As a landlord since 2005, I'm constantly faced with the dilemma of selling a rental property or renting it out whenever my tenants move out. The older and wealthier I've gotten, the more I prefer to sell rather than rent out. I have a love-hate relationship with owning rental properties.
Being a landlord can sometimes create some very unpleasant experiences. Whether it's getting paid late, experiencing damage, having to fix something, or resolving some type of misunderstanding, being a landlord is not for everyone. You need to be very disciplined and have good patience.
After I reached my limit of managing three rental properties, I stopped buying. Instead, I started investing my cash flow in private real estate funds that invest across the Sunbelt through platforms like Fundrise. This way, I could diversify my real estate holdings, and more importantly, earn more 100% passive income. Being a dad is a full-time job.
Current Dilemma To Rent Out Or Sell Property
Once again, I'm faced with the dilemma of whether to rent out my investment property or sell it. But this time, we are in a unusually high inflation environment.
If you're facing the same dilemma, I will walk through the pros and cons like I do with other dilemmas in my book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. There are three chapters on real estate.
Every dilemma I face is viewed with a 70/30 decision-making framework. After analyzing the situation, my goal is to make the right decision at least 70% of the time with 70% confidence or greater.
At the same time, I recognize that about 30% of the time, I will make a suboptimal choice and need to learn from it. I also accept there will always be some level of uncertainty.
Rent Out Home Or Sell In A High Inflation Environment?
When we are in a high inflation environment, the best thing we can do is own important real assets that inflate with inflation. This way, we get to benefit from inflation rather than get beat up by inflation. Cash continuously loses its purchasing power due to inflation.
Real assets include real estate, cars, fine art, fine watches, fine wine, rare jewelry, and other collectibles. But only shelter is a must-have item if you've got access to affordable transportation.
In a high inflation environment, we also want to hold onto as much affordable mortgage debt as possible. If you have a negative real interest rate mortgage, you're golden as inflation helps pay down your debt for you.
As a result, the 70%+ move is to rent out your rental property in a high inflation environment to capture higher rents. Real estate is not only a great hedge against inflation, it is a great beneficiary of inflation.
Now let's go into more detail about why renting out your investment property in a high inflation environment is the better choice. Then we'll discuss the reasons why you might want to sell instead. I've tried to make the arguments as balanced as possible.
Why Renting Out An Investment Property In A High Inflation Environment Is The Right Move
As a landlord, your goal is to maximize rents and minimize costs for maximum profits. You're running a business. Profit maximization can also mean not raising rents if it may cause turnover. Each situation is different. Let's look at why renting out is the right decision.
1) To ride the inflation wave as long as possible
If you are faced with the dilemma to rent out or sell, you should rent out when inflation is high. Take full advantage by capturing market rents. This is especially true if high inflation is transitory.
Since the mid-1990s, the average U.S. inflation rate has hovered between 2% – 2.5%. 2% is the official Fed inflation rate target.
U.S. inflation is now running at elevated levels. However, it is unlikely an inflation rate that's 2-4X the 30-year average will remain for longer than a couple of years. Just look at this historical inflation chart.
2) To buffer against downturns
Given the economy is cyclical, landlords may one day face tough times when they must cut rents to attract tenants. Landlords may also face times where they will have higher vacancies than normal. Vacancy is what tends to kill profitability the fastest.
Therefore, the savvy landlord will take advantage of high rents when times are good and save the extra profits to cover for when times are bad. The situation is similar to saving money when you experience a tax cut to pay for future tax hikes.
3) To cover higher costs
Good times are one of the key causes of high inflation. People feel richer and tend to spend more, which pushes prices higher. Eventually, demand destruction sets in if prices get too high.
During a strong economy, property prices tend to increase. As a result, property taxes and maintenance expenses also increase. The hope is for rent increases to rise faster than property tax and maintenance expense increases.
Given the largest cost to own a rental property, a mortgage, is almost always fixed for a certain period, rents tend to increase faster than the cost of ownership. If so, rental profits tend to increase at a more rapid rate in a high inflationary environment.
Below is a recent Bloomberg economist survey that shows inflation is expected to fade to around 3% by mid-2023. We got close as the May 2023 inflation reading came in at 4%. The economists have kept pushing back the date as to when inflation will peak.
4) To generate more valuable passive income
Even though interest rates have increased from their 2020 lows, interest rates are still historically low. Low interest rates mean more capital is required to generate the same amount of passive income compared to when interest rates were higher. Therefore, the value of rental cash flow or any cash flow increases when interest rates are relatively low.
Earning real estate rental income is one of the best passive income streams due to higher yields and great tax efficiency. Non-cash depreciation expense helps reduce your taxable rental income. So do all other expenses associated with owning a rental property.
If you are in a higher marginal income tax bracket, earning rental income also is more valuable as well. Earning stock dividend income is completely passive. However, the yields are usually under 2%.
