Time to sell?

[Jonah Slove]

My fiancé owes a small 2bed 2bath townhouse outright. It was her primary with a roommate until she moved in with me, now it is rented fully. It is valued at $1.3mil and she bought for $550k 5 years ago so not a bad return at all. Currently she only rents it for $2500mo because affordable housing is an issue in our small town..also STR is not allowed per the town. Now we are considering selling it to buy a more cash flowing property. Maybe some MFR in a bigger town an hour away. We would 1031. Pros and cons to this idea?

[Timothy Howdeshell]

Quote from @Jonah Slove:

Quote from @Andrew Postell:

@Jonah Slove tell her to look into capital gains taxes and how much she can exclude if she lived in it for 2 out of the past 5 years.  Renting a $1.3million home is a terrible return.  She can certainly do better with other properties. 

 We can exclude $500k of gains if we are married. Once fees and improvements are taken off too we should be maximizing that. So what are your thoughts on our scenario? She moved in with me 2 years ago and before the property in question was her primary.

 Just a caveat here. If you exclude the majority of your capital gains via the two out of the five-year exemption, then there's no need to do a 1031. I assume you have some repairs that will knock the basis down in the property from 1.3 to maybe close to a million and then you have the $500,000 in capital gains exemption. So you should be good to sell outright. You can then dump that money into rentals which will cash flow. You could even buy properties out riding cash with that much dry powder. That's what I would be doing if I was in your situation.

[Jonah Slove]

Quote from @Timothy Howdeshell:

Quote from @Jonah Slove:

Quote from @Andrew Postell:

@Jonah Slove tell her to look into capital gains taxes and how much she can exclude if she lived in it for 2 out of the past 5 years.  Renting a $1.3million home is a terrible return.  She can certainly do better with other properties. 

 We can exclude $500k of gains if we are married. Once fees and improvements are taken off too we should be maximizing that. So what are your thoughts on our scenario? She moved in with me 2 years ago and before the property in question was her primary.

 Just a caveat here. If you exclude the majority of your capital gains via the two out of the five-year exemption, then there's no need to do a 1031. I assume you have some repairs that will knock the basis down in the property from 1.3 to maybe close to a million and then you have the $500,000 in capital gains exemption. So you should be good to sell outright. You can then dump that money into rentals which will cash flow. You could even buy properties out riding cash with that much dry powder. That's what I would be doing if I was in your situation.

 Yes totally. The biggest question at the moment is if the cap gains for single vs couple or 250k vs 500k. I need to consult with a CPA and learn what we qualify for.

[Nate Meeker]

@Jonah Slove 

These are the 3 main tests:

1. Ownership. The taxpayer must have owned the residence for periods aggregating at least two years during the five years ending on the date of the sale or exchange [ IRC Sec. 121(a) ].

2. Use. The taxpayer must have occupied the residence as a principal residence for periods adding up to at least two years within the five-year period ending on the date of the sale or exchange [ IRC Sec.121(a) ]. Short, temporary absences are generally counted as periods of use [ Reg. 1.121-1(c) ]. However, a one-year sabbatical leave is not considered a short, temporary absence [ Reg. 1.121-1(c)(4) , Example 4]. However, certain periods of nonqualified use may preclude excluding some of the gain.

3. One Sale in Two Years. The taxpayer must not have used the $250,000 (or $500,000) exclusion for any residence sold or exchanged during the two-year period ending on the date of the current sale or exchange.

[Dave Foster]

@Jonah Slove, No need to choose on the primary/1031 front.  If she has lived in it for 2 out of the 5 years prior to selling it she'll qualify for $500K of profit tax free.  Since it's a rental now she can also do a 1031 exchange on the rest.  Looks like she probably has a $800K gain +/- with depreciation recapture.  She'd get 250K of that tax free.  And could indefinitely defer paying on the other $550K or profit.  That's a real win win.

[Basit Siddiqi]

There are two types of 'returns' that you get with rental real estate

Cash-flow
Appreciation

It appears that currently the cash-flow is lacking, however, the appreciation was strong the past 4-5 years.
If you thikn the appreciation will continue to be just as strong, I would consider keeping it as a rental.

If you think the appreciation will be flat, negative or low, you may want to consider selling it and getting a better return elsewhere.

[Evan Miller]

All of that analysis was only taking into account the gains she would realize on a sale. So I wasn't even including any money she put into a down payment when she purchased it. For example, if she put 20% down, that's another $110,000 which is just sitting there. That get's added to the denominator which decreases the return number even further.

