What is real net worth when on investment properties?

Question

So the main definition of net worth to my knowledge is, after selling all assets minus liabilities you get your net worth.
I believe a lot of times when we try and do a quick net worth calculation for an investment property we think,

Example:Rental A it’s worth 200k, I bought it at 100k and own 80k. So it would seem my net worth is 120k right? But isn’t that really wrong?

If on average, selling a property costs about 8% So then we would have:

200k-8% = 184k - 80 (mortgage) = 104k

But, let’s say the property was a long term holding so capital gains taxes due on it are 15% (assuming no state taxes in Florida

So our capital gain was 100k and 15% is 15k due in taxes!

So we have a networth so far of:

104k - 15k = 89k

But, we depreciated the property for 2 years at 3.7k/yr total 7.4K taxable amount  which we would owe about 1.8k at 25% tax rate (I might be off a bit here and there)

Final total net worth from what we thought it was 120k now is 87.1k which is a big difference!

Is this something most of us neglect or do not think about?

On my spreadsheets I’ve always deducted 8% (sell costs)  from the actual equity on my properties but I haven’t thought about all the grainy details until now!

What do you guys think as far as calculating net worth on investment properties?

Bill B. · Answer

It is. But does it matter?  Nobody says they can retire because they have a net worth of X. You need an income of Y.

Let’s say you were 30 and could choose between $1M in stocks/cash, whatever. Is there any chance you would feel confident retiring? Personally, I wouldn’t feel confident living 40-50 years on $3M, but that’s me.

As an alternative, would you feel confident retiring on $5k/$10k/or $15k/mo of income that increased about the same as inflation every year? (Say 4 x $250k properties for every million, bringing in $1,250/mo in cash flow each.)

Your retirement is affected in the least when the values go up or down 10% and your networth isn’t slowly being “eaten alive” as you withdraw more than the returns. This just leads to hoping you die before you run out of money.

See if your properties work with a PM, if you can find a good one. I only have a dozen properties but I don’t work an hour a month. Rough numbers, maybe they’re worth $3.5m. But I don’t care, I’ll never sell them except to buy something bigger/nicer. What I like is the stability of the income. I’m probably only making 7% (Call it $275k) BUT, I paid less than half of the current value. So either I’m making 14% on my investment or you need to calculate that $2M tax free gain in to the return. If I ever needed the money I could withdraw it tax free, but it literally would not affect me if the value fell 20-30-40% if the income remained  (ps  I’ve been  invested in Vegas since 1999. When the real estate crash occured, rents skyrocketed. My net worth dropped 30% in a year, but my income increased.)

OTH: yesterday, with half as much in stocks I managed to lose almost $20k. I don’t have anything rare/super risky, mostly broad market index funds. If I was trying to live off my stocks, do I take $20k less out this year if it doesn’t recover? It turns out I don’t plan to ever touch the money, I should have invested it in more real estate, but I was a young and dumb sheep.

TLDR: I treated real estate as my retirement account because when I was young I dreaded starting to withdraw funds from my accounts and running out. I wanted an income stream, not a net worth on a brokerage statement. I didn’t want to pray I died before I ran out of money, or stocks crashed again like they had on me in 1999 and 2008.

Treating real estate like a retirement account means I didn’t expect cash flow, I sunk all the money coming in to buying more and paying them off. “Luckily” I never made more than $60k/yr working. So it only took about 4-5 years to replace my income and 8 or 9 to “feel financial free” it’s not overnight, but I had been taught people worked 40 years and it felt like overnight.

I used to say I did it before the Internet forums and real estate craze, so obviously it was harder. I didn’t know anyone that owned a rental, or even a 2nd home. But now I watch people fail to start because it’s too hard, it’s not overnight, other people are doing better, people who aren’t doing it say it’s risky. So maybe I had it easier.

Nobody, especially me can tell you what’s right for you. I am only so passionate because it has truly blessed me. When my employer closed up shop I was probably the only person that didn’t care. I finally went on a 20 day Baltic Sea cruise the next month.

Sorry. I tend to ramble but thoughts keep coming up. Good luck with whichever path you choose. I don’t know what the future holds for this country but it has been a great place to live, work, invest, and grow older.

Javier Carrizosa · Answer

@Bill Brandt

I'm so slow at this, so, is it ok then say a net worth for that 200k property is 120k regardless of all I brought up?

Javier Carrizosa · Answer

Thanks for the insights! I don't know, lately I've been thinking if I would still want to be doing this whole landlord thing in the future and therefore trying to figure out if there was an tax convenient way of liquidating all rental properties and live off a brokerage portfolio. I know the properties would perform better but at the same time the headaches that come with it.

I'm just exploring what if scenarios at the moment.  I guess I really never thought how I would be dealing with the rental properties in say 20 years from now, or what is possible. Im missing a few chapters of rental investments, the after math!

If you solely have rental properties as your investments, what plays might be the best for retirement? I currently manage all my properties and thats what is getting me burned out. I figure for now I would self manage sense I've had bad experiences with PM, one, being very slow at getting things resolved and two, the contractors they usually get seem to charge the highest rates possible!

Bill B. · Answer

Do you do the same calculation on your retirement funds? I bet nobody else does. And they’re facing 30-40-maybe 50%% combined state and federal taxes. On 100% of the balance. Not just the gain.

I would suggest you just treat your investment properties like retirement funds. Borrow against them tax free if you need the cash. But then you also get the massive tax break of leaving them tax free to your heirs. Instantly your investment properties are worth 40-50% more than retirement accounts.

Would you rather be left a retirement account with a $1million in it with required minimum distributions that are added on top of your regular income. (Lucky to end up with $500k?)  Or a $1million paid off property you could keep for the income, depreciate for the tax writeoffs, or sell and net $920k tax free. Seems like a no-brainer.