The PFG AdminKnowing When to Sell Your Rental Property
It was several years ago, but I remember it as if it were yesterday. A real estate and financial coach reviewed my financials with me, picking apart the decisions I had made and was currently making. “What is your plan with this vacant lot in New Mexico?” “What are you doing with that condo?” “What is your return on your Memphis portfolio?” I was getting tired as the questions kept coming.
He was trying to get me thinking about ways to maximize my assets for optimal results. What should stay, and what should go, and how to convert some assets to investments that better align with my financial goals. It was an intense conversation that I will not forget and one from which I got a great deal of value. I got off that Zoom call feeling a bit deflated but also excited, with a clearer picture of a different approach to investing. I still have that darn lot in New Mexico, but I liquidated about a third of my portfolio after that call. Some assets were slowing down my progress. I am grateful for what I learned during those two challenging hours.
Now that real estate values seem to have settled and rental rates are stabilizing in the markets where I invest, it has me thinking if another portfolio review is a good idea. Are there properties in my portfolio that shouldn’t be? Let’s look at three factors worth considering when deciding the right time to sell a rental.
Is it time to simplify?
Some rentals are easier to manage than others. I own three condos in one complex, which represents a small portion of my portfolio but takes up a significant amount of my time. Even though I have professional management in place, I still need to manage the manager. Issues with neighbors or the HOA tend to consume my time. There is also high turnover, so I feel like we are constantly cleaning a unit up. If my priority is freedom with a passive income, I may consider selling these even if they are producing higher cash flow and higher returns than my other properties.
There will be a time when passive income becomes more important than the total return or growth of your money. As we age or get closer to retirement, we tend to trade investments that take effort for those with safer returns that do not take our time or effort. As I progress through my career, I find myself looking at assets with lower returns that help produce a much higher quality of life. For example, I have decided to sell many single-family homes for commercial assets with income, professional management, and a seasoned rent roll instead of rehabs or BRRRR strategies. I am also investing heavily in private debt. I like the stability and cash flow of private lending. If you are interested in private lending for passive income, please stay safe with it. It is only a safe and passive investment if you know what you are doing. Learn more here: The Pine Report.
Upgrading
My financial coach was working hard to get me to see this message. Prior to that call I would only sell rental properties I thought were toxic. For example, I sold a small extended-stay motel because it was outside my market and attracted tenants that paid in cash, if they paid at all. I suspected that not all the cash was making it to me. Add the high crime and high vacancy, and this asset had to go.
After that call, I realized that if I was chasing a combination of high cash flow, high tax benefits, and some upside, I needed to move into larger assets. The more a building costs, the smaller the buyer pool, making it easier to find opportunities. Single-family homes are great, and I still own several, but they are easy to finance, they trade based on comps instead of returns, and they are used by both consumers and investors, so there is a large pool of buyers. That increases value and makes it more difficult to find great investment opportunities. Larger buildings typically trade based on the income they produce so your only competition is other investors, and the more expensive a building gets, the fewer buyers there are. The smaller buyer pool brings the value down, making them easier to cash flow. Selling a handful of houses to buy a small apartment building or other commercial assets could significantly increase monthly cash flow without giving up other benefits of owning real estate like appreciation, loan pay down, and tax savings.
Eroding ROE
The longer you own a property, the more appreciation you will capture and the more of the loan you will pay down. That combination creates a lower return on your equity. Return on equity calculates how hard your equity is working for you. Many investors focus on return on investment (ROI), which is also important. ROI calculates how hard your investment is working for you but does not account for any lost opportunities from having locked up equity. To calculate ROE, divide the amount you are making by the equity in the property. This calculation makes it much easier to decide on when to refinance or sell and upgrade into a different asset.
In my opinion, once your ROE drops below eight to ten percent, it is worth looking at your options. Once your ROE drops, you have three options: refinance, sell, or hold.
Refinance
At some point, it may make sense to cash in your equity. By refinancing and increasing the loan size, you will reduce your equity, which should increase your ROE. You can take the proceeds from the cash-out refinance and apply them to another investment to accelerate your financial growth. Often this is the best option, but it is not as clear now with some interest rates higher than the rental rate a house can yield, so make sure to look at your situation carefully. This is the exact problem we are seeing in many parts of the country. Be careful with this strategy and be sure that your ROE is increasing with a refinance and not further decreasing. Cash in the bank is not great if you are reducing your ROE.
Sell
Because rates are high, making profits harder to extract from rentals, with expectations that we are entering into a prolonged flat market, many investors are selling their rentals. Many believe that single-family rentals have run their course in this cycle, making it less attractive to hold. Of course, that is only true in the current environment. When values reset or rents increase in a meaningful way, this opinion would certainly change. If you sell, though, you need to have a replacement asset to purchase. Moving money out of properties to put into a money market might be a safe bet, but it will not accelerate growth. Great options to invest in include upgrading to a larger property or other cash-flowing assets like private lending. Again, moving to another asset type does not mean you are locked in. If you think you want to own rentals again in the future, invest in something that can be liquidated when the market is more ripe for rental acquisitions and then jump back in.
Hold
If a refinance deteriorates your ROE and you don’t want to invest in another asset, it probably makes sense to hang tight. There is nothing necessarily wrong with holding onto rentals with equity as long as you understand that it is not the most efficient way to grow your wealth. If the property performs, you have great tenants, or you simply just like the home, keep it!
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