Now factor in that she owns the house outright, and we have to include the full $550K in her capital equation, bringing her returns even lower per dollar invested. All of that only improves the case to sell and use the capital elsewhere. 

So instead of the apples to apples number being $565,000, we add in the $550,000 of equity that she already has by owning the house outright. Now the equation is as follows:

$565,000 (gains net of capital gains taxes and sales costs) + $550,000 (her additional equity in the house now that we know she owns it outright) = $1,115,000 of capital deployed in this investment.

Expenses are less because there is not mortgage payment, but we still need to allocate 30% to other expenses (property taxes, OpEx, CapEx, etc.). So let's say she's netting $21,000 in rent every year. That is still only 1.83% return. Some savings accounts pay that out right now, let alone a completely passive middle-of-the-road bond. If she took that money and put it in the right index funds she will likely get close to an average of 10% annually without having to manage anything.

[Jordan Tinning]

@Bud Gaffney your kids and grandkids will sell your portfolio as soon as you croak let’s be real 😂

[John Clark]

Quote from @Evan Miller:

All of that analysis was only taking into account the gains she would realize on a sale. So I wasn't even including any money she put into a down payment when she purchased it. For example, if she put 20% down, that's another $110,000 which is just sitting there. That get's added to the denominator which decreases the return number even further.

Now factor in that she owns the house outright, and we have to include the full $550K in her capital equation, bringing her returns even lower per dollar invested. All of that only improves the case to sell and use the capital elsewhere. 

So instead of the apples to apples number being $565,000, we add in the $550,000 of equity that she already has by owning the house outright. Now the equation is as follows:

$565,000 (gains net of capital gains taxes and sales costs) + $550,000 (her additional equity in the house now that we know she owns it outright) = $1,115,000 of capital deployed in this investment.

Expenses are less because there is not mortgage payment, but we still need to allocate 30% to other expenses (property taxes, OpEx, CapEx, etc.). So let's say she's netting $21,000 in rent every year. That is still only 1.83% return. Some savings accounts pay that out right now, let alone a completely passive middle-of-the-road bond. If she took that money and put it in the right index funds she will likely get close to an average of 10% annually without having to manage anything.

 Ten percent on an index fund? Talk about risk!!!! This is why people hate real estate shills. One does NOT get ten percent annual return without significant risk.

what return are you crediting her with being able to sleep at night?

[James Hamling]

Quote from @John Clark:

Quote from @Evan Miller:

All of that analysis was only taking into account the gains she would realize on a sale. So I wasn't even including any money she put into a down payment when she purchased it. For example, if she put 20% down, that's another $110,000 which is just sitting there. That get's added to the denominator which decreases the return number even further.

Now factor in that she owns the house outright, and we have to include the full $550K in her capital equation, bringing her returns even lower per dollar invested. All of that only improves the case to sell and use the capital elsewhere. 

So instead of the apples to apples number being $565,000, we add in the $550,000 of equity that she already has by owning the house outright. Now the equation is as follows:

$565,000 (gains net of capital gains taxes and sales costs) + $550,000 (her additional equity in the house now that we know she owns it outright) = $1,115,000 of capital deployed in this investment.

Expenses are less because there is not mortgage payment, but we still need to allocate 30% to other expenses (property taxes, OpEx, CapEx, etc.). So let's say she's netting $21,000 in rent every year. That is still only 1.83% return. Some savings accounts pay that out right now, let alone a completely passive middle-of-the-road bond. If she took that money and put it in the right index funds she will likely get close to an average of 10% annually without having to manage anything.

 Ten percent on an index fund? Talk about risk!!!! This is why people hate real estate shills. One does NOT get ten percent annual return without significant risk.

what return are you crediting her with being able to sleep at night?

 Name it Evan! Name the index fund that has a consistent proven track record of annual 10%+ returns, NET, after all the fee's removed, real ACTUAL, year after year right as rain.    No, don't show me some fluff BS saying "oh, this one did ___ after the covid drop" or other BS twisted #'s. Show us just 4. 

In real estate, I can show 147 that are doing an aggregate 10%+ annual return, all done post covid to keep it simple for relevance today. Or, if want to go pre-covid, well the data pool get's a whole lot deeper. 

I don't comprehend the math to twist real estate investment into a sub 2% aggregate return, that is some gold medal level gymnastics to pull that off, or just epic arrogant ignorance maybe, with sub-par math's. 

