When does it make sense to sell your rental?
Miami, FL · Member since 2011 · 296 posts · 72 votes
When does it make sense to sell your rental?
Most Popular Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votesNOW!!!!
Here's why. Think of your equity as as cash that's locked up in the property, and that equity is the asset, not the property. The property is just the temporary resting place for it. I say this because the equity value would be the same dollar amount...no matter what property, or properties, it is in. When your equity builds up, it looks good on paper, but only on paper. It's greatest value is when you release it into the real world.
Here's an example.
Property A:
PV = $100k
Equity = $20k
Cash flow = $1000
Property appreciates to $25k. New number$ for...
Property A: REI keeps property
PV = $125k
Equity = $45k (plus whatever paydown happened...thanks to the tenant, and their rent payment)
Cash flow = $1000 (assuming rent increase covers taxes/insurance increase)
Property increases in value, but CF remains the same...the landlord gets no real value from the appreciated PV...yet.
Property B*: REI sells property
DP = $40k
PV = $200k
Equity = $40k (still the same as when it was in the original property - closing costs)
Cash flow = $2000
* This could be more than 1 property, but the total equity would still be the same...just split up, and it would still be a 20% DP on the Properties...so the Total PV would also be the same. What changes is the cash flow, and the total PV...and,
since the PV goes up, so would the appreciation compared to the original Property A since the Original Property A's PV would be only $125k but the new PV would be $200k. That means if the same appreciation rate (say 10%) was applied to both, the original property A's new PV would be $137.5K, while the new PV would be $220k.
80 Replies
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
NOW!!!!
Here's why. Think of your equity as as cash that's locked up in the property, and that equity is the asset, not the property. The property is just the temporary resting place for it. I say this because the equity value would be the same dollar amount...no matter what property, or properties, it is in. When your equity builds up, it looks good on paper, but only on paper. It's greatest value is when you release it into the real world.
Here's an example.
Property A:
PV = $100k
Equity = $20k
Cash flow = $1000Property appreciates to $25k. New number$ for...
Property A: REI keeps property
PV = $125k
Equity = $45k (plus whatever paydown happened...thanks to the tenant, and their rent payment)
Cash flow = $1000 (assuming rent increase covers taxes/insurance increase)Property increases in value, but CF remains the same...the landlord gets no real value from the appreciated PV...yet.
Property B*: REI sells property
DP = $40k
PV = $200k
Equity = $40k (still the same as when it was in the original property - closing costs)
Cash flow = $2000* This could be more than 1 property, but the total equity would still be the same...just split up, and it would still be a 20% DP on the Properties...so the Total PV would also be the same. What changes is the cash flow, and the total PV...and,
since the PV goes up, so would the appreciation compared to the original Property A since the Original Property A's PV would be only $125k but the new PV would be $200k. That means if the same appreciation rate (say 10%) was applied to both, the original property A's new PV would be $137.5K, while the new PV would be $220k. - Real Estate Investor · Chattahoochee, FL · Member since 2014 · 133 posts · 107 votes5y
@Joe Villeneuve Great response to an excellent question. Quick f/u: I read your response and it does make sense. In short, deploy your equity that is currently trapped in the cash flowing asset. OK. Would you wait until you had sufficient equity in the asset(s) that would allow for an additional down payment for a new unit or two? How do you make the clear decision on this? When you put the original 20%, assuming traditional financing, it would take many years to double the original deposit. Perhaps you were just suggesting this action in this specific situation b/c the house already had many years of payments behind it and appears to have high equity currently. I sold a house last year b/c the margins were too tight after I'd refinanced it and taken equity out for another purchase. There was about 70K equity in the property, but monthly difference between rent and PITI was only $250 (not enough, but the house was relatively new without any major maintenance needs outside of typical A/C services). I assume that this would fit your recommendation given above. I guess my question is centered around where to draw the line for pulling the trigger on selling. Thanks.
