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Wednesday, February 14, 2007

Accounting for real estate in one's net worth statement

While I'm not a "personal finance" blogger per se, several personal finance blogs are places I frequently visit. One ongoing topic on those blogs is how to account for residential real estate in one's net worth calculations.

This is an area where personal finance meets High Finance, and where lots of fancy financial concepts hit personal reality. The choices vary greatly, from using a relatively conservative approach of going with your real-estate tax assessment, to bird-dogging comparables and using Zillow estimates to track your house price as if it's a stock.

Personally, I don't like using highly volatile measures to account for real property in the net worth statement, so we use a conservative approach: we use the appraised value of our house as of our last refinance. In the net worth spreadsheet, we regard "equity" as the difference between the appraised value and our mortgage principal. This ignores unrealized costs like the cost of selling the house, but this refi was several years ago and our house has appreciated enough since then (even accounting for recent price drops) that there's definitely enough "headroom" in our actual equity to cover this sort of thing.

This approach has the advantage that we capture monthly mortgage principal paydown, but other than that the real-estate part of our net worth stays fixed. This means the main contributor to our net worth changes is investment appreciation and savings.

I use Zillow because it helps me keep things closer to accurate. I don't want to count on an asset that I don't really have.

Also since similar homes in my area have dropped in value some 15%, it seems smart to stay on the conservative side.
I guess some part of this is the timing. My appraisal was long enough ago that _it's_ the "conservative" valuation; real-estate values went up about 60% since then, and have since dropped about 5-10% locally.

I still think tracking with something as volatile as Zillow introduces too much noise into net worth monitoring; part of the nice thing about watching your net worth is seeing it trend upward over time. Watching Zillow knock $20K off one month and add back $15K the next makes this a pain.

If I was to take a "conservative line" with Zillow, I'd only let it trend down, resetting the market value only as it drops. This way, one has a "pessimistic" net worth calculation. I'd note the current Zillow number as a "footnote" in the spreadsheet.
I use the value on the tax roles plus about 10%. I figure this is fairly conservative.

I agree that if people use pie-in-the-sky estimates of value, they may as well not even do a net worth statement since it's not worth anything.

The whole purpose of the net worth statement is to see how you are doing financially. You have to be honest or you're wasting your time.


In California, the "Prop 13" rules make the tax assessment not useful if you've lived in your house for awhile; the assessment is set at the price you paid when you bought your house, and changes 1% per year. This results in houses that are older being assessed at far less than market value, making it not so useful for net worth calculations.

But in states where assessments generally track market value, it's probably a reasonable conservative estimate.
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