Asset Allocation Rethink - Overweight Equities ==> Primary Residence Upgrade

[Route246]

Retiring late next year, currently heavily weighted in equities, mostly 500-index funds plus a few stocks and odds and ends mutual funds. We live way below our means and have for our entire adult lives and have saved a lot through 500-index fund growth and the magic of compounding. I've also got an outsized overweight in three Mag Seven stocks that I also need to pare down.

That said, wife and I are contemplating moving upscale from where we currently live. CPA told me we could withstand a 75% contraction in the stock market and still be quite comfortable but it would be painful. This move is mainly a diversification play and if we buy a fixer-upper (the worst home in the best neighborhood and best location) it will give me something to focus on in retirement late next year so there is some benefit in that I would stay busy and occupied after leaving corporate life. I really enjoy home improvement projects and have decent carpentry skills to help out.

From a pure financial standpoint, we have plenty of cash and retirement accounts to generate living expenses once earned income drops to zero so no problem there as we don't spend much, anyway. The neighborhoods we are looking at are top-tier where many Silicon Valley elites already live. During every financial downturn the home values drop the least and drop last with respect to surrounding communities so I'm thinking of this as an asset allocation diversification play as much as moving upscale in our domicile.

I figure we would reduce our equities position 25-30%, pay capital gains taxes in the process and own an asset that has proven to have a decent, albeit lumpy ROI over decades of time. The tax bill is daunting but the diversification is alluring.

Any thoughts from a financial perspective if this makes any sense at all?

 

[Koolau]

^^^^^^^^

As far as a "real estate" play, I'd (personally) avoid investing in A house. I don't even count my living quarters as being an investment (not the way I look at stock and bond MFs, bank CDs, etc.)

Doing a fixer-upper may be fun and even profitable, but I'm guessing the potential down side is worse than most stock portfolios. We've seen down turns in markets - and, so far, they seem to turn around and eventually surge forward. Housing does that too, but a single house may just sit or find itself suddenly in a "bad neighborhood."

Just suggesting an awareness of the risks. Other than that, enjoy your retirement project. Let us know of your progress.

 

[marko]

I'd never consider the house I live in within an investment context except for calculating net worth. Yes, in a roundabout way, it can eventually generate gains and thus potentially usable "income", but accessing those gains is quite cumbersome. Income property is, of course, different.

 

[FLSUnFIRE]

I don't consider my home an "asset" but it does return imputed rent and owning free and clear reduces my cash-flow needs and makes tax management a bit easier. I'd consider the move as a lifestyle move letting that be the deciding factor and probably build myself a spreadsheet to evaluate mortgage costs vs tax impact (up front CG paid but lower CG/income later due to not servicing mortgage balance) to decide if I'd want to finance/use leverage. In hindsight, I'd probably have carried a mortgage but owning free and clear made quitting easier to do.

 

[Exchme]

I had a relative try this. After flipping several houses, they pretty much experienced the risks - the real estate market wasn't as hot as they hoped, the neighborhood didn't appreciate like they thought, the home needed more work than they thought, the repairs took more time and money than planned, there was minutia of getting permits and HOA permissions that caused headaches and delays.

They didn't lose, but didn't make much of anything, certainly not enough for the time and effort and even more certainly far less than the stock market would have returned had they just laid back on the couch and let the money work.

 

[pb4uski]

Like others, I don't consider properties that I live in as invested assets. This also applies to a Florida condo/winter getaway that we owned that was bought with portfolio funds... it was a lifestyle decision. It did work our ok from a financial perspective... we sold for 132% of what we had invested after enjoying the property for 8 years.

It sounds like you would have more than 25-30% of your assets in a single house, and at that an expensive house that will likely have high property taxes, maintenance costs, etc.

It doesn't sound wise to me. Sounds like you are trading your current house and 25-30% of your retirement portfolio for a part-time job and a more risky asset than equities.

Why don't you just reitre and enjoy life?

If you want a real estate tilt, buy some O.

 

[VanWinkle]

Saw a recent story on Michael Jordan's 15M dollar home that has been on the market for 15 years. Now that is not a liquid investment....... Hard to believe some billionaire wouldn't want to live in Michael's house.

 

[Mark1]

Any thoughts from a financial perspective if this makes any sense at all?

I doesn't make sense to me from a financial perspective to me, but if this is the neighborhood you want to live within, then it sounds like you have the the funds to afford it based on the following three statements.

...CPA told me we could withstand a 75% contraction in the stock market...
....The neighborhoods we are looking at are top-tier where many Silicon Valley elites already live...
.......reduce our equities position 25-30%, pay capital gains taxes in the process...

Of course, I'm assuming your net worth is at least 15 million and probably closer to 20 million range to make these 3 statements true.

 

[Fielding]

As @Mark1 points out, you are in a very unusual position. With your likely net worth, you could move to all but a handful of locations in the US and your Silicon Valley fixer upper budget ($3 million minimum I'm guessing?), would buy a palace in tip-top shape, or a stunning location, or possibly both.