- 5yTheresa HarrisPro MemberMember since 2019 · 15k+ posts · 11k+ votes
Look at the money you'd get from the sale and then what returns you'd get if you bought another place or invested your money elsewhere. there is no magic number, but if you can make more by selling, then I'd do it.
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @David Clay:
@Joe Villeneuve Great response to an excellent question. Quick f/u: I read your response and it does make sense. In short, deploy your equity that is currently trapped in the cash flowing asset. OK. Would you wait until you had sufficient equity in the asset(s) that would allow for an additional down payment for a new unit or two? How do you make the clear decision on this? When you put the original 20%, assuming traditional financing, it would take many years to double the original deposit. Perhaps you were just suggesting this action in this specific situation b/c the house already had many years of payments behind it and appears to have high equity currently. I sold a house last year b/c the margins were too tight after I'd refinanced it and taken equity out for another purchase. There was about 70K equity in the property, but monthly difference between rent and PITI was only $250 (not enough, but the house was relatively new without any major maintenance needs outside of typical A/C services). I assume that this would fit your recommendation given above. I guess my question is centered around where to draw the line for pulling the trigger on selling. Thanks.
My preference of timing is when I can double what I have. Usually that means when the paid for equity and the free equity are equal. However, that doesn't mean I can't double what I have sooner than that. The timing is specific to the circumstances at any given moment.
Sometimes you are paying under market value, and are getting the benefit of some free equity at the time of purchase. Sometimes the strategy you used to buy the original property established a ready made exit that will occur over a much shorter period of time than just waiting for appreciation to deliver. Sometimes the terms of the original agreement to purchase establishes its own timeline to that magic number.
It all comes down to an understanding of how money works, and how to apply that knowledge to REI by the strategies you use...and invent.
- Miami, FL · Member since 2011 · 296 posts · 72 votes5y
Thank you very much for the help, as usual, this place is gold.
I'll do a bit of homework with agents friend of mine to kind of find out how much spread is reasonable to expect in this market if I were to sell and then split the equity to purchase more than one property. I am afraid I'll have to compete with the same buyers paying above market value for them.
Also, if that is the case in the Miami area, wouldn't that mean that property values should continue to raise? If buyers are paying 10% aprox. above market value, that should push comps up...therefore appraisals until the market gets to a balance. Wouldn't be smart to wait that up and build up some more free equity?
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Allende Hernandez:
Thank you very much for the help, as usual, this place is gold.
I'll do a bit of homework with agents friend of mine to kind of find out how much spread is reasonable to expect in this market if I were to sell and then split the equity to purchase more than one property. I am afraid I'll have to compete with the same buyers paying above market value for them.
Also, if that is the case in the Miami area, wouldn't that mean that property values should continue to raise? If buyers are paying 10% aprox. above market value, that should push comps up...therefore appraisals until the market gets to a balance. Wouldn't be smart to wait that up and build up some more free equity?
There's only one instance where I will offer higher than the AP...and that's when I'm getting seller financing. I don't bid against myself, and if that means I have to bid what it takes to get the property, and in the process bidding over what is needed to make it a deal, I'm not bidding at all. I'm not interested in owning real estate...I'm interested in getting control over locations (properties) where I can immediately start to make a profit on cash flow, and quickly recover all the cash (my only cost) I put into it.
- 5yJon KellyPro MemberInvestor · Bethlehem, PA · Member since 2016 · 929 posts · 951 votes
@Allende Hernandez It's all about the numbers. What is the current ROI on your property? If you sell the property, where will you put the cash? Do you have another asset with a greater ROI to move it to (e.g. a larger investment property)?
If you have equity built up, consider a cash out refinance. You keep the investment property and pull out cash from the equity, which you can use to purchase other income producing assets.
- Member since 2020 · 671 posts · 937 votes5y
Man, if I'm ever in your neck of the woods, I'm going to message you and try to buy you lunch or a beer or something and pick your brain if you're up for it. Our investment philosophies are extremely similar (although I assume you're a lot better at acting as I'm terribly lazy) and I've broached this subject with you before, but I'll try to be more specific.
