When does it make sense to sell your rental?
Miami, FL · Member since 2011 · 296 posts · 72 votes
Good evening folks,
I've been wondering around this lately and decided to come to where the expert live.
I have a rental property that used to be my primary home until a year ago(Miami, FL). We bought it in 2010 and priced has doubled since.
Last year we bought a new house and decided to keep the previous one as a rental, I had a 15Y loan and refinanced it to 30Y to maximize cash flow. At present time, spread is aprox $1,500/mo (just rent-PITI to simplify things). It will shrink some as I already know insurance will increase quite a bit at renewal.
Prices in the area have gone up and talking to a couple of agents I learned that houses are closing about 10% above appraisal, which makes me wonder where is the "line" where selling outright makes more sense than holding on to it?
I understand that a solid plan for the profits of the sale plays a factor in the decision but I want to keep the question single-threaded for now.
Any pointers?
Thanks in advance!
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 = $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.
in similar situation as well. Decided to sell for variety of reasons but mostly because bears make money, bulls make money and pigs get slaughtered.
When to sell :
1. If profit is larger than 500K
2. If price point has been consolidated in the last 12 months and you have double your investments
3. If the affordability index is reaching 40%. Eg: Miami is 44%
4. If there's no rent growth or reduction.
@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.
Next time, Dave, when I'm better prepped and my buyer isn't as squirrelly.
I think there are strong points for both the sale and exchange approach and for the cash out refinance approach.
Yes, you can access more equity with a sale and exchange than with a cash out. However, the transactions costs can be much higher. In a refinance scenario, you're just paying origination fees, title fees, and settlement agent fees. In a sale, you may pay some of those, and you will also pay commissions if you are using a real estate agent. You need to factor those costs in as part of the initial investment in your target property. Including these costs lowers the project IRR.
A cash out doesn't change the amount of starting equity, nor does a sale, but it does spread it over multiple assets which can reduce your risk from litigation and asset impairment.
At the end of the day, you are not buying houses you are buying streams of cash flow. The way you structure it will affect your cost of capital. Generally speaking, debt costs less than what most investors require for a return on their equitable contribution. If your mortgage constant is lower than the capitalization rate of the asset, you can create rate arbitrage. Just mind your debt service coverage ratio to make sure you are not overburdening the income potential of the property.
The correct answer to the question is that you should use whatever strategy gives you the best net present value. However, you should be mindful of financial risk metrics and also determine the relative value of diversification vs ease of management. As for "when" to go through this process, I generally base it on return on equity (I calculate this as levered cash flow divided by accessible equity).
Best answer from Chris. If we can break down the number: refinance cost is 2% and non-taxable. If you sell and buy: 10-15% plus taxes. There's another strategy to 'defer' the tax other than 1031 although 1031 is usually the best if the acquired property is performing better.
Right, selling based on RoE is making sense too. For some of us in CA, we feel this issue where investment has reached more than 2000 per cent.
I prefer to sell when the market is overbought though, currently, some market in CA is signalling huge sell signal (rent /occupancy decreasing while price increases).
@Allende Hernandez
NEVER!
Just kidding, mostly, if you are strictly looking at ROI eventually it starts to decline. The BP calculator gives you a good look at that.
However literally every elder statesman landlord I talk to says they wish they would have kept more and sold less.
There are other ways to unlock the ROI (refi, LOC, etc).
Anthony, the problem with keeping a property is many times it's not cash flowing (DSCR <1), and rent is so far from market rent, so the exit strategy possible for some market is only appreciation. To get appreciation is only possible by either selling or refi. But even with a refi, it's only making sense when the interest rate is lower, such as now. You don't do refi when the interest rate is upper single digit.
I believe the answer to this question is very market-specific. I just read the Apartment report for 2021 and every market has different volatility.
Hey Allende,
When I am considering selling a rental (actually thinking about this myself right now) the questions I ask are:
1. What am I going to do with the money?
If I am going to invest at a better return or buy properties in a better market for my goals then great, if it is just going to sit in my bank account then probably not.
