Monitoring Financial Health: Real Estate Term

by | | Other Cool Stuff, Retirement

Real Estate Term

What is Real Estate Term?

Real Estate Term indicates the number of years you could live on your current real estate equity. Real estate equity includes homes and investment properties, minus related debts.

Real Estate Equity / Annual Living Expenses = Real Estate Term

Example: If you have a home worth $600,000 with a $300,000 mortgage, and you spend $100,000 per year, your Real Estate Term is 3.0. $600K home value – $300K debt = $300K equity. $300K equity / $100K spending = 3.0.

Real Estate Term (Rt) is one of four Elements that make up your Total Term.

Why is Real Estate Term Important?

Real estate is a big part of many people’s net worth. This makes real estate a major factor in whether you are prepared for financial independence.

Real estate is unique because it has a financial aspect and a sentimental aspect. Kids grow up and memories are made in places that also happen to be worth hundreds of thousands of dollars.

Real estate is also illiquid, which means you can’t easily convert it to cash to fund your lifestyle. You can sell real estate, but it may take longer than you hope, and you might not get the price you want. You also have transaction costs, including a sizable commission unless you sell on your own, plus tax in some cases.

Personal-Use Property

Personal-use property includes your primary residence and vacation property. This is where the sentimental aspect of real estate lives. Everyone puts their own price on that.

Now let’s focus on the financial aspect. Owning, maintaining, and remodeling personal-use property can consume a sizable chunk of household income, depending on your taste in real estate. Your equity in personal-use property makes your net worth look nice, but you can’t spend it.

Be realistic about how vacation property fits into your financial independence plan. Some people wouldn’t sell their vacation home for any reason and will pass it on to their kids. Others enjoy vacation property but would sell if the time is right.

Investment Property

Investment property is property you own purely for investment purposes. It may generate cash flow to help with other expenses, or it may just pay for itself. As with personal-use property, equity in investment property makes your net worth look nice, but you can’t spend it.

Improving Your Real Estate Term

To evaluate the health of your Real Estate Term (Rt), look at it in relation to your Total Term (Tt). Rt is how long you could live on just your real estate equity. Tt is how long you could live on your entire net worth.

Healthy Rt

A healthy Rt is only a moderate percentage of Tt. This means you’ve built substantial assets outside of real estate, which gives you more flexibility to cut back shifts and retire, without accessing your real estate equity.

Needs Work

If Rt is a high percentage of Tt, you’ve haven’t built as much in assets outside of real estate. This means you’ll have less flexibility, unless you access your real estate equity by selling or borrowing against it. You may be feeling house rich and cash poor.

Ways to Improve

One way to improve your Real Estate Term is to downsize your primary residence. Along with a smaller mortgage (if any!), you’ll have less maintenance and remodeling cost. You could also downsize or eliminate vacation property.

Another way to improve your Rt is to increase your Savings Rate to build more assets outside of real estate. Add to cash reserves and nonretirement investments (increasing your Liquid Term), or to retirement accounts (increasing your Qualified Term).

Still another way to improve your Rt is to reduce your spending (or Burn Rate). Annual living expenses is the denominator in the Real Estate Term calculation. Even a small reduction in spending has a big impact.

Some options that relate to financing:

  • Consider not paying extra on your mortgage each month.
  • Refinance to lower your monthly payment.
  • Open a home equity line of credit as a safety valve to access cash if needed.
  • Do a cash-out refinance.
  • Take out a reverse mortgage in retirement.

If you own investment property, you can look for ways to improve cash flow, exchange into properties with more cash flow, borrow against properties if they’ll still generate cash flow after the new debt, or consider selling and paying the tax.

Do you know your Real Estate Term? Do you have a healthy balance between real estate and other assets? That’s where we come in. Schedule a FREE Financial Pulse Assessment™. This is a 3-step process to get clarity on your finances and “test drive” our services.

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