Why Our Real Estate Values are Not Going Down On Our Net Worth
I have been getting several comments about the steady value of the real estate in our net worth given the decline of housing prices across the US. Am I ignorant of the US housing market crisis since I am currently overseas?
Value Reported is Our Cost Basis
The real estate line item in our net worth calculations have always been based on our COST BASIS. They are not based on the current value of our real estate. We benefit from it now, but we paid for it for the past 5 years as our net worth did not benefit from monthly upticks in real estate prices.
Given how illiquid real estate can be, I think its short sighted to use a mark to market valuation of our real estate like many folks do. I believe valuing it at cost basis is a conservative valuation given the long term time horizon of these investments. Profit (if any) will be recognized when the property is sold
Regardless of the valuation technique we use in our net worth statements, the location of the real estate (Raleigh, NC) is not suffering from the same degree of a housing slowdown being felt elsewhere. While real estate transactions in the Raleigh market appear to have slowed, housing prices appear to have only leveled off and not suffered from any significant valuation drop.
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Comments (3)
2 Milllion,
I'm a huge reader of your blog and often visit it.
In this case however, I think your thinking may be a bit restrictive. If I am hearing you correctly you are basically saying that you value your real estate as the price you paid when when you purchased the property - and your rationale is that because the market is illiquid, this is the proper value.
This reasoning seems suspect in two regards.
1) You could borrow on the current market value of your real estate, not on its last exchange price.
2) In some markets, the price and liquidity is actually quite fluid, e.g. it varies by month.
So, I think if you take a good look at the actual valuation, you'd find that for borrowing purposes and actual market dynamics predict a value different from the last time the place was actually sold.
Thanks again for a good posting and a wonderful blog.
Best,
james
Posted by James | April 12, 2008 11:56 PM
Hey James -- thanks for the comment.
I am not saying that valuing the real estate by its cost basis is the proper way to value real estate, but I think it makes sense for us to create our conservative net worth.
There are many factors at play here that will effect the value of these assets. Deprecation, market value, market efficiency, tax impact, transaction costs, are just a few. To sell one of these assets your likely going to take 6% right off the top plus extra expenses. In 10 years when the market value of these properties is 200% of the cost basis it might make sense to alter the value, but in the first 5 years of ownership I don't think it makes sense - it creates additional swings in net worth that causes unnecessary distractions in our goals.
Posted by 2million | April 13, 2008 2:49 AM
right there with ya, i also do cost basis. gives me a clear idea of exactly what profit we'd have if we sold primary residence or rental house, and it gives me better perspective on what they have actually cost.
Posted by finance girl | May 1, 2008 2:52 PM