2. Do I have certain advantages to selling now?
So for example if you lived in the property as your primary residence for 2 of the last 5 years then you can sell it for no tax up to profits of 250k if you're single and 500k if your married.
3. What is the urgency?
Properties tend to go up in value, cash flow is great, so why sell now?
Anyways hope that is helpful, best of luck!
Anthony, the problem with keeping a property is many times it's not cash flowing (DSCR <1), and rent is so far from market rent, so the exit strategy possible for some market is only appreciation. To get appreciation is only possible by either selling or refi. But even with a refi, it's only making sense when the interest rate is lower, such as now. You don't do refi when the interest rate is upper single digit.
I believe the answer to this question is very market-specific. I just read the Apartment report for 2021 and every market has different volatility.
Where I am I don't buy real estate that doesn't cash flow. So I guess that's not something that I really consider.
We also don't have rent control so below market rents can always be fixed.
So there are a number of factors at play here that I suppose I just wasnt even considering as part of the situation
@Joe Villeneuve
I was referring to the original post. He said the property has doubled in price so he has substantial equity. He didn’t give numbers so I will throw out a strawman. Purchased in 2010 let’s assume for $100k, 25% down so $75k loan. Property has now doubled to $200k. This leaves $125k plus equity. Refinances and pulls $150k out. If he sells he only gets $125k, less 6% commission ($12k), less 15% capital gains ($18.75). Less State taxes ??? Net $94.25k to buy two more properties. Now factor in closing costs, 2-3 months lost revenue while you look for new properties, buy them, get them settled with new tenants.
Option B. Cashout refinance 75% of $200k. After paying off original loan he has $75k to buy a second property. Plus he still has Cashflow from first property to help qualify for new loan.
The only reason I see to sell the first property is if it is underperforming or doesn’t fit long term strategy. If it is a good property by all means hang on to it.
@Joe Villeneuve
I was referring to the original post. He said the property has doubled in price so he has substantial equity. He didn’t give numbers so I will throw out a strawman. Purchased in 2010 let’s assume for $100k, 25% down so $75k loan. Property has now doubled to $200k. This leaves $125k plus equity. Refinances and pulls $150k out. If he sells he only gets $125k, less 6% commission ($12k), less 15% capital gains ($18.75). Less State taxes ??? Net $94.25k to buy two more properties. Now factor in closing costs, 2-3 months lost revenue while you look for new properties, buy them, get them settled with new tenants.
Option B. Cashout refinance 75% of $200k. After paying off original loan he has $75k to buy a second property. Plus he still has Cashflow from first property to help qualify for new loan.
The only reason I see to sell the first property is if it is underperforming or doesn’t fit long term strategy. If it is a good property by all means hang on to it.
OK, first, CG will be negated when the sale profit is rolled into the next deal, so that's $19k added to the "sale" side. AFter you apply the closing expenses you're looking at an additional 18k added to the cash available, which leaves you with Next, lost revenue isn't part of the equation. The part of it is added expenses during the time you are looking for, or waiting to close on a property that you already have lined up. That's totals about $1000, which makes the total available cash after sale $106k.
Your 75% refi is on the high side, it's usually between 65-70%...and that's on the appraised value, which rarely equals the actual price if sold. Appraisers are very conservative. I'll give you the appraisal of $200k, but only let you refi at 70% ($140k), which leaves you with $65k after refi. Also, the original comment says the properties are selling at 10% higher than appraisal, which means an additional $20k on the sale side, or $18k after expenses/costs are subtracted. So the new "after sale" total cash available is now $124k.