Reality is, realty estate blow's the doors off anything & EVERYTHING stock market or bond market BAR NONE.    The 1 and ONLY exclusion to this fundamental fact of reality is in very specific, very SHORT-term and very rare instances which are for example last year where for some month's taking a break in bond's was, via the "witches brew" of factor's, the better play. And that's gone.      So back to reality of Real Estate sitting as KING. 

[Evan Miller]

Love the passion @John Clark!

John, I'm not sure what you mean by "this is why people hate real estate shills" but I 100% agree that there is value to peace of mind! My post that you're referencing is purely addressing the math side of the equation, but everybody needs to make their own decision because each situation is very personal. I think some people see the stock market as super risky and some people see the real estate market as super risky - and they're both right! Ultimately most people are more comfortable with what they are familiar with, simple as that. Always good to compare apples to apples and include cold hard numbers in your decision making.

[Evan Miller]

Love the passion @James Hamling!

The S&P 500 Index has averaged a 10.26% return since it settled on the 500 company limit in 1953. Dating back to its inception in 1920 (exact date is debatable) it's averaged about 9.9% annual returns. There are several index funds that have similar performance including Vanguard's total stock index fund - VTSAX and Fidelity's Total Market Index fund - FSKAX. It's a good point that you need to take into account the fees and tax implications of gains, but this is a good starting point. Management fees for index funds tend to be in the 0.3% - 0.6% range, so the foundational principle holds true.

One more note - I think it is always smart to add some skepticism when someone presents subjective opinions as indisputable fact. There are very few one-sided arguments in any investment world and Stock Market vs. Real Estate is certainly no exception.

Again, I love the passion and appreciate getting some opinions throne my way!

[James Hamling]

Quote from @Evan Miller:

Love the passion @James Hamling!

The S&P 500 Index has averaged a 10.26% return since it settled on the 500 company limit in 1953. Dating back to its inception in 1920 (exact date is debatable) it's averaged about 9.9% annual returns. There are several index funds that have similar performance including Vanguard's total stock index fund - VTSAX and Fidelity's Total Market Index fund - FSKAX. It's a good point that you need to take into account the fees and tax implications of gains, but this is a good starting point. Management fees for index funds tend to be in the 0.3% - 0.6% range, so the foundational principle holds true.

One more note - I think it is always smart to add some skepticism when someone presents subjective opinions as indisputable fact. There are very few one-sided arguments in any investment world and Stock Market vs. Real Estate is certainly no exception.

Again, I love the passion and appreciate getting some opinions throne my way!

Taking this in bit's:     Am i to understand your using a 71yr data grouping, to then declare an "expected" average annual return? Because that would be a serious misuse and misinterpretation, misinformation of things. UNLESS stating it's also an "average" that persons have 71 years to invest.     Most, are sub 30yrs, and 20yrs is much more "average" so I would say use 20yr data set's.     Because we both know those BIG down swing's are going to show themselves a lot more in these more "average" time windows than using a time window longer than most adult life spans. 

On the examples you gave of your "assured 10% annual return+" it took me 15 seconds to find that statement is not correct at all, as the data shows: 

ALL the examples you gave had some good years BUT they also had some negative years, some ok, and some REALLY bad years. 

Now, you can argue it "averages" to 10% if...... if, if, if....... And THAT is the point, one has to do all kinds of gymnastics of "IF" to make your argument flesh out. IF a person buys, sells, holds at/during certain times...... IF a person does not suffer a margin call in the drops........ IF a person hold's it in a certain way and does not have a trader who trades there position at loss....... IF, if, if........ 

And here is the reality. Margin calls happen, especially in big down drops, which amplifies one's losses. And reality is MOST buy when things are going up after a certain point that makes it clear it's "ok" to buy in thus neutering potential gains. Amplified loss, neutered profit potentials, THAT's reality for non-professionals "on the street". 

Just recently the covid drop was called the biggest wealth transference in history. Yes, I made $ in it BECAUSE I am not the average retail investor AND I am a contrarian investor. Most lost a lot. AND most have been working to edge back loses, still. 

Yes, I will say it's 100% "possible" to "average" 10% annual return via W.S. investing, without doubt, even much more then that. BUT, and this is a VERY important but; the VAST MAJORITY OF PEOPLE do not have the knowledge, experience, acumen, insight, patience, capital or risk tolerance to navigate what is beyond doubt the MOST DANGEROUS investing environment on Earth. 

Remember, every winner on W.S. comes on the back of several losers. That's just the reality of it. One hit's it big on options, that $ came from other people, think about that. A 10:1 profit means at least 10 others lost for your 1 win. 

