Hold or Fold? Knowing when to Sell

26 Replies

For those who buy and hold - how do you decide when to fold (sell)?

Here's the situation: Bought several OOS properties starting 2.5 years ago. We "chose" this location because my husband was assigned there for work and we realized there were many other commuters like him needing housing and luckily nice housing was dirt cheap there at that time.

Our accidental niche has yielded financial freedom, class A tenants in class B/C areas, and great cash flow of ~ $1k per house after expenses (score!). we consistently have had a waiting list to get into our properties. We also have built an awesome team that makes self managing long distance manageable.

Unfortunately, several others have recently discovered our niche - increasing competition, driving down prices, and shrinking cash flow (we're looking at $400-600 per house after expenses for Oct - our worst month ever). In the meantime, these are 1960s ranch houses that have increased ~ 60% in value since purchase BUT I'm expecting that we'll start having to replace roofs and furnaces in the next couple of years, cutting further into profits.

The question: hold or fold? I'm considering folding b/c my husband has an ATL base starting in Nov so he no longer needs to commute to this location for work; AND it seems that our sweet spot niche is souring with a lot of cheaper competition...
We did make one house a traditional rental with solid margins but the tenant quality isn't as good versus our niche and it has been a headache.

I'm wondering if we should sell the 4 OOS houses in 2018 before capital expenditures start to hit and then roll the profits into a small apartment complex where we live. We have 4 units here and Ive found self managing locally much easier.

On the flip side, we're still doing pretty well and it's likely that these houses will appreciate further as they are still well below the highs seen at the last peak.

Is there a rule of thumb for how long to hold properties? Would you hold or fold?

This is a generalization, but *generally* the longer you hold the property the more profitable it becomes. You buy properties in 2000 dollars but utilize them in 2017 dollars. Capital expenses tend to level out over time, rents tend to increase, and trying to time new roofs & new HVAC at the same time as a market high is like trying to time the stock market. If you have made acceptable profit on these homes and don't want them any more, sell and move on. If your motivation is more or less strictly financial, there are a lot of places in the US where people who had property 25 years ago say "Boy, I wish I never sold that house". 

@JD Martin good point about inflation - I like the idea of year 2000 dollars yielding year 2017 rewards...will give this some more thought.

Also - apologies for the double post! Did this from my phone and didn't think it went through the first time

 I would highly consider selling. I disagree with the previous post. The longer you hold a property the less your return on investment is. This is due to items like the capital expenditures that you mentioned and the overall use of leverage on your money. there is definitely a benefit to holding onto properties forever, but you can accelerate your profitability and return on the original investment much faster if you sell those properties and exchange them into a profititablemulti family in a growing market

I've been selling a couple of my least favorite rental houses a year since last year. As they turn over, why not sell into the froth? Went under contract on my current one FSBO in 3 weeks.

I am careful with taxes though.  2 houses is my max per year if not exchanging.  No sense in building it over all these years only to sell too many at once and get into new tax thresholds.   I fear 4 at once will net cost more than spreading it out over 2 calendar years.  Doesn't have to be all at once does it @Ericka Grant ?  

Awesome work with having 4 OOS. 

It sounds like you're a little more excited about a local deal! In all reality you could do a 1031 on the properties and put it towards a new complex locally. I think it really depends on when you think those cap ex costs are going to come into play. Are all four HVAC systems on their last legs? Also what are they? SFH, Duplex, Triplex?

Personally, a SFH in this situation, I'd be more willing to sell. A multifamily (with room to grow on rent) would be a good idea to keep up spend the cap ex and raise the rent. Although it wouldn't be a commercial deal, lenders still take into account income.

Thanks for the varied input, gives me a lot to think about...

@Todd Dexheimer definitely see some capital expenditures coming. One property in particular will likely need a new roof and boiler in the next few years. HVAC and everything else is in good shape on these - roofs are what scare me

Steve Vaughan Tax point is a good reminder and something I always forget about, will think about staggering the sales (if/when we sell) to avoid a big hit there - definitely planning to roll the $ into another, bigger property, though, so that will help too

@Josh Calcanis I'm definitely finding managing local properties easier though our team OOS is WAY better than the folks we work with locally. The ones OOS are all SFHs and I see at least one of them needing a roof in the next few years. We had a great thing going but now I'm concerned that increased competition in our niche will limit our ability to raise rents. We'll see

@Ericka Grant

I could see where the competition coming in below market rent could really disrupt your cash flow, but if they're right around market rent, if you're competitive you should be alright.

Also, imho, if you're providing the value worth the rent it should be great whether or not the competition is there. Downtown Orlando is relatively competitive and we still were able to raise rents over a year and a half. We did have to remodel one of the kitchens in the triplex to raise rent for one v.s. another unit where the tenant said there is no need to remodel if we took $100 off the rent.

good luck on your decision

Bundle it, sell to your competition leased at market rates and as is. 1031 into a apt complex then when your previous competition can not afford the capex because they are over-leveraged by back at discount and continue on...