I personally would be more interested in a vacation house elsewhere before I'd pour that much capital into some Atherton money pit.

But can you afford it? It does sound like it, yes.

 

[luckydude]

I would view this move as a lifestyle move. If you have enough assets left over after the move to cover your living expenses and maintain the house, I don't see why not.

But financially I would never tie up a big % of my assets in an illiquid, non-income generating primary residence. I don't see it as a wise move financially and would not do it.

 

[RetiredHappy]

You have posted here about your net worth. Any more expensive home that you would want to buy would be purely for enjoyment only. You can afford it, so just do it. But you should not look at it as an investment. I personally would never want to buy a home so that I can fix it but then I am not handy. Just buy a home that you would enjoy living in.

 

[OldShooter]

I don't think your idea needs to be evaluated as a financial decision. If I understand your post correctly, after the house purchase and improvements you will still have, separately, more money than you need to fund your retirement including consideration of market risk. So how you categorize your house project in your mind is totally up to you. It will not affect anything or anyone.

That said, Silicon Valley is probably the last place in the world where I would make a major investment. But I am not you. YMMV and bon voyage to you.

 

[Koolau]

You have posted here about your net worth. Any more expensive home that you would want to buy would be purely for enjoyment only. You can afford it, so just do it. But you should not look at it as an investment. I personally would never want to buy a home so that I can fix it but then I am not handy. Just buy a home that you would enjoy living in.

My thinking as well.

 

[skipro33]

Well, I DO consider my house an asset and it's not that hard to sell it, buy smaller or not at all and realize the cash it would provide me with for something like long term assisted living for example. In fact, it's part of my financial plan to use the sale of my home to fund that expense.

 

[Route246]

Thank you all for the comments. They are all greatly appreciated. First, a clarification. At this point I am no longer in growth and accumulation mode. We have more than enough to live on and more than enough to fund contingencies like comfortable long term care when that becomes necessary. I watched both parents go through hospice and long term care, all self-funded by my parents and their departures were comfortable, dignified and never caused any financial stress. My parents did a wonderful thing by saving for this, actually over-saving for this and it paid off for the entire family. I feel we achieved that for ourselves so that box is checked off.

With regards to current assets, 95%+ is in equities, much of it in 500-index funds. It is that way because once we achieved critical mass and I was still working there was little motivation to do AA adjustments into more fixed-income bonds and dividends. It just kept compounding and growing and the motivation to diversify became less and less as it kept growing.

Regarding asset allocation, paying some CG tax and diverting ~25% from investable asset equities to premium real estate is being considered for estate planning purposes along with the housing/lifestyle upgrade and retirement project aspect. I have no delusions of flipping this property for a profit, nor do I really care if our estate makes a profit on it after we are gone. The main consideration is that our heirs will benefit from a basis step-up upon our demise and are free to sell the home and do with the proceeds as they wish, tax-free. It is my belief that location/location/location never changes at this end of the real estate market so the tax laws are very kind to the "haves/rich/well-off" regardless of the "death tax" scare tactics that are employed to justify favorable tax policy for the well-off. I feel it is time we cash in some of those chips. The property tax in California is considerable so the heirs will most likely be forced to sell this property and take their inheritance from the proceeds. When my father died I marveled at how easy it was for my brother and me to receive 50% shares of the proceeds of his house sale in the form of a wire transfer that was devoid of any tax liability. I would expect the same to occur when we die as we have setup a family trust structured the same way.

To sum up, this would not be an investment in terms of expecting growth returns. I do however consider it an asset reallocation in that it is different from a BTD expense. If you use the OPEX/CAPEX model this is just a CAPEX acquisition, hopefully without the depreciation to zero after three years. OTOH, if you BTD on travel, dining, cars or manicures it is an OPEX play and yields nothing in terms of your estate being left to the heirs. At least a property in a desirable location will maintain asset value for our estate when we are gone.

Thank you again for all the great responses. This forum rocks.

 

[Route246]

I don't think your idea needs to be evaluated as a financial decision. If I understand your post correctly, after the house purchase and improvements you will still have, separately, more money than you need to fund your retirement including consideration of market risk. So how you categorize your house project in your mind is totally up to you. It will not affect anything or anyone.

That said, Silicon Valley is probably the last place in the world where I would make a major investment. But I am not you. YMMV and bon voyage to you.

Regarding the Silicon Valley assessment, I agree wholeheartedly, except I was born, raised, educated and prospered here. It is the only place I know and we are firmly grounded here, we are in a financial situation where we can easily afford the cost of living and the taxes so there is not much motivation to leave this weather which I believe is the best in the world from all of the places I've been to except perhaps the Côte d'Azur (Nice, Monaco) which has weather that rivals what we have here in NorCal.