My favorite way to earn passive real estate investment income is through private real estate funds like those offered by Fundrise. Below is the latest monthly CPI data.
5) Keeping your negative real mortgage interest rate
One of the downsides of selling a rental property is losing your low fixed-rate mortgage if you have one. Someone should start a fintech company that makes your existing mortgage portable if you buy a new property.
Many mom-and-pop landlords first owned their homes with a primary fixed-rate mortgage before renting them out. As a result, the mortgage rate is likely lower than a rental property mortgage rate. More than 90% of existing mortgages have an interest rate below 6%.
So long as inflation is higher than the landlord's mortgage rate, the landlord has a negative real mortgage rate. As a result, it's best to keep the debt for as long as possible and let inflation whittle away the real cost of the debt.
6) Minimize tax liability
If you sell your rental property, you may have to pay capital gains tax due to depreciation recapture and price appreciation. Paying taxes creates economic waste.
In general, the best holding period for real estate is forever. If you need money, you can tap your equity to reinvest it in something else. This is what billionaires do. They borrow from their equity holdings, partly so they don't incur capital gains tax.
If you still want to sell your rental property, then you should look into a 1031 exchange to save on capital gains tax. However, you need to buy a similar type of rental property to save.
7) Minimize reinvestment headaches
If you sell your rental property and have a healthy gain, you will then have to figure out how to reinvest the proceeds. It's often very hard to reinvest a much larger sum of money than you are used to. As a result, many people may sit on their windfall for a while. This may not be the greatest move if inflation is high given the purchasing power of cash declines quicker.
It took me about six months to reinvest my house sale proceeds in 2017. I had almost $1.8 million to reinvest and it was hard! The last thing I wanted to do was lose money after my rental property was just chugging along for so many years.
When you have your equity locked up in a rental property, you tend to just forget about it. All you care about is the cash flow that you use to stay free or pay for life.
8) Avoid paying high commission until rates come down
The National Association of Realtors, Kelleher Williams, and HomeServices of America were found guilty of real estate collusion. As a result, there is a high probability real estate commissions rates will come down significantly within the next five years. As a result, renting out the property now and waiting may save sellers 1-2% in commission costs.
Arguments For Selling A Rental Property In A High Inflation Environment
Selling your investment property in a high inflation environment is the 30% move. However, there are definitely some positives which I discuss below.
1) High inflation may only be temporary
If you live in a country where inflation is historically not so high, then chances are the pace of rent and property price appreciation will normalize (slow). If and when inflation does normalize, then you might not get as high of a price for your property in the future.
Given interest rates are rising to help counteract high inflation, the cost to get a mortgage is also rising. As a result, the incremental demand for real estate should decline, all else being equal, given affordability is declining.
The real estate market moves in cycles. When downturns come, you may have to wait one to five years before getting back to the high watermark. For some cities with increasing supply, they may already be in Phase III, so watch out.
2) When your depreciation benefit runs out it may be time to sell
One of the best times to sell rental property is when depreciation benefits run out, regardless of the inflationary environment. Depreciation is a non-cash expense that every rental property owner can take.
You can usually either accelerate your depreciation or straight-line depreciation. The most common form of depreciation is the straight-line depreciation method which is taken off an IRS instituted 27.5 years.
Formula:
1. Purchase price – Land Value = Building Value.
2. Building Value / 27.5 = Annual allowable depreciation deduction.
Example:
1. $500,000 purchase price – $200,000 land value = $300,000 building value
2. $300,000 building value / 27.5 = $10,909 annual allowable depreciation deduction.
3. Current annual rental income is $20,000 (4% gross rental yield).
4. Taxable rental income if we include no other costs like property tax, maintenance, and HOA costs for simplicity purposes = $20,000 – 10,909 = $9,091.
5. Total tax savings if you are in the 32% marginal federal tax bracket = $10,909 X 0.32 = $3,491.
Depreciation Doesn't Last Forever
Deprecation expense is all about saving on taxes. The depreciation criteria basically states that you should aim to hold on to your property for the number of years you are allowed to depreciate.
If you are in one of the top marginal income tax brackets (32%, 35%, 37%), depreciation is your most valuable non-cash expense. If your overall income starts to decline, you may be more willing to earn rental income again given your marginal tax rate will be lower.
It's important to note that depreciation amounts get adjusted back during the time of sale (aka depreciation recapture). For example, if you took 20 years of depreciation at $10,909 a year, you would reduce your cost basis of the $500,000 purchase price by $218,180 (10 X $10,909) = $281,820.
With a lower cost basis, you would pay more taxes due to a higher difference in sales price vs. adjusted cost basis. Depreciation isn't free money in the end. This is why you need to be proactive in your estate and tax planning. Check the latest real estate tax laws.
3) When there's an easier way to own rental property, sell to simplify
The main reason why I sold a rental property in 2017 was that I was becoming a first-time father. I didn't want to have the stress of owning that rental property weigh on me. The rental property had constant turnover due to having 4-5 roommates who always threw house parties.
