A wise man once said…All good things must come to an end. But was that man so wise that he could have been talking about the ownership of a long-term income producing rental property? Perhaps. But in my mind the answer really lies in the eye of the property owner and their investment strategy and goals.
A common question I get from my long-term investor clients now days since home sale prices are up, is: Should I sell my rental property and capitalize on the market appreciation now or keep holding and collecting income for years to come?
There are a lot of factors that can come into play here:
What would do with the capital if you sold the property?
Where do you see the market heading/future appreciation?
Can you 1031 into another viable investment property, or are prices too high?
Do you want to pay capital gains taxes?
How would you replace the income and/or tax benefits of owning the property?
If you are into statistics something to consider may be your Return on Equity (ROE) in the subject property.
In layman terms, Return on Equity can be calculated by dividing your yearly net income by the amount of equity you have in the property. For this example, let’s say that you owe $50,000 on a property that is worth $100,000. Your equity in that property is $50,000. If your yearly net income (your profit after expenses) is $5,000 per year than your Return on Equity for the subject property is 10%. Your ROE will change as that property appreciates in value, as your debt principal is paid down, or as your rent or net income goes up. Using the same example let us say the property appreciates to $125,000 in value while your loan is paid down to a $45,000 principal balance. You now have $80,000 in equity in this property! Rents have also increased a bit so your yearly NOI went from $5,000 to $6,000. At this point your ROE is $6,000/$80,000 which equates to 7.5% which is still not a bad return. If home values continue to increase you may get to a point where the ROE becomes very low (think under 5%) at this point it may be time to look to sell and re-capitalize your newfound equity into another more profitable property or venture.
Personally, I have always been a big fan of ‘trading up’ when it comes to properties. Start small, buy a few older single-family homes, ride the appreciation wave and pay down the debt all the while covering your costs with the rent and hopefully making a small profit. When the ROE gets exceptionally low on those units, sell them and 1031 into something larger or nicer.
The best real estate advice I have ever read is a quote from Warren Buffet: Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1
But since that is not always realistic and is also not very constructive advice, I will fall back on this close second place reference from Andrew Carnegie: Ninety percent of all millionaires become so through owning real estate.
Now, when you determine that it is time to sell your property, it is important to strategize and understand the details and nuances of how best to sell your property. See, selling a property while it is rented is not always the best decision. Every investor wants a deal (didn’t you?). So, why would you think that another savvy investor would be willing to pay you top dollar for your property? They likely will not! You will typically get your best price selling to a retail buyer (someone who plans to move into the home to use as their residence). Typically, a retail buyer will need to obtain financing and will generally need about 45 days to close. It is worth the wait! Retail buyers will pay much more than investors as they are buying based on their emotions and not just dollars and cents.
While it may be in the lease agreement that the resident must cooperate with all previews, showings, inspections, appraisals, etc., the reality is that not only does the home sale process conflict with their peaceful use and quiet enjoyment of the property, a successful sale also likely means they must move out! If time and resources allow, the best plan would be to wait until the property is vacant. Then properly turn/renovate the unit and make any necessary upgrades (think flooring, paint, bathroom, kitchen) and then list your property for sale. I would HIGHLY encourage any home seller to spend the extra time and money to make the house nice and presentable as you should be able to increase your purchase price over what was spent and will certainly reduce the time on market. Your property management company can be an extremely helpful resource in this regard. Having leased the property for years they have maintenance records on the property, they know what needs to be fixed, they have resources to affordably and timely make any/all necessary repairs, and they most likely have an in-house broker who can then list the property for sale, sometimes even at a discount! The process from move out to renovation to listing and closing can be done seamlessly through your property management company as all pieces of the real estate puzzle (or a maze rather sometimes) come together!
The same broker can also refer you to a 1031 exchange company (also known as a Qualified Intermediary) and help you identify a replacement property to purchase so you can avoid paying Uncle Sam and keep the party going! You may recall how I mentioned ‘trading up’ earlier. You could use this strategy and opportunity to put your recaptured equity down as a payment on a loan towards a larger or nicer property that rents out for more and is more stable. Wait for that property to appreciate while paying down debt and covering the monthly payment with rental income, rinse and repeat.
I will leave you with this gem from Will Rogers to ponder as you plan your next investment purchase:
Don’t wait to buy real estate. Buy real estate and wait.