Originally posted by @Ericka Grant :

Thanks for the varied input, gives me a lot to think about...

Todd Dexheimer definitely see some capital expenditures coming. One property in particular will likely need a new roof and boiler in the next few years. HVAC and everything else is in good shape on these - roofs are what scare me

Steve Vaughan Tax point is a good reminder and something I always forget about, will think about staggering the sales (if/when we sell) to avoid a big hit there - definitely planning to roll the $ into another, bigger property, though, so that will help too

Josh Calcanis I'm definitely finding managing local properties easier though our team OOS is WAY better than the folks we work with locally. The ones OOS are all SFHs and I see at least one of them needing a roof in the next few years. We had a great thing going but now I'm concerned that increased competition in our niche will limit our ability to raise rents. We'll see

 There's nothing scary about a roof. It's sheathing, felt paper, and asphalt shingles. Most of them, anyway. And unless you have a gargantuan house, they're really not that expensive. I did two in the last two years and spent less than $10k combined, and one of them was a 3br/2ba ranch with several roof lines. A $5000 roof, amortized over 25 years (arch shingles are 30 but being realistic), is $200 per year. That's not even $20 per month of capex on just about the most expensive capital project you'll deal with in a rental. 

Sounds like a good time to do a Return on Equity calculation. Go from there.

This appears to be a case where there was a temporary housing/rental shortage with little barrier to entry...those don't last long.

Many investors feel that it is prudent to map out your exit strategy(s) at acquisition. This is especially true in the commercial world where the financing terms need to match the strategy and when investor capital needs to be returned. It fits for the SFR world too...helps keep emotion and uncertainty out of the exit decision. It's hard to calculate estimated returns (IRR) when buying a property if you can't or don't forecast the exit.

IMO, the best way to decide how to allocate capital is to compare alternatives.  Figure out your estimated returns holding them (as if you just purchased them) and compare that to your estimated returns for investing the money elsewhere.

Good luck and congratulations on the added value.

@Matt K. I think most of our recent competitors are novices like we were 2.5 years ago who stumbled upon this opportunity, not sure any of them will be ready to buy 4 at once BUT we might be able to sell off individually if we can get the word out to the right niche of folk - perhaps via a trade magazine or website. Great idea if we decide to sell!

@JD Martin that's reassuring to hear. I wasn't previously scared of roofs but several months ago went to a REIA event in Atlanta where a very well established flipper opened up her latest rehab, a small bungalow, and when she said the roof on that tiny place cost $8k I was floored. It is good to hear there is a range. These are small houses so hopefully the roofs will be on the lower end of the scale. We'll see

@Dustin Beam good idea - not familiar with that calculation but will google it. If you don't mind sharing the formula that you use that would be great. We own 3 of the 4 outright and one is leveraged with a VA loan - not sure if that impacts the recommendation

@Josh Calcanis we definitely provide value and are considered the best but these new guys are charging 30% less for a similar offering and our niche, tho class A with solid income - is price sensitive because this is a second home while they commute/are on call for work...I may try to mystery shop some the competition and get more info on what they are offering

@Mike Dymski great points - I will run a couple of scenarios and see where things land.

You're right that we had the perfect market entry conditions, but amazing bargains + rental shortages can't last forever. Initially the rough plan was to sell when the properties doubled in value, especially if we could get to that point before any major capital expenditures. using that rule of thumb we can sell 2 in the spring (both have doubled or nearly doubled and are also the 2 with the most capital expenses coming up) and roll that into something in ATL and hold onto the other 2 a while longer. Eureka! This is why I love this site - all the various advice has just helped me figure out a viable next step. Thanks all!

Originally posted by @Ericka Grant :

Dustin Beam good idea - not familiar with that calculation but will google it. If you don't mind sharing the formula that you use that would be great. We own 3 of the 4 outright and one is leveraged with a VA loan - not sure if that impacts the recommendation

I think what Dustin was referring to is calculating what kind of investment return you are getting from the equity in each property.  For example, if your property is worth 100k and you have no loan and you are getting 20k net profit each year, then you are getting 20% return on equity.  If you own a property worth 100k, but have a 50k mortgage on it, then your equity is 50k, so 20k yearly profit would be 40% return on equity.  Therefore the formula would be:

Net yearly profit/[market value of property-loan amount]=ROE

Multiply by 100 to convert to %.

One option to consider is doing a cash out refinance on some of the properties and redeploying the capital toward other investments.  That would increase the ROE.  However, it would also increase the risk as your cash flow would be reduced and you would now have a leveraged asset.

I wouldn’t just blow out of them. Id either ride it out, or I’d tap into your A+ tenants. I’m sure they’d love to be homeowners, and holding the note on a sale to them gives you the best of both worlds. Cash flow, less maintenance, and most importantly leverage! Good luck with whatever you decide.