Comparing the two at this point you get $65k after refi, and $124k after sale.Here's where the real separation happens:
Item.....................REFI.............SALE
Cash Avail..............$65k..............$124k
Remaining CF/M.....$1500...............0
New PV (25% DP)....$260k..............$496k
New TOTAL PV.......$460k..............$496k
Added CF/M.........$1950..............$3750
New Total CFpM....$3450..............$3750
* CF/M per $100k PV...$750
Now you may be saying the difference is minimal, but there is a difference favoring the sale. However, if you take this further down the road, the new PV's means if both scenarios appreciate at the same rate (let's use easy math and go with 5%/year) that gives us, without repeating the refi/sale actions:
Year.........REFI.........Sale
5..........$587k.........$633k
10.........$749k.........$808k
Let's say we do execute the same actions (refis and flips), when the same equity situation occurs, we would be repeating the same actions (refi's and flips) in years 6 and 11 (not on chart) for the refi, and years 5, 8 and 11 (not on chart) for the sale scenario.
This accelerated PV also accelerates the Cash flow.
...and before you can say, "if you are selling the properties, then you don't have any cash flow to show income for loan qualification", I will tell you that you don't sell all the properties at the exact same time.
...and, one more thing, when you are refinancing, you are adding properties with the cash out money. How many loans will that be? You can't have that many loans. On the flip side (yes, that was intentional), since you are replacing properties with larger ones, you are not adding to the number of loans.
Hi, @Allende Hernandez!
The short answer to this key question in real estate is: When the money you will get from the sale of your current property will be able to make you more money if invested elsewhere.
Of course, the appreciation you've already got on your property is important, but what matters the most is what you can do with the money from the sale and how much more profit you can generate if you invest it elsewhere.
Since property prices in the local market are on the rise, I'd look into selling your current property and using the cash from the sale to invest in 2 or 3 properties in another area, potentially out of state. Building up and diversifying your investment portfolio is really important as it lowers the risk while increasing the potential for return. While earning monthly rental income from a single property is a great income supplement, making money from multiple properties is the only way to gain financial independence and retire early, and that's what most investors aspire to.
The key, of course, is to invest in a location which promises higher return than your current market. If you are open to out of state investing, I'd look into Camden, NJ; Gary, IN; Marlborough, MA; Muncie, IN; and Saint Cloud, MN. I know this sounds like a random list of markets. The reason I am highlighting these is that recently our team conducted a nationwide analysis of the performance of traditional, long-term rental properties, and these locations emerged as the top ones for return. For example, Camden, NJ offers a city-average cap rate of 7.4%, the absolute highest across the US housing market. Although this figure does not sound like a lot, it is the highest on the city level across the entire nation. Individual properties can achieve double-digit returns in this market.
Good luck and keep us updated on your decision!
@Allende Hernandez
When your return on equity drops below your personal acceptable threshold.
@Allende Hernandez
I was in a similar situation this year. Depends on what your goals are. For me, with interest rates so low I decided to cash out refinance using a conventional loan up to 70%ltv, no closing cost loan at a 30yr fixed, 3.25% loan. Then, to get even more equity, I used the same bank to do a second mortgage all the way up to 80%. Sure I could sell it, if I really need the extra 20% equity, but by the time I pay capital gains tax and seller fees, etc. I'd be left with just a little more then my refinance. So this way I get the best of both worlds, cash flow, 30 year mortgage, and high LTV (more cash out).
When ROI drops below what can be earned in a basic income fund (10%) it is no longer a worth while investment. This type of individual that ignores or sit on dead equity is no longer a investor, they are cash hoarders. Their money is no longer working efficiently for them and they are simply ignoring their investments, preparing to sell to retire or waiting to die.
I think this has probably been chewed over quite well, but just in case it hasn't.. it depends on your goals.
If you're in acquisition mode, then by all means tap that equity with refinance or line of credit; but failing that, sell it and buy multiple more. If you're coming up on the 5 year mark and you originally lived in it is approaching 3 years ago, run don't walk to your agent friend to get it sold. 0% CG is nothing to sneeze at. As others have brought up, you can 1031 it into something else... but what if the current administration does away with 1031s? It's been talked about.
