigates them, and anticipates conservative returns.
Yeah, it's risk management. I'm about to turn my primary residence into my first rental. In terms of risk, it feels like a bond, so I'm likely to reduce my bond allocation because I want to keep the same level of risk. The question then becomes "what is my comfortable allocation to stocks versus bonds?". Real estate is out of the picture, except that it affects my overall impression of how much risk I'm comfortable with. Not very scientific, but investing isn't really a science, is it?
I can't consider my rental to be the totality of my bond allocation because I can't rebalanace from my rental house into stocks. So I need to reduce my bond allocation at some fraction of the value of my rental. Likely I'll glide from 75/25 stocks/bonds to 80/20 or 85/15.
I guess the other question I need to ask myself when I have a rental: should I stay in REITs? I currently have 10% of my equity allocation in REITs and I think I'm comfortable retaining that. But I'll continue to consider it on the equity side of things, rather than my own personal real estate holdings. Anyone have an opinion on that?