Should I sell my 1year old investment property.

Question

Hi Bigger Pockets.

I am a new investor that purchased an investment property last year in LA. I had some cash on hand and was ready to get into the investment market and I hoped that the rates would come down in a year or two given how high they crept up. So I purchased a property that rented quickly and for a great price ($6000/mth) but I still had to cover a portion of the mortgage (close to $2000). My thought was that I could refinance once the rates came down and at least get closer to breaking even, and in the long run, cash flow. I am regretting this purchase now since my guess was wrong and it probably wasn’t a great investment to begin with.

Unfortunately, our family situation has changed. I have a new baby and although we currently have a fairly new single family home in a nice community, it’s does not have yard space and the 3 levels is not helpful for the potential of aging parents visiting or even moving in. So we would like to purchase a new single family home with more outdoor space and less floors. We purchased our current home during COVID at a great price and have great equity in the home as well as a sub 3% interest rate so we are not inclined to sell this home as it would rent easily and cash flow right away.

The LA home market is pricey so we need some cash to get a new primary residence with a solid down payment and will likely have to sell one property. Should we sell the investment property (8% interest rate and requires $2k/mth out of pocket), sell the primary residence (3% interest rate, >$400k equity), or use some other means to get the new primary residence (HELOC, take money out of index funds/retirement,refinance and don’t sell anything) , or just wait?

Sheronda Smith · Answer

Thanks for all the feedback!  It’s super helpful

Dan H. · Answer

At 0.5% rent ratio, 30% does not come close to working.   The property tax alone will be real close to 20%.  That leaves 10% for maintenance/cap ex, pm, insurance, vacancy.   I suspect 40% will not be sufficient if allocating maintenance/cap ex for sustained basis (meaning full life cycle of all items).  In addition, experienced investors are unlikely to accept 5% cap on single family home.   In my view this was always true, but with the net rest rates much higher than 5% this would result in the investor being in the same situation of the OP.  The OP got here via poor underwriting and it could happen again, but I consider it unlikely.  It s not a good investment property and most investors will quickly recognize this.   ADUs have valuation issues and is a poor investment if a hands off addition (meaning owner does not have an active role in the ADU addition).  I see no reason to keep this as an investment property.

The OP will get best value selling this property to an owner occupant.

I do not say this to be mean, but I do not have confidence that the primary will “cash flow right away”    Take the rent multiply by .6 the subtract P&i    This reflects a 40% expense ratio.  My belief is that it will be a negative number and it is likely not a good rental (but getting a good assist from the low interest rate).

Thoughts for OP:

- first step is decide where you want to live: current home, current rental, a different home.

- you do not want to keep the rental as a rental.   It is a bad rental

- your primary has a good loan which makes it a better rental than the current rental.

- you have to decide where you desire to live between current home, current rental, new property.   Any choice other than moving into the rental implies you should not renew the tenant’s lease at the lease end and sell the rental.

- as indicated, I suspect your current primary does not have decent cash flow but that interest rate is no longer attainable.   If you decide to not continue to live in your primary do the above calculation to get a different cash flow estimate (I expect it to be negative).   Then weigh the (negative?) cash flow versus the positives of appreciation, equity pay down, tax advantages (mostly depreciation and other write offs).   In Los Angeles (or San Diego) in this market I would easily choose to keep a class b or higher property if it was only a few hundred negative a month at a high LTV.   In my San Diego market, my worst appreciating property has appreciated $2700/month over its hold.   I have a few properties that are near or over $10k/month of appreciation over the hold.   Do I care about a couple hundred negative on a property or two?

Good luck

Tyler Thorson · Answer

Congrats on the baby!  My advice would be to take your lumps and sell the investment property.   It's a bummer to make a mistake but it happens to all of us.

Is it a single family?  If so, you may want to wait until the lease expires first (so you can kick out the tenant and maximize the sale price).

Sheronda Smith · Answer

Thanks Theresa.

That’s sounding like the only reasonable option at this point. Thanks for the feedback!

Basit Siddiqi · Answer

It looks like at the very minimum you are cash-flow negative $2,000 a month if there is no major renovation. If there is a major renovation, you might be out more than $2,000 a month.How much is the property appreciating on an annual basis?If the property is appreciating signifcantly, you may be actually winning on this property but it is hard to tell.Best of luck!

Rick Albert · Answer

Did you factor in the tax implications, if any, when selling the investment property? Are you intending to sell the investment property with tenants in it? These can change anyone's recommendation.

I wouldn't focus on the interest rates. That's a trap many people fall into. Just because something is a low interest rate doesn't mean it is worth keeping.

Can you pivot on the investment property to generate more cash flow? For example mid term rental for fire victims while their homes are being rebuilt? Would it actually make sense to put more money into and build out an ADU? The ADU alone might close the gap. The money can come from a HELOC, etc.

How much equity do you have in your current home? That money is going to be tax free and generally speaking a three level home with no yard can be a tough sell. Your buyer pool is very small for a property like that. I've sold homes like those in the past in LA and it ends up being a price play. Maybe taking the liability away with tax free money makes more sense while pivoting the investment property.

Another option that wasn't talked about was moving into the investment property, refi into an owner occupied rate, and then sell the old primary where, again, the money is tax free.

Rick Albert · Answer

So now you brought up a sticking point: Selling with tenants in place.

A single family home will likely sell for more vacant than with a tenant. If you are hoping to sell with the tenant in place, then it becomes an investor play, where the numbers have to make sense. If you sell vacant, then you follow the comparable sales in a neighborhood.

For example:

Selling as an investment property:

Rent is $6,000/month= $72,000/year

30% for property taxes, insurance, vacancy, cap ex, etc.: $50,400 net

If an investor wants a 5% CAP rate, that's a $1,008,000 value.

But typically we see about the .5% rule (versus the 1% rule of rent versus price), so that means comps are likely showing around $1,200,000 as a valuation.

Of course this is all hypothetical because I don't know about the home, what area, etc. But with this example you are leaving $200K on the table.

Also yes you are losing $2K/month, but that may not factor in tax benefits, loan buy down, and appreciation. You might be making that up in unrealized ways.

Putting my investor hat on, I would consider finding the money to convert the garage into an ADU and generate income. The challenge is your tenants have the rights to use the garage, so it may be after they move out. In which case then you can consider selling.

Sheronda Smith · Answer

I suspect that the tenant would actually like if the garage was an ADU because they have a large family. That may be an option worth considering.

Thanks!

Jake Yuskaitis · Answer

Why did you decide on LA as your area of investment?

Should I sell my 1year old investment property.

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