Asset Allocation question

My financial planner is concerned that I have a high percentage of my assets (equity) concentrated in a single asset class.

This planner wants me to either sell some of my investment property, or refinance to increase the LTV. Then he is telling me to invest the sale or loan proceeds in a different asset class – the stock market/bonds/etc.

Are there any high net worth investors who have also faced this issue? If so, what asset allocation ratio are you using and what asset classes are you invested in?

I have about $2MM equity in my rental properties, and about $500K in cash/CDs/stocks. My planner is not suggesting an asset allocation ratio yet, just telling me that he would like to see me lower my equity concentration in real estate.


Your planner raises a valid point. Using your numbers you have 80% of your equity exposed to the RE sector while only 20% is exposed to other more liquid assets. There are two goals of asset allocation; one is to diversify your holdings so as not to be overly exposed to a single asset class the other is to participate in the returns generated by multiple asset classes. There are studies that suggest 80-90% of total portfolio (RE,stock,bond,cash) return is determined by your asset allocation decision and only 10-20% comes from the actual selection of the underlying assets (ie.stockpicking).

Before you liquidate some of your RE equity and reinvest you should consider what your tolerance for risk is and also your investment time horizon. That is do you need to liquidate any assets in the short, medium or long term to pay for life events. I won’t make any recommendations for your situation but will share my general details for reference.

I am a financial market professional by trade and a RE investor as secondary occupation. My net asset allocation is approximately 50% stocks/bonds, 25% RE, 10% private equity and 15% cash. Obviously the numbers are driven by our comfort level and area of expertise. Hope this is helpful.

I would tend to agree with his desire to see more diversification. As we are seeing today, having all of your eggs in the RE basket can be dangerous when the market softens.

Having said that, I’m not sure that borrowing against equity to invest elsewhere is the answer. That adds to the RE risk side of the equation at the same time as you add risk to the stock side of the equation (while more “balanced” you have also increased total risk). Ideally you would want to remove risk from the RE side to move it elsewhere (achieve balance without increasing total risk).

just my 2c. I’m not a financial planner.

I’m in not too different situation than yours and had several people look my porfolio. I would agree with other that borrowing to pull equity out seems a bit iffy.

I think the real core of the question is what is your time horizon and risk tolerance. Obviously real estate is relative illiquid of an asset and expensive to cash out, but real estate does not drop 10% in one week because a group of analysts thing that earns growth a company or sector of stocks is too low and can provide a very steady stream of income regardless of the underlying asset value.

One thing that seems to frequently unaccounted for in the move from asset class A to B is the transaction cost. On paper would might have $100k in equity, but by the time you get funds in your hands net of taxes you might $60K. This is where the discussion of time horizon really comes into play.

In my case, I’ve decided not to plow any new money into real estate and keep an eye out for opportunties to move money out of real estate if it make sense for a specific purpose rather than generically “you-need-to-reallocate”

Thank you all for your feedback.

I got some working numbers from my planner. Since I already have one year’s living expenses in cash and bank CDs, he is telling me not to touch that, just keep rolling over the CDs until I have an emergency need for the money. For the rest of my investments, he is suggesting that I lower my real estate equity to 60%, and increase my stock portfolio to 40%.

He really wants me to sell some of my real estate as market conditions permit and reinvest the proceeds in stocks and bonds. I balked at selling due to the high cost of liquidation (unrecaptured depreciation, capital gains, sales commissions, etc), so that is when he said to consider pulling cash our of equity with targeted refinances.


If I were in your California real estate market, I would be sitting on the sidelines, too, these days. If you are not plowing money into real esatte, what are you doing? As it is now, I am also sitting on the sidelines in my markets. I am making offers on REOs and even attempting the occasional short sale, but the banks are not flexible enough on pricing yet to accept my deeply discounted offers.

Instead, I have just been working on debt reduction. Even though we just refinanced our primary residence, we should have our home free and clear in six to ten years.

Right now, I am using excess cash flow to increase replacement reserves. Later this year (maybe in Jul), I will start accelerating debt reduction on the rental property with the lowest mortgage balance. I figure that I should try to get some more of my properties free and clear so I will drop below the ten financed property limit that is keeping me from getting conforming loans. In years past, I did not worry about it because a lot of lenders had Alt-A programs. Not any more. My favorite portfolio lender just went out of the portfolio loan business this past August and now only does confoming loans.

To answer your risk tolerance and timeline questions, my risk tolerance is about 4 on a six point scale where 1 is the least tolerance for risk. My investment timeline is forever, or death whichever comes first, though I am using 40 years in all my projections. We are financially independent, have plenty of pension income, and don’t need to live off our investments. My wife and I retired from our W-2 jobs just before I turned 50 and we have been living the retirement lifestyle ever since. In a few more years, I will be eligible for the reduced social security benefit which will simply increase our monthly discretionary income

There are no major life events on the near horizon. No new home purchase, no marriage or divorce. The kids are grown and raising their own families. Should there be a medical crisis, we have great health insurance plans.