W.S. is SUPER easy and fast to loose a LOT of $. 

In early covid days I was on phone several times with trading desk adjusting some things for assorted positions and expanding trading limit's and discussed how swamped busy they were with avalanche of those deep into margin calls, people loosing massive amounts of $, massive. 

It's wildly dangerous and inaccurate to state or infer it's "simple" or "reliable" 10%+ annual returns with literally ANYTHING on W.S..    As I say, they are called TRADERS for a reason, W.S. is designed to TRADE not invest, meaning the entirety of W.S. has a vested interest in swinging, and the more it swings the more things trade and the more the entire trading system makes including the gigantic investment banks that all but own W.S..     

Are you aware of the location of some server farms for it's HFT? Yes, I mean the physical location of the server room? Try measured in feet from the physical trading floor, literally. That is an entire existence designed on movement, not stability. 

And don't even get me started on mutual fund's, lol. 

"Ratatouille" said it best; yes anyone "can" cook, but only few will be great at it.     Yes, anyone "can" invest on W.S., but no, don't expect it to be simple, safe, assured, easy, reliable etc.. 

[Bobby Nilsen]

Quote from @Evan Miller:

All of that analysis was only taking into account the gains she would realize on a sale. So I wasn't even including any money she put into a down payment when she purchased it. For example, if she put 20% down, that's another $110,000 which is just sitting there. That get's added to the denominator which decreases the return number even further.

Now factor in that she owns the house outright, and we have to include the full $550K in her capital equation, bringing her returns even lower per dollar invested. All of that only improves the case to sell and use the capital elsewhere. 

So instead of the apples to apples number being $565,000, we add in the $550,000 of equity that she already has by owning the house outright. Now the equation is as follows:

$565,000 (gains net of capital gains taxes and sales costs) + $550,000 (her additional equity in the house now that we know she owns it outright) = $1,115,000 of capital deployed in this investment.

Expenses are less because there is not mortgage payment, but we still need to allocate 30% to other expenses (property taxes, OpEx, CapEx, etc.). So let's say she's netting $21,000 in rent every year. That is still only 1.83% return. Some savings accounts pay that out right now, let alone a completely passive middle-of-the-road bond. If she took that money and put it in the right index funds she will likely get close to an average of 10% annually without having to manage anything.

This math ain’t mathin for me. 1.83% return is based on current value. Can’t really use that number because say the value goes down to 100k, now her return is 21%. I’m only using that extreme of a number to show that it’s calculated in a skewed way. 

The best way to calculate a return is COC, which would be about 3.8% if rented. If we calculate COC with it selling, no rents, it’s roughly 80%. And if we use IRR we’re at about 12% per year for the 5 years it’s been owned. 

If this were me and I sell the property, I would  buy a fourplex for 1.6m with 130k in rents. This is at market so not a tough deal to find. After 10 years it’ll probably double in value, I’m using $3m for easier math, with the way our financial system is going. With 68% down and those rents the COC is 197% and IRR is 14% per year now let’s say it sells for $1.9m we’re still at a 9.6% IRR and 105% COC. Any which way it gets sliced I’d say the real estate is much better and safer than going into a “safe” fund. The only better investment would be a 5% savings account and hoping it doesn’t drop.  

 

[Evan Miller]

@James Hamling

Thanks for the reply James! I think it's a fair point to say that a 71 year timeline doesn't apply to most individual investors. My point there is to say there is a very good track record of great returns over time so if I am going to choose real estate over just investing in index funds then I am only doing so because I believe my returns will far exceed 10%. Otherwise it's not worth it.

The rest of your points are only relevant to very active traders, and not the point here. Further, real estate has just as many nuanced bearish points to make. Not super relevant to a long-term investor which I think 99% of us on these forums should be. 

[James Hamling]

Quote from @Evan Miller:

@James Hamling

Thanks for the reply James! I think it's a fair point to say that a 71 year timeline doesn't apply to most individual investors. My point there is to say there is a very good track record of great returns over time so if I am going to choose real estate over just investing in index funds then I am only doing so because I believe my returns will far exceed 10%. Otherwise it's not worth it.

The rest of your points are only relevant to very active traders, and not the point here. Further, real estate has just as many nuanced bearish points to make. Not super relevant to a long-term investor which I think 99% of us on these forums should be. 

Ok, well here is the issue with using those numbers for projecting forward. 

Let's look at a time window that had inflation/interest rates like they are now. Because the last 2 decades were completely different from now, and by all measure of reason, what next decades will be. 

