Real Estate in the PP

[dr ratdog]

Hey everyone.

I think I understand the PP well enough to answer this question but I though I'd toss it to all of you who are far more experienced than I am.  If I wanted to buy real estate for an investment (as a rental property) where does that fit into the PP?  Is that solely a VP investment?  Would it be foolish to make it a fifth component of the PP? 

And while I'm on the topic of the VP I'd like to ask another question.  I read that the PP should have money that you can't afford to lose and the VP is money you are ok with losing.  Unless someone is very well off I can't understand why there would be any money in someone's VP.  Or is this just something one does after saving a sufficient amount for retirement? 

All your thoughts are appreciated.

[Tyler]

I'd personally consider a rental property in my VP.  Don't over-think it -- Just appreciate a good investment property for what it is and don't bother mixing the two or you'll muck up both.

IMHO, a VP is kinda like the old political joke -- a liberal is just a conservative who hasn't been mugged yet.  A person with a high risk tolerance is just a future conservative investor who hasn't been mugged yet by the markets.    I kid... but if you're more comfortable with a 100% PP just do that.  It's what I do. 

[Pointedstick]

Rental real estate should definitely be VP. How would you rebalance it? Sell the property? Do home improvement work to increase its value, funded with profits from selling some of another asset? How would the tenants feel about these things?

IMHO, rental real estate should really be kept on its own because it's something that :
1. owned almost entirely for its income stream, not its capital value
2. has a very high effective "expense ratio" due to all the maintenance and taxes

The PP is all about owning liquid assets for their capital value.

[dr ratdog]

PS:

As far as rebalancing goes my initial thought would be to own a REIT as well and use that for rebalancing.  I know that REITs are not identical to real estate but it seemed like the easiest way to do it. 

Tyler:

I think I'm ok with a VP in theory and I'd like to be able to take on some risk for more reward but I don't think I know how to quantify it.  What am I risking?  How "much" am I risking?  But I appreciate your thoughts.  I'm actually surprised how often I read on these forums about someone who decided to alter the PP radically (which of course is precisely what I'm suggesting here) instead of just posting whatever in the VP part of the forum.  It feels like the VP allows one to engage in the tinkering that a lot of people desire without messing around with their core objectives. 

Anyway thanks for feedback.

[Ad Orientem]

Real estate is a VP thing. It's also a very time and labor intensive investment. I'd stick to a REIT if you want to get into rental property. As Craig once famously observed in anothe thread...

*REITs don't call you at 1 AM when a water pipe breaks.
*REITs don't give you an excuse when the rent check is due on the first of the month.
*REITs don't write rubber checks.
*REITs don't trash an apartment and then skip on the last two months rent.

etc...

[whatchamacallit]

I think I have seen Craig suggest real estate as an alternative to gold if gold was illegal.

If your PP was big enough, a portion of your gold could be real estate. The maintenance cost would be like your gold storage cost.

I wouldn't want to have leveraged real estate as part of the PP.

[dr ratdog]

Is the leveraged aspect of real estate what's problematic for the PP?  That would make sense to me.

I like REITs and I use them now but they seem like basically another kind of stock.  When the stock market goes down REITs do too.  I know the correlation is generally less than with other stock funds but I was considering real estate because it seems like it would not respond as vigorously to changes in market conditions as REITs would.

But I think that answers my question: REITs or real estate are both VP. 

[rickb]

And while I'm on the topic of the VP I'd like to ask another question.  I read that the PP should have money that you can't afford to lose and the VP is money you are ok with losing.  Unless someone is very well off I can't understand why there would be any money in someone's VP.  Or is this just something one does after saving a sufficient amount for retirement? 

The distinction between PP and VP is twofold.  One distinction is that your VP is "money you can afford to lose".  What I think Browne actually means by this is that it is money you're willing to speculate with.  Speculating (as opposed to investing) is putting money in something that might have a very high reward - higher than you can get from passively investing in the overall market, but also comes with a significant risk.  This is what venture capitalists do (for example).  Most startups go bankrupt.  But if you've funded a successful one you can make a LOT of money.  Ditto picking individual stocks (not as risky as startups, but generally less reward as well).  Or timing markets.  Or betting on horse races.  The rules on what you do with money in your VP are totally up to you.  How much risk you can tolerate is an entirely individual decision.

The other distinction is that money in your PP never flows into your VP.  It's OK for money to flow from VP to PP, but not the other way around.  If you speculate with your VP money and lose it all, then don't refund it from your PP.  So, it's OK to target a VP as (for example) 20% of your total and rebalance if your VP becomes more than this.  But if your VP lags your PP (in the limit, you lose it all), it's not OK to rebalance from your PP.  This also means it's not OK to use leverage in your VP such that you might be forced to cover losses with funds from your PP.

[Libertarian666]

I consider real estate to be a VERY poor substitute for gold. It does not have the portability, divisibility, relative immunity to government confiscation, high liquidity, or many valuable attributes that that gold has.

In fact, I don't consider real estate a desirable investment at all. I "own" a house but only because I have to live somewhere, and that's about it.

[magneto]

I consider real estate to be a VERY poor substitute for gold. It does not have the portability, divisibility, relative immunity to government confiscation, high liquidity, or many valuable attributes that that gold has.

In fact, I don't consider real estate a desirable investment at all. I "own" a house but only because I have to live somewhere, and that's about it.