I follow your line of thought, but I don’t see much risk in rental real estate. Even if we have a prolonged period of consolidation before we see real estate prices move back up, my rental income does not stop. I always have to make adjustments in turnover rents in response to the prevailing market rental conditions, but my properties cash flow when I am above 60% occupancy.

On the other hand, stocks decline and companies cut or eliminate their dividends. I see much higher risk in the stock market than I do in buy and hold real estate.

Do I have blinders on?

He really wants me to sell some of my real estate as market conditions permit and reinvest the proceeds in stocks and bonds.

Where was this financial planner when RE was in a bull market?..Old saying is sell when you can not when you have to…My larger question is what is your annual ROI on the 2 million in RE?..

You and I are on opposite sides of the spectrum (you have most in RE and I have most in Bond funds,closed end funds)…But be very careful using financial planners…More often than not these people are failed traders that couldn’t hack it on wall street…I find they often have limited knowledge of risk…Risk is the greatest concern a high net worth individual deals with when considering diversification…

Do I feel you should move all of that into stocks?..No…I wouldn’t advise that…Nor would I have my own parents loading into the market…I’m 37 years old and I’m guessing you are late 50’s early 60’s?..Point being the last thing you need is to put that kind of money into the stock market and ride it down…The markets are in a bad place right now and I firmly believe it could get worse before better but who really knows…But someone at your age should not be advised to increase risk at your age…I manage my parents accounts and I use various lower risk tactics,such as bond ladders,closed end funds bought at deep discounts to dollar value,hammered down cyclical dividend stocks,bond funds and the dreaded money market fund…

Capital preservation is the main premise when handling size money…Be very careful using financial planners…

RookieNYC is exactly right. Ask your “financial planner” to see his tax returns. See if he is a multi-millionaire like you! If not, why in the world would you take advice from someone that is not as successful as you? He should be paying to receive advice FROM YOU!!!

I think diversification is overblown. Generally, people get rich by becoming an expert in one business. You are a real estate expert. Do what you do best!


Do you really have 80% of your investments in the RE sector, or are you running a RE business? If these are only “investments”, you might want to take what your planner says into consideration, weigh you own tolerance for risk, return, and costs of change, and act in what YOU consider your own best interest.

If this is your BUSINESS, then I can’t see selling off a piece of YOUR successful business to invest in HIS business.

Even if looked at as an “investment”, my RE returns a minimum of 10% yield/cap rate from rent only, regardless of appreciation. I’ll take that over gambling in the stock market any day.



This financial planner started telling me this in 2004. I did not listen, real estate was up and the stock market wasn’t. I using 1031 exchanges to buy pre-construction deals and doing pretty well so I thought I would ride the wave for awhile. Fortunately I stopped buying just before the market collapse.

I don’t have any investments with this planner. If I purchase any stocks, I will do it in my own Schwab account. I reopened discussions with this planner when I was looking for limited partnerships that would throw off 130%+ Low Income Housing Tax Credits. Unfortunately, he could not find any that he could recommend in good conscience. In the past, when the IRS only required these Low Income Housing Tax Credit partnerships to operate the housing projects for 15 years before divesting, these limited partnerships were plentiful. Now that the IRS has changed the holding period to 30 years to qualify for the LIHTC, these LPs are not looking as attractive. If any of you subscribe to Investment Advisor magazine, this guy is one of the independent broker/dealers of the year featured on the Sep 2007 cover.

If ROE = NOI / Equity x 100%, then my ROE is 3.7% through the end of 2007. On the other hand, my stock portfolio is generating a current yield slightly over 10% right now. If I sold all my rentals and 1031 exchanged into a TIC pool, I could get a 6% yield and defer all the capital gains.

I believe the planners thinking was to cash out equity in the real estate since I was resisting the suggestion to sell. Use the cash out proceeds to earn better yields in the stock market then use the income to either pay down my lower interest real estate mortgages or to invest in other income generating assets. Sort of a “velocity of money” thing that I did not really understand. I think the concept is the more your money makes, the more money you have making money.

A couple years ago, my Dad was telling me that he could not afford to sell any of his stocks. Because his cost basis was so low, he did not want to give a huge chunk of his capital gains to the IRS especially since any large sales would trigger AMT for him. He is 90 years old. His plan is to let his heirs enjoy tax free capital gains after the step up in basis. Now I find myself in nearly the same position with all my properties bought before 1986 fully depreciated. Newer properties were acquired with 1031 exchanges and also have a low cost basis and a relatively low LTV.


I do not have to sell anything. I also don’t have to do a deal to put food on the table. I am OK financially, even if I do nothing. I outsource property management. I just do enough to claim active participation. Although I employ good investment criteria and make business decisions rather than emotional decisions with my real estate activity, real estate is more of a hobby than a business.

