Questions about factoring real estate holdings into FI planning

[Eli Altman]

Doing FI (financial independence) math is simple when you're only invested in stocks/bonds. Knowing your savings rate, and expenses + using tools like Networthify/FIREcalc get you there pretty quickly. MMM talks about how easy it is, and also says the real estate can be a part of a FI plan. I just haven't found any specific guidance for how to incorporate RE into the calculations.

Should I be basing it off net income? Equity? Both? Equity isn't accessible in the same way it is with ETFs – buying and selling is a much more involved process. Net income isn't stable to the point of being able to count on a specific withdraw rate. 

So what's the best way to think about real estate holdings as a part of a FI plan?

[Jim K.]

@Eli Altman

This is what we do. It's quick and dirty and works great. Keep in mind I am a renovation contractor and a self-managing DIY investor. I don't many have sudden, outsized expenses related to the deferred maintenance of properties that jump up and bite me in the a$$, because I know my properties like the back of my hand and I am the handyman handling the maintenance on them.

What's your free and clear annual cash flow per property? And I'm talking REALLY free and clear, after generous vacancy allowances, projected capex, current borrowing costs, mortgage interest, no funny numbers, no BSing yourself about how long the water heater and the furnace and the roof are are going to last. Eliminate short-term-itis by asking yourself what's the viability of the property to continue providing that free-and-clear cash flow for the next twenty years within your estimated free-and-clear cash flow. Figure out how much you save tax-wise on any other income because of this property. Your CPA can help you with this. Do you have rental properties and no CPA as a frugality measure? That's a silly move that you should remedy as soon as possible.

Multiply the annual cash flow number you get by 20. That gets you to a realistic figure of what the property is worth as a long-term holding in terms of net worth in the portfolio of someone heading for FI. Assume no appreciation or depreciation of the property whatsoever. Reassess this number every five years based on the performance of the property and the amount of debt left on the property.

If you do this properly, all your surprises will be good ones.

If, on the other hand, you are speculating in zero-cash-flow properties that you believe in your heart of hearts will appreciate and make you rich, I wouldn't feel confident saying that you are investing in real estate with FI as a goal. We have ten times the holdings in real estate that we do in the stock market, or rather, that we anticipate leaving in the stock market over the long haul. I have very little faith in the 4% rule, because a misspent youth taught me again and again and again that dice have no memory and I see more and more people investing in broad-based index funds every year.

One of the few truths I know about the stock market is that when investment is concentrated in a specific sector of the market, manipulating that sector becomes a very profitable endeavor.

So what would it take to manipulate the value of VTSAX holdings?

This terrifies me, ergo, my FI strategy.