If you are not in California the taxes here are insane, the highest in the US. The budgetary allocation for CG quoting directly from my CPA: "You’ll want to reserve 38.00% - rounding. The components are 20% federal income tax; 3.80% federal net investment income tax; and 13.3% CA tax on long-term gain."

I also view paying these high tax rates as a privilege, a privilege reserved for those who put themselves in a position to be assessed these high taxes. The alternative is not comfortable to think about.

 

[Koolau]

Well, I DO consider my house an asset and it's not that hard to sell it, buy smaller or not at all and realize the cash it would provide me with for something like long term assisted living for example. In fact, it's part of my financial plan to use the sale of my home to fund that expense.

I think the same way about my house - it is a potential source of cash to fund my/our stay in a LTC facility. But, semantically, I don't think of it as an "investment" - aka "financial asset" - but rather a back-up to my overall plan in which I would fund LTC with my LTCi policy. So to me, my condo is just where I live - not something that makes me money. Just semantics so YMMV.

 

[Koolau]

Thank you all for the comments. They are all greatly appreciated. First, a clarification. At this point I am no longer in growth and accumulation mode. We have more than enough to live on and more than enough to fund contingencies like comfortable long term care when that becomes necessary. I watched both parents go through hospice and long term care, all self-funded by my parents and their departures were comfortable, dignified and never caused any financial stress. My parents did a wonderful thing by saving for this, actually over-saving for this and it paid off for the entire family. I feel we achieved that for ourselves so that box is checked off.

With regards to current assets, 95%+ is in equities, much of it in 500-index funds. It is that way because once we achieved critical mass and I was still working there was little motivation to do AA adjustments into more fixed-income bonds and dividends. It just kept compounding and growing and the motivation to diversify became less and less as it kept growing.

Regarding asset allocation, paying some CG tax and diverting ~25% from investable asset equities to premium real estate is being considered for estate planning purposes along with the housing/lifestyle upgrade and retirement project aspect. I have no delusions of flipping this property for a profit, nor do I really care if our estate makes a profit on it after we are gone. The main consideration is that our heirs will benefit from a basis step-up upon our demise and are free to sell the home and do with the proceeds as they wish, tax-free. It is my belief that location/location/location never changes at this end of the real estate market so the tax laws are very kind to the "haves/rich/well-off" regardless of the "death tax" scare tactics that are employed to justify favorable tax policy for the well-off. I feel it is time we cash in some of those chips. The property tax in California is considerable so the heirs will most likely be forced to sell this property and take their inheritance from the proceeds. When my father died I marveled at how easy it was for my brother and me to receive 50% shares of the proceeds of his house sale in the form of a wire transfer that was devoid of any tax liability. I would expect the same to occur when we die as we have setup a family trust structured the same way.

To sum up, this would not be an investment in terms of expecting growth returns. I do however consider it an asset reallocation in that it is different from a BTD expense. If you use the OPEX/CAPEX model this is just a CAPEX acquisition, hopefully without the depreciation to zero after three years. OTOH, if you BTD on travel, dining, cars or manicures it is an OPEX play and yields nothing in terms of your estate being left to the heirs. At least a property in a desirable location will maintain asset value for our estate when we are gone.

Thank you again for all the great responses. This forum rocks.

Well, now I think I finally understand your plan more fully. (Sorry to be so dense.)

I'm guessing there are more efficient ways to accomplish what you want but your plan should w*rk. You have plenty of money, so even if it's not a perfect plan (and I'm I'm not saying it isn't) I see what you want to accomplish. Kinda unique approach.

In your shoes, I'd probably investigate such things as paid up life insurance instead, but this way you can live in an even nicer house and enjoy it until you "don't need it" any longer. Why not?

 

[Koolau]

Oh, I forgot to comment on your philosophy on "paying taxes as a privilege." I try never tell anyone else how to "feel" about something (anything, really.) You feel what you feel and that makes it valid for you.

For me, I hate paying taxes and I'm probably "irrationally self destructive" on the subject. IOW I'll "cost" myself some ability to spend money rather than "rush" the income source if it costs me more taxes. (For instance, I'll try to stay in a lower bracket rather than take more from my stash and pay the extra taxes - even though I could easily spend that extra for such things as first-class travel.)

SO, I'd say you are likely the more rational of the two of us. Good on you!

 

[pb4uski]

Well, I DO consider my house an asset and it's not that hard to sell it, buy smaller or not at all and realize the cash it would provide me with for something like long term assisted living for example. In fact, it's part of my financial plan to use the sale of my home to fund that expense.

I have a similar plan, but if we have to sell the house that we live in and use the proceeds for assisted living or nursing home care that is the last resort... IOW, plan Z. As a result, like many others here, I don't include either of my two homes as a cash producing asset for retirement planning... but I do include them in net worth since they are assets, they are just not assets that I plan to use for retirement funding... except as a last resort.

There is a benefit to owning the properties in that I have a place to live and don't have to pay rent, but I do have to pay property taxes, insurance, and maintenance instead of rent so my spending need is lower all else being equal.