@Ericka Grant From personal experience I would sell and buy the property close to you. It will be a lot harder to coordinate all of the upcoming capex at a distance and making a 60% profit on an out of state investment is a win in my book. You never see people posting on here saying they made that kind of money OOS. 

Now sell and 1031 the profits into a bigger building that will be easier for you to manage locally. Just my 2 cents. 

@Ericka Grant

Every year I sell a few properties, though a primary focus is buy and hold.  Usually a review the property performance at the end of the year when going over income, expenses and profit.  I usually don't give major consideration to the component replacements, though i do track the age of furnaces, hot water heaters and roofs on every property with a spread sheet.  Furnaces and roofs last a long time.  

I'm just replacing a 1952 furnace last week, not because it failed, but because I'm selling the former rental and want to prevent buyers from thinking, "Wow that's an old furnace I'm going to have to replace it soon."  The common thought is not reality.  Many of the older furnaces are better built with cast iron heat exchanges, versus steel in later models and have no electronics to fail. I've replaced 10 year old furnaces and 6 year old water heaters because they have failed, but have had 60 year old furnaces and 35 year old water heaters that continue to work trouble free.  So age is not the only factor in how long mechanical components will last.  

At a 2 unit I switched from central heat to individual heat with the tenants paying their own heat bill.  Due to not having a lot of money, I retained the old furnace to heat the first floor and added a new furnace on the second floor.  My thought was that the older furnace would last for a few more years and then when I had more money I'd replace it.  It kept running for 40 more years and never quit, I finally replaced it right before selling.  (Efficiency is a whole 'nuther topic.)

At a 1955 house I just replaced the roof; our standard procedure is to remove all old roofs at that time.  It was discovered that the roof underneath was the original roof.  so I was replacing a 62 year old roof.

At a 1890 house I sold it when it was 120 years old with the original roof albeit slate.  The neighbor with the identical house and roof had replaced the slate with shingles and was doing his second replacement before I did my first.

The first house I bought was a 17 year old ranch house that the roof was just replaced due to wind damage.  I kept the house for another 24 years, never had any roof problem and never replaced.

I've bought and sold over 900 properties and have replaced many roofs and furnaces, neither of which scare me.

Factors I use to determine if I'd selling a buy and hold include profitability, distance away from me, proximity to other investments I own, schools, crime, and neighborhood desirability.  The roof and furnace are way down at the bottom of my list.  And it is a rare, very rare occasion where I have lowered rent even in a recession, so even if the value has declined and the rent has remained the same; I'm more likely to keep that property rather than sell.  I'm looking for long term tenants, several have stayed over 30 years, so the fluctuations of market value are irrelavent to me except when I'm selling.

Bigger Pockets Podcast Guest #82

Originally posted by @David S. :
Originally posted by @Ericka Grant:

Dustin Beam good idea - not familiar with that calculation but will google it. If you don't mind sharing the formula that you use that would be great. We own 3 of the 4 outright and one is leveraged with a VA loan - not sure if that impacts the recommendation

I think what Dustin was referring to is calculating what kind of investment return you are getting from the equity in each property.  For example, if your property is worth 100k and you have no loan and you are getting 20k net profit each year, then you are getting 20% return on equity.  If you own a property worth 100k, but have a 50k mortgage on it, then your equity is 50k, so 20k yearly profit would be 40% return on equity.  Therefore the formula would be:

Net yearly profit/[market value of property-loan amount]=ROE

Multiply by 100 to convert to %.

One option to consider is doing a cash out refinance on some of the properties and redeploying the capital toward other investments.  That would increase the ROE.  However, it would also increase the risk as your cash flow would be reduced and you would now have a leveraged asset.

 Right. It's a good way to look to see if your equity in your property is working as hard for you as it could. You also have to consider your comfort level with riskk.

Using the example above, could you sell the 100k house and buy something around 400k? Yes you could. 

Would it bring you more than 20k a year, and if so are you comfortable with the leverage? That's what you have to consider. If it does but only by a small amount, maybe it's not worth the risk. Maybe it's twice as much and is worth the risk.

Whether people are consciously thinking about return on equity or not, it's what makes 1031 exchanges work well for some people.

@Ericka Grant  This is a no brainer - sell.  You mentioned the properties have increased 60% and you own 3 outright.  You should realize the equity and appreciation then 1031 into ( insert your choice here).  You’re in a great position right now.  Best of luck to you.  Also listen to bp podcasts 238 there is a lot of applicable info to your situation.

Price and profit is one concern, but also remember tax liability, cost for marketing and closing cost, etc.

This is all very helpful and has given me a lot to think about.

@David S. and @Dustin Beam thanks for clarifying the formula - started to run those numbers but they don't look great when you own a property outright

@Michael Noto yeah, we bought at a good time - found a gem of a neighborhood right before the values started to rebound 

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