A good reference to figure out when the opportune time to trade up is, and to pyramid your investing acquisitions, check out Nickerson's book about "How I Turned $1,000 into a Million in Real Estate". The $ amounts are dated and some of the old tax rules as well, but his philosophy is sound and he was one of the very few RE gurus to hold onto his portfolio and fortunes through the trying times to retirement.
If you're moving towards the end of your investing goals, and looking for an exit or enjoying the fruits of your labor, you might investigate how to transition your rental portfolio into notes. It's the much more passive strategy that can bring you income in your later years when you're wanting more free time, or to be done with tenants/toilets.
Happy hunting!
I bought a rental in Decatur, GA for $37k in 2012, casually looked at Opendoor and got a preliminary offer for $244k.
Rents have gone up. I can get $1325 as is or $1800 to $2000 with about $17k upgrades.
I am thinking of selling to release the equity and wait for opportunities down the line. Due to prior losses I may not need a 1031. What do you guys think?
sell especially if no taxes. Sold in 0ctober. took tax hit, looking to sell again in next month but don't want that tax hit again. looking for 1031 but it is hard to find any that makes sense. my $.02
@ronjackson Given that I probably wont have much taxes to pay and have to run a rescue mission on couple of floundering properties elsewhere (Chicago), I think selling makes more sense. I have another one in belt line (30310) that has also appreciated but it is small and I am thinking of doing AirBnb as I know a good AirBnb manager after refinance.
2012-2013 was a great time, picked up SFR's in Mableton and Douglasville for $16.5K and $20.5K but since I was out of state, couldn't manage rehabs and had to dump :-(
When to sell :
1. If profit is larger than 500K
2. If price point has been consolidated in the last 12 months and you have double your investments
3. If the affordability index is reaching 40%. Eg: Miami is 44%
4. If there's no rent growth or reduction.
Very few markets give $500K profits. Some of them went real low in 2013-2013, Atlanta was an example. I was buying sight unseen from California, obviously didn't get the same deals as locals. Still, decent SFR's were available from $20k to $60K all over - Decatur, Stone Mountain, Mableton, Douglasville and even close to the (now new) beltline. They have all appreciated - even 5 to 8 fold but not $500K profit.
Also the sell decision is never just on one property, depends on overall portfolio. If money is needed for other properties in the portfolio, to rescue them from under water, I think it makes sense to take profit and use it elsewhere.
So you are saying, you are going to sell to have good money chase bad money? Atlanta is like most markets, cyclical. It goes up and goes down. I'm cashing out and using leverage to get into higher quality properties. Those 30k properties may not go back down to those levels but I wouldn't bet against them taking a big hit in next cycle. I definitely wouldn't put good money in an underperforming asset at this point in the market. I would say that you were smart enough to buy when everyone else was scared so you are way ahead in the game.
@Allende Hernandez hard to ague with Joe’s knowledge and points. Generally, I’d say don’t sell if you don’t have to. You could pull lines of credit off that property and use it as a tool, all while continuing to own it and enjoy varying amounts of cash flow.
If you’re able to buy more without selling (assuming a bit on your goals, forgive me if not accurate), then do that. Yeah, you could take that equity and pay cash or leverage it for mid west property for long term cash flow.
What are the chances that in 15-30 years, that Miami house will be worth double what it is now? Probably good, yeah? That’s the fun of real estate, no wrong answers, just a very extended game of chess. Best of luck with whatever route you decide.
So you are saying, you are going to sell to have good money chase bad money? Atlanta is like most markets, cyclical. It goes up and goes down. I'm cashing out and using leverage to get into higher quality properties. Those 30k properties may not go back down to those levels but I wouldn't bet against them taking a big hit in next cycle. I definitely wouldn't put good money in an underperforming asset at this point in the market. I would say that you were smart enough to buy when everyone else was scared so you are way ahead in the game.
Not chasing bad money but to rescue a incomplete rehab. If I didn't do it now, I would have to dump it at low price. Rehab gives a chance to get reasonable profit. Also to accumulate some cash to get into local market if needed. But the overriding reason is tax savings as I can write off previous capital losses.