Agree with para one wholeheartedly.
However on para two, see what you mean.  But maybe for us we just struck lucky?
We heavily sold stocks and purchased UK Residential Real Estate (RRE), when in early retirement in the late 90s.  The real yields were screaming sell stocks buy RRE, and we badly needed income.  Those sort of signals don't come often in life.  For us it worked out well outperforming a 100% stock portfolio by a multiple in excess of 4, and that was after taking much of the rental income for essential spending.  However stocks have been historically atypical over the period by not outperforming other assets.   
The income stream produced by RRE could be regarded as a Liability Matching Portfolio.  But then quite how the RRE is best reconciled with the PP is an interesting issue. Do not see RRE as merely part of a VP, as it is very much a core asset.

[Libertarian666]

I consider real estate to be a VERY poor substitute for gold. It does not have the portability, divisibility, relative immunity to government confiscation, high liquidity, or many valuable attributes that that gold has.

In fact, I don't consider real estate a desirable investment at all. I "own" a house but only because I have to live somewhere, and that's about it.

Agree with para one wholeheartedly.
However on para two, see what you mean.  But maybe for us we just struck lucky?
We heavily sold stocks and purchased UK Residential Real Estate (RRE), when in early retirement in the late 90s.  The real yields were screaming sell stocks buy RRE, and we badly needed income.  Those sort of signals don't come often in life.  For us it worked out well outperforming a 100% stock portfolio by a multiple in excess of 4, and that was after taking much of the rental income for essential spending.  However stocks have been historically atypical over the period by not outperforming other assets.   
The income stream produced by RRE could be regarded as a Liability Matching Portfolio.  But then quite how the RRE is best reconciled with the PP is an interesting issue. Do not see RRE as merely part of a VP, as it is very much a core asset.

Congratulations. But have you sold it yet? If not, I wouldn't count my winnings yet. Real estate can crash silently and you won't know until you try to sell and there are no bidders.

[magneto]

I think I understand the PP well enough to answer this question but I though I'd toss it to all of you who are far more experienced than I am.  If I wanted to buy real estate for an investment (as a rental property) where does that fit into the PP?  Is that solely a VP investment?  Would it be foolish to make it a fifth component of the PP? 

To get the thread back on track.  Let us suppose an investor has the following asssets :-

40% Rental Property
15% Stocks
15% Long Bonds
15% Gold
15% Cash

This can be viewed in two ways:-
a) The investor has a conventional PP plus a rental income stream.
b) The investor has a modified PP modified with the additional asset class.

If a) is adopted, it would still be prudent to check from time to time the overall portfolio valuations, including real estate, to make sure allocations have not drifted too far out of whack.  So am leaning towards b).

[gizmo_rat]

When I was reading through Harry Browne's book I was suprised at how much he loathed it as an investment.

He couldn't fit it into the PP

[RE] sits in the Permanent Portfolio like an elephant at a tea party, It may be dressed correctly but it doesn't seem to fit in.

and didn't rate it for a VP because of its illiquidity.

[rickb]

To get the thread back on track.  Let us suppose an investor has the following asssets :-

40% Rental Property
15% Stocks
15% Long Bonds
15% Gold
15% Cash

This can be viewed in two ways:-
a) The investor has a conventional PP plus a rental income stream.
b) The investor has a modified PP modified with the additional asset class.

If a) is adopted, it would still be prudent to check from time to time the overall portfolio valuations, including real estate, to make sure allocations have not drifted too far out of whack.  So am leaning towards b).

If a) is adopted with the intent to never rebalance into the rental property investment from funds in the other assets (rebalancing in the other direction is fine), then it's a conventional PP plus a VP consisting of rental property. 

The difference is what you do if the rental property drops in value by, say, 40% or more and you're now at 24% rental property and 19% in each of the PP assets.  If you're treating this as a PP plus a VP, you do nothing.  If you're treating this as a modified PP, you rebalance to your target by selling PP assets to buy more rental property. 

In either case, if the value of the rental property goes up so you're now at 56% rental property and 11% in each of the PP assets you can rebalance back to your target 40/15/15/15/15 (you're transferring money from your VP into your PP).

If you modify the PP by adding asset classes what you're actually doing is diluting the ability of the dissimilar assets to carry the portfolio when the added asset goes down in price.  Given the 4 basic economic conditions, rental property does best in inflationary times, so you are effectively overweighting the gold component.  You'll do better during periods of inflation, but worse during deflationary periods (you'll have less long term bonds to carry you).  If you split the gold allocation between gold and rental property then the question is what does better during periods of inflation - gold or rental property?  I believe Browne would say gold.  And gold has another purpose as well, which is (partial) protection in a period of total economic collapse.  By cutting the amount of gold in half, you're reducing the protection in this scenario as well (it's very difficult to leave the country with a pocketful of rental properties).

[Libertarian666]

When I was reading through Harry Browne's book I was suprised at how much he loathed it as an investment.

He couldn't fit it into the PP

[RE] sits in the Permanent Portfolio like an elephant at a tea party, It may be dressed correctly but it doesn't seem to fit in.

and didn't rate it for a VP because of its illiquidity.

I agree completely.

[barrett]

dr ratdog,

I'm kinda with rickb on this in that you have to figure out under which economic condition a rental property is likely to do well. My thought is that if it's rented out you'd do OK in most environments. It just throws the math of the PP off because it doesn't fit neatly into one category (meaning an asset that is almost guaranteed to do well under inflation, deflation or prosperity). Best to keep it out of the PP.

Regarding your VP question, I don't feel like I have any money that I "can afford to lose" so I don't really have a VP... just some assets that will eventually make their way into my PP.

I had wondered the same thing about real estate a few months ago, and then I realized that the only reason I was considering it was that I wanted to feel that my PP is bigger than it actually is. Not a good justification but there you have it.