Should I Sell or Keep

Question

I'll admit it ... I'm a collector. I really really like to buy real estate but I don't really like to sell it. That being said, I have a sneaking suspicion that I should be trading up, leveraging more, stacking, etc.

I would love some advice from those of you out there who have a method or systematic way of knowing when to sell. Are there certain metrics that you use? (for example ... Do you sell when depreciation vs. value hits a certain point? Or do you sell when you have a certain percentage of equity?)

And ... for those who would rather speak to a specific scenario; here's mine. Single family 3 bed 2 bath. Purchased for 140,000 and current value is 240,000. The rent is right about $1500, which is in the top 80th percentile. I have owned this property for 2 years. What would you do? Sell? Refinance? Sit and stay?  ...

What would you do? Why?

I think that I know the answer but I would appreciate your perspective!

Jeff Carlisle · Answer

I see what you're saying now.  However, I'm not sure if using diminishing ROE is a good measure for keeping or selling, mathematically speaking it should always go down in an increasing market which is what you want, you don't want your home value going down.  Making it simple for myself - home is paid for and rent is 1000 a month....

Scenario A) - Home value stays the same for 3 years at 100K and you made 12,000/year that's 12% ROE.... you made 36,000 totalScenario B) - Home value increases 5000 per year for 3 years and you kept rent same because awesome tenants.... year 1 12%, year 2 11.4%, year 3 10.9%... you made 36,000 plus 10,000 in unrealized gains (in reality probably a hair more as rent increases)

Now if you're comfortable with lots of leveraging then sure it makes sense to sell / cash out refi as you can now take that equity and split it and have two investors (renters) paying over 100% for two investments.  I don't think one should base that on diminishing ROE though, eventually your ROE is going to completely flip (when the majority of the return is no longer going towards equity i.e. when you pay off the loan).  You may then have an increasing ROE and still sell as now you can have 5+ "investors" paying 100%+.Funny I can type confidently that a more aggressive and leveraged approach is usually more profitable, yet can't bring myself to do it =D

Jeff Carlisle · Answer

I'm not sure I'm following, year 30 your property value nor income has increased.  Where are you pulling the total profit if sold number from?  I can't imagine the return on the investment going down over 30 years your cap / cash on cash should increase as rents and housing prices increase.  I could definitely see the return on the investment dropping in a 10 year time span (imaging buying around 2006).Thanks in advance!

Brian G. · Answer

@Chad Matthews My guess is that they decide on a metric they feel is worth the time and energy to them of selling and rolling that into/finding a new deal. A metric takes the emotion and guesswork out of it. No reason it can’t be 5, 7, 10 years, etc. Same with those who sell when their ROE drops below a certain %. Some may choose 8%, 7%, 5%, 3%, etc. Those that have one or more metrics like the above generally have a “trade up” philosophy or “take the profits now” philosophy in their investing approach rather than a longterm buy and hold approach. Probably the classic example of this are value add apartment investors who reposition a property for big gains and sell after holding 3-5 years. In appreciation markets like CA for example, it’s common for appreciation to be where the big money is made in SFH. Lots of people could care less what their ROE is when the equity in the property held keeps growing over time. However, others may choose to sell after a big run up in appreciation like what we’ve experienced over the last 8-10 years. I think a lot of it depends on personal goals, the market/s one is in, what scale someone is trying/not trying to accomplish, how active an investor is in RE, their experience, etc.

Brian G. · Answer

@Chad Matthews I’ve heard of others that will sell and trade up or redeploy the capital if they have the equivalent of let’s say 10 years of their current returns after selling. For example if someone is seeing $10k a year in total return (cashflow, debt pay down, appreciation, tax benefits) they would sell if they can net $100k after the sale (ie take the next 10 years of profit now and reinvest it). As mentioned above ROE (return on equity) is a common metric but others simply continue to hold for the longterm and find an alternative was to access the equity rather than selling.

Nathan Gesner · Answer

Example taken from another web site because I'm not smart enough to explain it clearly:

You buy a rental home for $100,000 with $20,000 down. The year of the purchase, you see that it is worth $100,000, but you only owe $80,000, as you have that $20,000 down payment as equity. Let's say that your annual positive cash flow is $3,600, or $300 per month over mortgage and expenses. So, our ROE is $3,600 / $20,000, or 0.18 = 18% Return on Equity. You're an investment guru!

Now let's fast forward 10 years. You've been paying down your mortgage, and the home has appreciated in value, now worth $118,000. Your balance due on the mortgage has dropped from $80,000 to $66,000. Now, look at your equity. $118,000 - $66,000 = $52,000, your new equity in our simple example. Now let's do the calculation again for ROE. You're getting a little more in rent, so your cash flow is now $4,400 per year. $4,400 / $52,000 = 8.5 percent Return on Equity.

What happened? It's simple; as equity increased, you certainly couldn't increase rents that quickly. So, is this still a great investment? Look into what you can do now with $52,000. It may be time to sell and reinvest.

Calvin Ozanick · Answer

I think that you have to revisit your personal goals of real estate investing. If your goal is to let your units keep making easy cash flow and do the hard work, then I would say keep it and be happy. However, if your goal is to grow continuously, I would begin speaking with your lender to see what you could get on a cash out refinance. Best of luck and let me know if you have any interest in looking elsewhere.

Nathan Gesner · Answer

You should evaluate your properties every year to see what kind of return you're getting. The annual return will decrease the longer you hold the property. Here's an example of a property I purchased last year:

You can see the annualized total return typically drops around the 7-10 year mark. If your goal is a 12% return or better, then you would consider selling any property with an annual return below 12%. Of course, you have to time your sales with market conditions because it may be a bad time to sell.

Theresa Harris · Answer

@Chad Matthews  If you were to sell it, what would you do with the money?  Refinancing would give you money to work with, but would also increase your expenses and you wouldn't cover it with $1500 in rent.

I don't have a good strategy. I held on my my first place for about 20 years and it paid for itself.  The price of the home almost tripled. I sold it and bought two other properties and combined, they bring in almost double the rent that the one place did.  I sold because it was a condo and the condo board was spending money like there was no tomorrow on stuff that didn't need to be done, the person looking after my unit was getting older and I just felt it was time.  It sold quickly as the market was hot and the price continued to go up after I sold it, but so did one of the places I bought with the money from that sale (none of the homes were in the same area).

Brent Paul · Answer

If am going to sell and do a 1031 exchange for another property it needs to be better than what I had before.  That's a lot of equity sitting there that could be put to better use and you probably could buy 2 or even 3 SFH with that.  I might consider taking out a HELOC and using that as a downpayment for a few more houses or one Multifamily.

Carlos Ptriawan · Answer

I am thinking on the same direction, if the next year price appreciation is near zero while price to rent ratio is higher than 20 and your equity is larger than 45 %, with this simple algo, it makes sense to sell rather than buy and hold.We can buy it again anytime anyway ....There're lot of fixed income funds outthere that can give decent return of 6-9pct with decent risk.

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