Rental housing equity and the 4% rule

[rahby1us]

What do you guys “count” your equity in rental properties as?

Should I count it as part of my asset base for my 4% calculation? Anything else I should do with equity and valuation for various calculations? I have some stuff in my spreadsheets for each property projecting yearly appreciation, mortgage pay down and cashflow. What considerations come into play with this stuff from your perspectives? (For ref, own 3 multi fam rentals, 1 Airbnb, all about 10 years since purchase more or less. Purchase prices all around 200-300k. Have all appreciated nicely.

[GilesMM]

What do you guys “count” your equity in rental properties as?

Should I count it as part of my asset base for my 4% calculation? Anything else I should do with equity and valuation for various calculations? I have some stuff in my spreadsheets for each property projecting yearly appreciation, mortgage pay down and cashflow. What considerations come into play with this stuff from your perspectives? (For ref, own 3 multi fam rentals, 1 Airbnb, all about 10 years since purchase more or less. Purchase prices all around 200-300k. Have all appreciated nicely.

They are only part of your investment portfolio if you plan to liquidate them, otherwise there is no reason to assume they will behave like an index fund.  If you don't plan to liquidate, simply use your forecast of cash flow from them to reduce the amount the rest of your portfolio needs to provide, just like SS or a pension.

[rahby1us]

Ok, so let me ask: let’s say I have $1m index fund investments and 1m equity in rentals…
The investments will in theory appreciate. And I will draw from that for my 4%… (after first using rental cash flows of course) but only let’s say 40k per year. The other 960k of index funds will just appreciate according to the market. Won’t the houses also be appreciating? Won’t I also be continuing to increase my equity with each payment as my renters pay down my mortgage? My equity should also be growing based on appreciation and equity so why wouldn’t I count that towards net worth?

If you say because it’s not liquid, wouldn’t I count a 10 year CD  towards net worth? Now I know you could say the 4% rule works for equities but wasn’t based on real estate… but my appreciation and equity growth annually(since 2015) trounces the stock market average returns… so by using as 4% would actually be conservative by that logic plus I’ve got solid rent increases over that time period.

Or to think of it another way, if I owned only $2m stocks that paid a $20k annual dividends… couldn’t the dividend be thought of as equivalent to the rental cash flows and the stock appreciation be the same as the home appreciation and equity growth?im not spending the entirety of the best egg in either scenario land both could eventually become liquid too.

[GilesMM]

Ok, so let me ask: let’s say I have $1m index fund investments and 1m equity in rentals…
The investments will in theory appreciate. And I will draw from that for my 4%… (after first using rental cash flows of course) but only let’s say 40k per year. The other 960k of index funds will just appreciate according to the market. Won’t the houses also be appreciating? Won’t I also be continuing to increase my equity with each payment as my renters pay down my mortgage? My equity should also be growing based on appreciation and equity so why wouldn’t I count that towards net worth?

If you say because it’s not liquid, wouldn’t I count a 10 year CD  towards net worth? Now I know you could say the 4% rule works for equities but wasn’t based on real estate… but my appreciation and equity growth annually(since 2015) trounces the stock market average returns… so by using as 4% would actually be conservative by that logic plus I’ve got solid rent increases over that time period.

Or to think of it another way, if I owned only $2m stocks that paid a $20k annual dividends… couldn’t the dividend be thought of as equivalent to the rental cash flows and the stock appreciation be the same as the home appreciation and equity growth?im not spending the entirety of the best egg in either scenario land both could eventually become liquid too.

Housing can appreciate or depreciate, quickly or slowly, depending on local market conditions that can also be independent of stock market behavior.  Housing values in Austin, for example, totally collapsed in the mid 80s and didn't recover for a decade, to cite just one example.   Of course, the stock market did the same in 1929. 


The 4% rule is based on back-testing a portfolio of stocks and bonds, not your local home real estate market.  So you may do well, terrible or somewhere in between making it very hard to derive a SWR rate sustainable for 30 years.

[maizefolk]

I think one misconception a lot of people have is that the 4% rule is based on the expected return of the stock market over the long term. It isn't. If it was it'd be the 9% rule. Instead 4% is a rough estimate, based on historical data, on how much one can safely spend out of a stock+bond portfolio in the worst times to retire in the last 150 years.