If ROE = NOI / Equity x 100%, then my ROE is 3.7% through the end of 2007. On the other hand, my stock portfolio is generating a current yield slightly over 10% right now. If I sold all my rentals and 1031 exchanged into a TIC pool, I could get a 6% yield and defer all the capital gains.

Now I see why he advised you to sell more RE and invest the difference…%10 is very good, I’m getting %11.75 but I’m sure with slightly more volatility…Also my parents are in the same boat as your dad…

My only advice is make sure you are ready for a rockier road than holding RE…You are entering foreign waters of volatility with 2mill+ swimming around in the markets…If you can stomach that and you are comfortable then you have the answer…You are not in need of the money but all the same your RE isn’t doing enough with that capital…It’s really up to you…


Has there been any talk of estate taxes and probate?

Yes, I have been having infrequent conversations with a local attorney who specializes in estate planning. His first priority for me is to put all my investment property into a revocable trust to avoid probate especially ancillary probate for the out of state properties.

I hear what he is saying but I don’t want to lose the opportunity to use the net passive loss allowance to offset other ordinary income – at least for the next couple of years until my net passive losses from rental activities turn into net passive income. As I understand the tax code, the $25K net passive loss allowance is only available to individuals and can not be used by trusts.

The attorney’s second priority is to reallocate the investment property ownership between my wife and myself so we can maximize the opportunity to step up basis for the surviving spouse. He is suggesting that the investment real estate trust(s) in turn be “owned” by another trust or a business entity where my wife and I can declare unequal ownership interests at the stroke of a pen. In this way, if one of us is near death, that individual can become a 90% (maybe 99%) owner of the trust assets which in turn will allow the survivor to enjoy a step up in basis for most of the trust assets’ value.

As far as I am concerned, I want my wife to get everything. I have a “sweetheart” will that does just that. The spousal inheritance rules (today) allow me to transfer unlimited wealth to my wife free of all federal estate taxes. As the surviving spouse, I expect that my wife will need to spend enough of her estate to maintain her lifestyle to take her below the $1MM federal estate tax unified credit we will have in 2011. If I am not around, assisted living may be her only option, and that is not cheap. If my wife is the first to go, her will provides bequests to her children and grandchildren.

My goal for the next meeting is to update our wills and to begin drafting whatever revocable trusts are needed for our bank accounts and stock portfolio. I may hold off on transferring the investment rentals into trusts at this point. I am not convinced that SMLLCs are the solution here either. Perhaps a partnership LLC with my wife will meet all our estate planning goals although it will add an additional tax return to our tax preparation workload.

The attorney did mention a QPRT for the primary residence, but I have to admit that I don’t know what that really is nor how that will help our estate plan. I have some research to do before our next meeting.

I like revocable trusts for personal assets, but I don’t hold business assets in them. I prefer pass through entities with some kind of limited liability. I don’t want to create a nexus between business and personal assets through common ownership.

I suspect you mean irrevocable trusts. Revocable trusts are grantor trusts and most times use the grantor’s SSN rather than get their own EINs. Income/loss passes to the individual’s personal return.

I do the opposite. Various entities own the property or business and the entities are in turn owned by limited partnerships, whose ownership is divided between trusts and other entities. I find it an easier way to manage the properties and simplify taxes and accounting. I can also change ownership allocation without affecting the individual property or business.

That is a qualified personal residence trust and it is used to remove an expensive personal residence from your taxable estate. There are many, many rules, but the simple description is you live in the residence and pay the expenses for a set term. If you die before the term ends, the home returns to your estate. If you survive the term, the remainder beneficiaries get the property free of estate taxes (there are some gift tax issues when creating the QPRT), but you may continue to live in it as long as you pay market rent. A great reference on the subject is The QPRT Manual by Natalie Choate. It is a bit pricey compared to many investment books and it is written for attorneys who practice in this area. It is written in clear enough English for a lay person to grasp the concepts and land mines.

I would also suggest you include this attorney with the discussions of your financial planner and have your tax expert review everything as well. This level of planning should integrate financial, tax, estate, succession, and business planning.


I am referring to IRC 469(i). An individual receives a special allowance of up to $25,000 in rental real estate losses. This passive loss allowance is only available to natural persons. Since tax law does not recognize a grantor trust as a separate taxable entity, can we treat the trust as a natural person? I don’t think so.

A trust is an artificial entity. Therefore, in my opinion, rental losses within a trust are disallowed in the absence of passive income, and the $25,000 net passive loss allowance for rental real estate is not applicable. Losses would have to be suspended and “captured” as an adjustment to basis when the property is disposed of in a taxable sale.

I may be taking an overly conservative position here, but until I get definitive clarification otherwise, I am going to treat the revocable trust that holds title to my rental property as a passive acitivty for which the net passive loss allowance does not apply.

I guess we read the regs differently, Dave, but I understand your point and can see how you came to that conclusion.