Sell rental to cash out equity or keep it long term

22 Replies

Hi there,

I need some help deciding if I should cash out of my primary home turned rental property before I am responsible for paying taxes on capital gains and pocket the equity or hold it long term with positive cash flow and possibly a retirement income. Our current rental was our primary home for over 6 years until September of 2017 when we decided to buy a bigger home. So, in short we have had our rental for last one year. Right now we are sitting on over $400k of equity on the rental along with over $750/month of positive cash flow. Here are the two major questions that I have been eagerly waiting to find answers to and need some expert opinion from all you experts out there:

  1. Cash out on equity on the rental property by selling it while market is high. Properties in the area for the like kind are going for over $700k but let's just say I am able to sell the rental for $700k. My purchase price on the property was $375k which means I have $325k of capital gains. My mortgage payoff balance is $295k at the moment. So, if I were to sell it by 2020 (within 3 years of turning it into rental), I pocket the entire capital gains on the property (roughly $65k) but I will instantly lose my $750/monthly cash flow from rent as well as all other tax deductions and depreciation I could benefit from each year. Basically, after paying agent commissions and other miscellaneous cost (roughly 8%), along with paying of the mortgage balance, I would pocket close to $350k, tax free.
  2. Stick to the rental long term with a great cash flow of $750/month and take advantage of all the tax deductions and depreciation, while the renters are paying off my rental slowly.

Please note, I don't need money at the moment and don't have any other investment vehicles that will generate a guaranteed 8-10% growth to my investment. What would you guys do in this situation? Thanks in advance guys.

I look at it this way, th eoportunity value to invest cash is easily a 10% return on average. You can easily get that on average in a income fund. 

If you look at it that way your 350K at a 10% return is wroth $2915/month. Your choice would be to earn $750 per month in income and hoard th ecash in yur property praying the markets do not turn or sell and reinvest to earn potentially $2900 per month.

Probably the same risk with more than 3X the reward.

That is a 2.5% return on that hypothetical 350K.

You can make that in a CD.

What tax deductions? You mean your expenses? The only tax deduction that doesn't represent an actual cash outlay is depreciation, which you're going to have to pay back in capital gains when you do sell the property, as opposed to now where you can avoid capital gains entirely.

Not to mention we are in a hot market with signs of a correction on the horizon.

No brainer.

Tying up $400k in cash to profit a lousy $750 a month is a poor return.  If you’re serious about rental properties you could take the $400k and buy multiple properties with multiple units in each property and have a significantly greater monthly net income.

Basically, you guys are saying I should cash in on the equity now and take advantage of the zero tax capital gains and later figure out how to invest that money to see it grow? The only reason I was considering it keeping long term was for a paid ofnproperty in 20 years or so and then a stable cash flow in form of rent. That could be the retirement investment. Otherwise, it’s way too tempting to sell it now.

As Sam said above, you're getting a terrible rate of return. And depending on where your property is and how inflated the prices are there, you could be about to lose a lot of equity. 

You can probably find a much better place to park that 350k. Hanging onto a poorly-performing property just because it will be paid off some day doesn't really make sense. Find a better performing property and let the tenants pay that off.  

Hi Pete,

Thank you for your response. About your comment below "Hanging onto a poorly-performing property just because it will be paid off some day doesn't really make sense. Find a better performing property and let the tenants pay that off.", I wanted to clarify that the investment from me for this rental is roughly $50k. Rest is all appreciation over last 6 years. So, to get $750/month is roughly a 18% return on $50k investment. I don't think I can find a better return on a rental today. But, I do agree with you that I can cash out and re-invest the $350k (possibly get 3 rental units with 20% down) to get a much higher return. By the way, the rental is located in Orange County, California.

Thanks again.

@Rohit S Bora Are you currently at market rent, and will it go up in the future? 

I like this tread but can't add much being from the mid-west. Purchasing a house with $50k down in Orange County, CA sounds like a deal! Where would you look for potential replacement properties? The answer to those questions will determine your exit strategy. 