We simply don't have a comparable 150 year dataset of home value and real estate data, and even if we did it would probably represent a sort of broad index of millions of houses across hundreds of cites, not a concentrated bet in a small number of houses in one city, which is what most rental investments necessarily end up being.

It sounds like you're already doing a good job of calculating what you expect for an average/typical return from those properties though: rental rates, maintenance, mortgage paydown, appreciation, inflation, vacancy. But no one can say with the level of evidence we have for the 4% rule in stocks how much or how little you can count on being able to take as income from your rental properties even if you end up picking one of the worst times to retire.

[Omy]

We count our rental equity when calculating net worth. We live in an area where it's a fairly liquid asset (we sold our last rental in about a month).

[clarkfan1979]

What do you guys “count” your equity in rental properties as?

Should I count it as part of my asset base for my 4% calculation? Anything else I should do with equity and valuation for various calculations? I have some stuff in my spreadsheets for each property projecting yearly appreciation, mortgage pay down and cashflow. What considerations come into play with this stuff from your perspectives? (For ref, own 3 multi fam rentals, 1 Airbnb, all about 10 years since purchase more or less. Purchase prices all around 200-300k. Have all appreciated nicely.

I have 3 rentals and a primary. The rentals are 5.5 to 15.5 years of ownership. I have a spreadsheet as well. I input expected home value appreciation and expected rent value increases in the spreadsheet. At some point, it might be reasonable to sell the rentals and buy index funds. As a result, I deduct 7% of the market value of each property for transaction costs that would happen upon a sale. I also have capital gains factored in if/when I sell and buy index funds.

I guess you could say that I am tracking my "exit equity" and I think you can apply the 4% rule to "exit equity" if you plan on buying index funds after selling your rentals.

If you get a check for 350K after selling a rental, are you going to have the balls to put all the funds into index funds all at once? If you think you might want to dollar cost average into index funds at 30K per month, then that needs to be factored in as well.

[ChpBstrd]

The process I've seen among many overly enthusiastic RE investors is to:

1) Subtract rent revenue after the mortgage payment, assuming 0% vacancy and no maintenance ever, from one's annual spending.
2) Multiply this adjusted spending number by 25 to arrive at a FIRE number.
3) Use one's RE equity to reach the FIRE number.

Just don't do that.

[Telecaster]

Or to think of it another way, if I owned only $2m stocks that paid a $20k annual dividends… couldn’t the dividend be thought of as equivalent to the rental cash flows and the stock appreciation be the same as the home appreciation and equity growth?im not spending the entirety of the best egg in either scenario land both could eventually become liquid too.

You're making it too hard.   The central question of retirement planning "is how much money do I need to retire?"   Let's say your spending is $80K/year and your rental income provides $40K/year.   That means you need another $40K/year from some other source.   The 4% rule tells us that you can "safely" withdraw $40K/year from a $1M balance portfolio, so that's how much money you need.

You can't spend the equity in your rental houses so it doesn't enter into the SWR calculation. 

[Morning Glory]

Or to think of it another way, if I owned only $2m stocks that paid a $20k annual dividends… couldn’t the dividend be thought of as equivalent to the rental cash flows and the stock appreciation be the same as the home appreciation and equity growth?im not spending the entirety of the best egg in either scenario land both could eventually become liquid too.

You're making it too hard.   The central question of retirement planning "is how much money do I need to retire?"   Let's say your spending is $80K/year and your rental income provides $40K/year.   That means you need another $40K/year from some other source.   The 4% rule tells us that you can "safely" withdraw $40K/year from a $1M balance portfolio, so that's how much money you need.

You can't spend the equity in your rental houses so it doesn't enter into the SWR calculation.

^^
What Telecaster said. Not everything that is part of your net worth counts as part of your stash for 4% rule purposes. 

The equity does help you in that the cash flow will increase once the mortgages are paid off, so you may be able to get away with slightly higher than 4% WR from your other funds until then. Some of the FIRE calculators have the ability to enter sources of income or expenses with specific start and end dates.