Similar rate environment to today is found 1970-1982: 

So let's look at what stocks did in that same time window: 

Ok, now let's check-in on what SFH prices did in same time window:

Wow, home values more than 3X in the same time stocks halved in value.... 

So, to put this to math, if someone had $100 to invest in 70/71 and put into stocks they'd have $50.     vs if put into real estate would have $320. 

Where I come from we call that a "no brainer". 

But sure, if one want's to take things out of context, compare apples to hand grenades, sure, one can get results that make real estate look as the poor investment vs the traders playground. 

Real Estate has only been coined "THE" #1 hedge against inflation for what, a thousand years or so.... Surviving world wars, countless currencies and empires as a store of wealth.... 

[James Hamling]

Quote from @James Hamling:

Quote from @Evan Miller:

@James Hamling

Thanks for the reply James! I think it's a fair point to say that a 71 year timeline doesn't apply to most individual investors. My point there is to say there is a very good track record of great returns over time so if I am going to choose real estate over just investing in index funds then I am only doing so because I believe my returns will far exceed 10%. Otherwise it's not worth it.

The rest of your points are only relevant to very active traders, and not the point here. Further, real estate has just as many nuanced bearish points to make. Not super relevant to a long-term investor which I think 99% of us on these forums should be. 

Ok, well here is the issue with using those numbers for projecting forward. 

Let's look at a time window that had inflation/interest rates like they are now. Because the last 2 decades were completely different from now, and by all measure of reason, what next decades will be. 

Similar rate environment to today is found 1970-1982: 

So let's look at what stocks did in that same time window: 

Ok, now let's check-in on what SFH prices did in same time window:

Wow, home values more than 3X in the same time stocks halved in value.... 

So, to put this to math, if someone had $100 to invest in 70/71 and put into stocks they'd have $50.     vs if put into real estate would have $320. 

Where I come from we call that a "no brainer". 

But sure, if one want's to take things out of context, compare apples to hand grenades, sure, one can get results that make real estate look as the poor investment vs the traders playground. 

Real Estate has only been coined "THE" #1 hedge against inflation for what, a thousand years or so.... Surviving world wars, countless currencies and empires as a store of wealth.... 

To explain myself, and the economics of how this works, that higher rate/inflationary market can simultaneously send stocks dropping for a decade, and real estate soaring for a decade, it's simpler than one may think. 

What happens during inflation? Were all living it now live-time so we should all know this answer. The price of everything is MORE, right. And with that, the bill cut's a bit deeper doesn't it. 

And, in response, we all put a bit more consideration into what were buying right. And that get's more and more pressing the longer that goes on. 

So, people spend less.

Volume drops. 

Business press on efficiency for the lower volume and.... people get laid off. 

People get laid off, so people spend less.... Less volume.... You get the picture. 

And STOCKS get wacked. Because less spending, less volume, means less profits. Less profits mean lower value. Simple simple. 

BUT.... in housing what happens? Cost increases pass onto the end user. A builder can't build for less than cost of labor, material etc. right, so, prices go up, volume drops. 

Volume of housing inventory drops, supply get's limited, prices go UP. 

Because people don't get "less" just because things cost more do they. No. So, OPTIONS for how one put's a roof over there head get's to be less, competition drives UP price. The less people can buy, the more they rent. More competition for rentals = higher price for what is available. 

Supply/demand curve. If Johnny has 5 apples and 7 people want Johnny's apples what happens to the price of an apple???? 

As rental prices go UP, value savings of home ownership goes UP, because home buyers look at utility of if a rental 3br costs $2,100 per month, and owning costs $2,100 per month, price doesn't matter now does it.... 

Most in the utility side of things have a perception of price via budgetary terms NOT whole dollar terms. 

So everything in inflationary market drives the price of assets UP, stock values DOWN, and real estate prices UP including rents. 

So if asking where I am going to plunk my $'s for best work in an inflationary market.... do I want to go where it's DOWNWARD value pricing, or UPWARD.... 

And if one says "but the price of a home is so much".... well yeah, that's kind of the point and evidence isn't it???? 

And what brings UP stock values? LIQUIDITY. People spending $, volume UP, spending UP, vibrant economy. 

What happens to housing when that happens???? Coming out of down volume inflationary market what is it people do when start getting flush with income? 

They buy the things they have been constrained upon. They buy homes and thus prices hold and soar on new winds. 

Boring stagnant stability is where housing suffers and stocks reign supreme. In the swings up, or down, real estate is KING.