Hi Jaron,

I am actually charging lower than market rent by $100-$200 and the rent in Orange County isn't likely to go down but either stay the same or go up as more people can't afford the high house prices here. We bought the house back in 2011 when the market was at the rock bottom with 3.5% down. Yes, we had a MI of $350/month for 5+ years (which I hated) but that fell off earlier this year. If you factor in 4% in down payment and closing costs and $350/month in MI for 6 years, you are looking at roughly $40k in investment. To say the least I have a really low 30 year fixed rate on it (2.75%). All this makes it really difficult to decide which way I want to go. Potential rental properties would be in Orange County itself. I know I can get a 2 bedroom condo for roughly $600k at the moment and I can easily pick up 3 rental properties with 20% down from my profits from selling my current rental. If a correction does happen in near future, I can possibly get them lower in the low to mid $500k range. But don't want to end up cashing out of this rental and end up with couple new rentals with lower cash flow in total. Thoughts??

What you paid for a property is irrelevant. Your return is based on it's total equity. That is how much cash you have invested in this property.

Your money is dying a slow painful death sitting doing absolutely nothing.

It is a shame it is being wasted.

Anyone of us on here would gladly borrow it from you at a better rate than your current return of 2.5%. Lend it out to a investor and it will be protected when the real estate markets crash.

Thomas,

Thank you for the feedback. This is why I posted the question. I wanted to make sure I wasn't making a rash decision of considering selling the rental in order to cash in on the profits. I really appreciate everyone's input here. Let me ask you, how would you re-invest $350k to maximize the return?

Wow, these numbers are impressive.... and you may be able to go a lot further (more properties) with more passivity by going long distance outside of CA after (if) you decide to cash out?

Thanks for sharing, @Rohit S Bora !

I would sell this property based on everything discussed here, @Rohit S Bora  

Look at it this way. You gained a great deal of knowledge!! Take that knowledge, potential gain, and find better performing assets. 

Good Luck

I wanted to clarify that the investment from me for this rental is roughly $50k. Rest is all appreciation over last 6 years. 

==> So, you've done really well on appreciation, and that's great. 

So, to get $750/month is roughly a 18% return on $50k investment. I don't think I can find a better return on a rental today. 

==> The key word is "today". Today, you aren't making an 18% return. You have a $350,000 asset earning a return of about 2.5%. The fact that you only spent 50k to get there means that you have done really well on appreciation. But that is not relevant to any discussion of how well your money is performing today. What's relevant to that discussion is, "What could I sell the property for now, and what return am I getting now."

What you are thinking is sort of like the sunk-cost fallacy in reverse: You spent so little on the place, that you feel you must hang on to it.  

==> But, I do agree with you that I can cash out and re-invest the $350k (possibly get 3 rental units with 20% down) to get a much higher return. 

Wouldn't that be the thing to do then? In fact, I never advise people to invest out of state, but with that kind of money, you might find A or B-grade stuff outside of CA that would return a lot more, and that would be of such quality that you would not have the usual C or D-grade OOS problems with it. 

Pete,

Thanks for breaking it down here. It's definitely starting to make sense. I really appreciate it. If possible, can you please give me a few examples of A & B-grade properties outside CA? I have never owned any OOS properties so know little to nothing when it comes to it. So, any information you can share will greatly help.

Hi,

I would think cashing out is the best route.  On top of $750 cashflow, are you also making more on the principal repayment?  It's great that you are making 18% return on your initial investment, but you have to consider the "investment" you've made over the years too (aka principal repayments).  what's more relevant here is opportunity cost (if I sold my property now and invest that amount, how much more or less can i be making?).

Note that like kind properties 1) does not have to be in the same area, you can invest in other states or cities that generate better returns, and 2) it doesn't have to be 1 to 1, you can buy 5 properties with your $350K, and that'll probably generate a lot more than $750 a month.  Check this link:

Price to Rent Ratio in US Cities

looks like texas is a good place to start.  

Hope that helps!

Rohit, 

I think my son sent you a couple of things. Really nothing is as cheap as it should be, right now, and a lot of people are holding onto their money and waiting. If you do decide to go OOS, just be cautious and skeptical,. There is a whole industry now in selling C and D stuff to out of staters who commonly lose their money.