I understand that there are fees associated with borrowing as well as selling, but the fees for borrowing are less. Also, in California, we have Prop 13 which keep our property taxes low. For instance, if I sold my properties, the new owner would pay about triple for taxes compared to what I pay. So, if I were to sell my property, I'd expect to pay triple the taxes on a new, similar property.
Have you calculated how much that impacts the sell and reinvest vs. the refinance and reinvest numbers? I know that not all states have a Prop 13, but it feels so significant to California investing. I'm so afraid to sell my California properties, but definitely follow what you're saying as I just refinanced my properties and am currently investing that money...
Thanks!
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
MI has their own version of your Prop 13, so I'm very familiar with that tax situation.
In every case, whether you are buying your first, last , or in between property, the decision on which property to buy will always be based on financial analysis. The change in taxes are part of it.
When I analyze, I always analyze based on the new taxes that would be applied. If the taxes are too high, then buy somewhere else. It's not uncommon for CA investors to flip in CA, and buy rentals in the midwest...sometimes the same house, just a different address (and in this case zipcode too).
Oh, and pizza a beer would do just fine, thank you...LOL.
- 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Jon Kelly:
@Allende Hernandez It's all about the numbers. What is the current ROI on your property? If you sell the property, where will you put the cash? Do you have another asset with a greater ROI to move it to (e.g. a larger investment property)?
If you have equity built up, consider a cash out refinance. You keep the investment property and pull out cash from the equity, which you can use to purchase other income producing assets.
You're not pulling out cash...you're paying for new cash, and not enough. When you refi, all you're getting out is whatever the finance company allows you to access. If you have 40% equity, and you can only refi up to 65-70%, then you're only accessing 5-10% of the equity...leaving 30% untouched.
In dollars, in other words what matters, if that was a $100k property you would have $40k in equity. If you assumed 5% in closing costs, that would leave you $35k, but you could only refi up to $70k, which means the original property cost you $30k...and you only have $5k to buy the next one.
- 5yJon KellyPro MemberInvestor · Bethlehem, PA · Member since 2016 · 929 posts · 951 votes
@Joe Villeneuve, I completely agree with you. Selling allows you to access the most amount of equity, and in an "all else equal" scenario, it is usually better than refinancing. Especially, if you utilized 1031 exchange to defer taxes on the sale. However, if the options are "Sell" or "Do nothing," you should consider "Sell" or "Refinance." If you find other properties with stronger ROI, then selling is likely the better option.
- Rental Property Investor · Charlotte, NC · Member since 2018 · 32 posts · 13 votes5y
@Allende Hernandez I'm in the same situation where a property I have has significantly increased in value (almost quadrupled) since I bought it in 2011. My hesitation in selling and cashing out of the property is that I probably won't be able to replicate the return I'm getting. I understand the merit of cashing out and capturing the dollars from the appreciation, but if I can't put that money to work to get the same kind of return, is it still worth it? There are probably some significant items coming up for replacement in the next few years (HVAC) which has got me thinking of selling now while prices are still so high. Thoughts welcome from anyone. TIA!
- Miami, FL · Member since 2011 · 296 posts · 72 votes5y
@Dave Kansagor That is one of the concerns I had when I started the post. After all the helpful responses I spoke with an agent friend of mine and there seems to be options. I may not find a single asset that gives me more than $1500/mo but I could potentially buy 3 that adds up to more than that, with the lowest DP possible to maximize the split.
- Investor · Raleigh, NC · Member since 2019 · 433 posts · 743 votes5y
@Joe Villeneuve love your advice on doubling what you paid for. I've been looking for something measurable to know when to sell and that gives a good idea. Thank you!
- Rental Property Investor · Savannah, GA · Member since 2019 · 66 posts · 30 votes5y
@Allende Hernandez
Great discussion!
