Sell a rental or take out the equity?

Question

Hi all,

Very new at this. I have a goal to replace my wife's income for health reasons with some buy and hold properties in Hershey, Hummelstown, Palmyra and possibly Harrisburg, PA.

I own a rental with that I could probably get about 230k for, great renter currently (been there for 4 years) owe about 160k on the place. Rent barely meets expenses. So in the + column, it's just a little bit of equity build up and some tax relief with depreciation. (it's a home we moved from and didn't want to sell after the market tanked)

The market is picking up there. I can take out about 25k in equity with a HELOC and with a HELOC on our primary home have enough to buy and hold or flip one property.

I'm trying to decide whether I bite the bullet and sell the place (it's about an hour from us) or take out the equity and wait for an upswing?

J. Martin · Answer

Hi Dave,

Don't forget about the transaction costs if getting rid of the old place. You're probably going to end up eating 6-10% of the sales price, in addition to any tax implications, unless you sell it yourself.

I think of the net proceeds that could be generated by the sale as my invested equity.. Would you buy it today as a rental property today if you could buy it at around a 10% discount to market price (approximately what your net proceeds would be if you were to sell it). If not, then why are you choosing to keep your equity in an investment that you wouldn't like today? Do you plan on moving back someday? If you would buy it again at a 10% discount to market price today, then maybe the transaction costs of selling the house outweigh the perceived benefit of holding onto it.

..or maybe you just don't want to get rid of it because you used to live there!!

Either way, I think answering the question about whether or not you would buy it today at the same price as the net proceeds you could if you were to sell the property will give you a good idea if it worth having all that equity tied up. Of course, you can extract some of that equity without selling it.. Personally, I like to hold on to my properties if they're performing reasonably well and I can extract most of the equity while keeping the investment in place (are you going to deploy ALL of the equity if you sell it? or just need the marginal equity for this next deal?)

In regards to @Jefferson Miner 's concerns, a bigger danger that many did in the last boom was count on appreciation rather than cash flow when looking at financing repayment. Be sure you can withstand drops in cash flow, keep reserves, and as others said, look at the difference between ROE and cash flow returns..

Good luck with your soul searching! And on your investments!

..

Ned Carey · Answer

I would be tempted to sell and put the money into something that would perform better.

One thing to consider is your capital gains. If you capital gains tax would be a big hit then it might be better to refi and get cash out. If on the other hand you might have a loss you can carry forward that may tip the scale towards selling.

Jefferson Miner · Answer

Hey Dave,

I too got bit in the you-know-what by the market tanking a few years back.  One thing that I greatly regret during that time is that I used a HELOC in my primary residence to buy an investment property.  If, or when (if you read some economists), the "Fed Reserve Bubble" pops, we could potentially see a drop in real estate value.  I'm not a 100% subscriber to that idea, but on the off chance it does happen, you will be SOL if your primary residence loses whatever equity you have left post-HELOC.  Its a corner that is NOT fun to be backed into.

With that said, using a HELOC for shorter term gains and then paying it off quickly is probably a safer and creative way to get ahead.  Just get rid of that HELOC ASAP, since it is a lien on your primary residence!

Good luck, and if you ski/board, see you at Whitetail this season!

Ian K. · Answer

I'm in a similar situation.  Mine is making money and it's close, but I want to get more into REI so I'm going to refinance, even though I just did in March.  I talked to my broker and he said I could take out all but the 25% of equity that I need to leave in there.  So, I'm thinking about taking a cash out refinance of 150K and leave 50K in the property.  It will still cash flow a bit and the place is appreciating like crazy.  I don't know if this could work for you, but it might be better than a HELOC.

Dave Hyatt · Answer

Thanks all! Great thoughts and I really appreciate your time and engagement. I guess the issue was, that this worked as a residence but not as an investment. We had to move early due to an employment change and were stuck with a low market, buy high/sell low situation.

Sounds like it's time to take my lumps in the spring market and move on...ROI is that I've learned some stuff :-)

Sell a rental or take out the equity?

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