Safe withdrawal rate is a powerful tool for assessing one's ability to handle retirement, and so much research has been presented on it that I would love to be able to use it myself. Tools like cFireSim are available for looking at FI from a cash in vs. cash out perspective, but after spending so many hours reading EarlyRetirementNow's many-part research on SWR, I'd love to assess my own SWR!
However, once one moves from having a pure stock/bond portfolio to have actual alternative investments, it becomes harder to account for the various sources of income. It then becomes more individualized. However, I have a feeling I’m not the only one playing with my FI spreadsheet and struggling with incorporating real estate. I've spent a few hours searching threads and haven't seen discussions on this topic that answered what I feel like I am asking.
My discussion topic today is accounting for income & the asset of rental properties with mortgages. The simplest way I’ve read is not to include asset in the denominator of your WR division, and simply subtract net rental income from living expenses, and the remainder of expenses is divided by stock portfolio = Withdrawal rate percentage. However, with a mortgage on the property, this simplified calculation is in my opinion too conservative, as it does not account for (1) the principal paydown from the mortgage payment and (2) price appreciation of the house. I would liken this simple method to a dividend investor who waits until he has enough dividends to cover his expenses before retiring. This person therefore never touches principal and dies with way too much money! I think its flawed to count only on the rent income of a house and not factor in the huge asset you are earning over the mortgage life of an appreciating house
Regarding (1), although principal paydowns are not the same as expenses, I agree they should still be quantified. More equity in the house does not improve returns at all - it doesn’t improve your net income, and it doesn’t make the house appreciate more. Although withdrawing from your stock portfolio to add more home equity is a reduction in the return of your overall portfolio, it’s not a true expense since it’s net worth neutral.
---An initial thought was to add back the principal paydown portion of the mortgage to my expenses ( if I had $20k of expenses after accounting living expenses less net rental income, but I paid $8k of principal on the mortgage that year, then my actual expenses numerator for WR % is $12k). However, I believe this incorrect as that $8k was taken out of my stock investments, where it returns say 8%, to pay the mortgage, and put into equity where it returns 0%.
---The way I’m leaning to is to look at the rental property as just a type of stock. Just like with stocks the dividend portion of total return isn’t relevant to the SWR %, we could treat rental real estate the same. As such the calculation would be living expenses, with no adjustment for rental income / (stock portfolio + equity in rental).
I’m still second guessing my latter suggestion above. I realize to a certain degree I'm trying to force square real estate peg into a round SWR hole. How else does everyone do this?!