I’m not sure if someone pointed this out already, but if you plan on selling it, keep this in mind.
If this was your primary residence for at least 2 year in the last 5, you might be eligible for a large capital gain exclusion when you sell. A tax break is always a great incentive!
- 5yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Allende Hernandez, And that's where the 1031 exchange will work best for you. A diversification exchange selling one and buying multiple replacements. You can also allocate your proceeds in any way you want - as multiple down payments. Or you can purchase one property for cash and use the maximum leverage on the second property. When you do this you actually increase your freedom as the free and clear property is available if you want to refi that one later.
The 1031 Investor5137 Reviews - 5yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Jon Kelly:
@Joe Villeneuve, I completely agree with you. Selling allows you to access the most amount of equity, and in an "all else equal" scenario, it is usually better than refinancing. Especially, if you utilized 1031 exchange to defer taxes on the sale. However, if the options are "Sell" or "Do nothing," you should consider "Sell" or "Refinance." If you find other properties with stronger ROI, then selling is likely the better option.
The idea of selling requires you know where to put your new lump sum. If you don't know, then don't sell...yet. When you see you're getting close to wanting to sell, is when you need to start looking.
If it's between doing nothing and refi while waiting to sell, then I would rather do nothing.
- 5yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Dave Kansagor, Looming Cap Ex can kill your IRR for years and leave you landlording for free for a long time! You won't get one penny more in rent whether your roof is 20 years old or your wallet is $20K lighter for a new roof. So if that's a concern I'd be running to get out.
Another hidden benefit in a sale vs refi is that purchase rates are generally a little lower, and you're financing more loan. Which, in a low interest environment means that the amortization of your loan (paid by the rentors) is more principle more quickly than in a higher interest loan. Again, a reason to put as much as you can into the next loan.
The 1031 Investor5137 Reviews - Rental Property Investor · Charlotte, NC · Member since 2018 · 32 posts · 13 votes5y
@Dave Foster Agreed 100%! The future CapEx is what has me entertaining the thought of cashing out, even if it's to only have that lump sum sitting around until I find the next deal.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes5y
At a minimum, sell and buy an identical house. That allows you to keep the tax benefit of the section 121 capital gain exclusion on the sale of a primary residence (and end up with a higher tax basis in the replacement property). The replacement property will have the same investment returns as the original property...they are identical. Factor in transaction costs in the analysis.
@Dave Kansagor and @Allende Hernandez holding your existing property is the same as buying your existing property at today's price.
Putting aside the capital gain exclusion, the existing property has little to do with a keep vs. sell decision. We have $X amount of equity in a property and we can either "buy" our existing home with it (i.e. keep it) or buy another property. The past irrelevant...what matters is the projected future returns as if you purchased the property today (vs another property).
Congrats on the appreciation!
- 5yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
Oh my goodness great catch @Mike Dymski!!! @Allende Hernandez, if you sell that property now you will get the first $250K of profit tax free ($500K if your married). No need to 1031. Just sell and pocket the cash. I missed that in the original post. And that changes the game in my mind. Always take the chance to sell if it can be tax free.
The 1031 Investor5137 Reviews - Miami, FL · Member since 2011 · 296 posts · 72 votes5y
Uh wow....this is turning crafty now. Gotta love REI. I just educated myself fairly quickly in chapter 121 and it seems that we can sell our primary home and exclude from capital gain up to $500K of the profit ( both myself and my wife are in the title).
I now understand @Mike Dymski statement of "At a minimum, sell and buy an identical house" and @Dave Foster "Just sell and pocket the cash". If we miss the 5 year boat..we're in the hook for an ugly amount of capital gain taxes.
Worse case if we buy a similar property, we just saved ourselves a hefty amount in taxes.
Thank you!
- 5ySamara HuntleyPro MemberInvestor · Charlotte, NC · Member since 2020 · 124 posts · 189 votes
@Allende Hernandez when you want to quit having passive income come in every month.
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