After selling the property, I reinvested $550,000 of the proceeds in real estate crowdfunding. Platforms like Fundrise make it easy to invest in private real estate across the country. I transferred capital from expensive San Francisco, to faster-growing and cheaper cities like Austin, Houston, Miami, and Memphis.
The older and wealthier you get, the more you probably want to simplify life. Diversifying your property holdings and earning more passive income are great moves. Personally, I've invested $810,000 in real estate crowdfunding since 2016 and have received over $500,000 in distributions.
4) When cap rates are no longer attractive, sell your rental property
If there is a lot of inventory coming to the market and the cap rate premium over the risk-free rate of return is not sufficient, you may want to sell your rental property. The cap rate is calculated as the ratio between the annual rental income to the property's current market value.
For example, let's say your property trades at a cap rate of 3%. It's appreciated handsomely over the past 10 years by 110%. Meanwhile, the 10-year bond yield is at 3.6%. Why own rental property when you can earn risk-free Treasury bonds yielding more?
It may be better to sell your rental property and reinvest the proceeds in other cities with higher cap rates. Cap rates in the heartland are easily above 5%.
When it comes to real estate investing, consider following my BURL Strategy. In other words, Buy Utility, Rent Luxury. It is one of the best real estate investing rules to follow.
5) When you have a major life event, sell your rental property to simplify
There are some key life events that warrant the re-evaluation of owning investment properties: a new family member, a death in the family, a terrible accident that requires extra care, an unwanted layoff, or a job relocation to name a few.
Managing rental properties take time, even if you hire a manager. Therefore, the more complicated your life, the more you may want to sell your rental property to help simplify life.
When my son was born, I decided to sell one of my main rental properties because I wanted to focus on fatherhood. It was difficult to lose the annual six figures in rent. But selling the investment property was the best thing I could have done for my mental health.
6) If you expect a really bad recession, sell your rental property before prices decline
Clearly, if you expect a recession and real estate prices to fall, then selling before prices decline may be a good move. The problem with selling is creating tax liability and finding safe ways to reinvest the proceeds. Further, you might time your sale right, but you might not time your repurchase right.
Think about all the people who sold real estate in February 2020, right before the lockdowns began. They probably felt good for a few months as the real estate market came to a halt. Some owners panic-sold as well. However, just a couple of years later, home prices are up 20% – 50% around the country.
Due to real estate transaction costs, it's much more costly and difficult to time the real estate market. However, if you expect a massive downturn, like the one we saw from 2007 to 2011, then selling your rental property while inflation is high is an excellent move.
Given the structural undersupply of housing and the likelihood of mortgage rates declining over time, I see a relatively buoyant real estate market. There is also a permanent shift higher in the demand curve given the acceptance of working from home.
7) When real estate is greater than 70% of your net worth
During the financial crisis, many Americans got wiped out because 80%+ of their net worth was tied to their primary residence. In contrast, I recommend everybody shoot for the value of their primary residence to equal 30% of their net worth or less.
Once one type of investment equals more than 50% of your net worth, you put yourself at greater risk of bigger downswings. It's good to have a variety of non-correlated investments that tend to zig while others zag. Diversification is why ultra-high net worth people like Bill Gates buy farmland and fine art.
8) When you begin to exceed the $250K / $500K tax-free profit
If you sell your primary residence, the government allows you to pay zero capital gains tax on the first $250K in profits for individuals, and the first $500K in profits for married couples. This tax-free profit benefit is huge for those in the highest marginal income tax brackets.
Some of you may want to rent out your primary residence to generate passive income. As long as you've lived in your primary residence for two out of the past five years, you get to take advantage of the tax-free profit exclusion. However, the exclusion gets prorated based on the years you've owned the rental property.
After selling your rental property, to defer taxes, you can 1031 exchange your investment property by buying another investment property of greater value within 180 days. You'll first have to contact a 1031 exchange company to handle the exchange.
It'll cost you about $1,000 – $2,000 for the optionality of doing such a transaction. If you can't find an investment property you like in 180 days, then you eat the $1,000 – $2,000 setup cost.
9) When commission rates decline, selling your rental becomes cheaper
One of the main reasons why there aren't more real estate transactions is because commission rates remain stubbornly high. We're talking still a 5% selling commission rate (2.5% to the listing agent, 2.5% to the buyer's agent).
Where every other commission rate has declined due to the internet, real estate commission rates are still holding strong. The irony is that if commission rates were lower, there would probably be more overall commission dollars to go around. Further, I would have probably sold one of my properties in 2012, right before the massive surge. Hooray for high transaction costs!
Below is an example of how much it costs to sell a home nowadays. We're talking roughly 6-7% of the home's value in selling costs. Who wants to sell and pay so much in fees and taxes, while also losing their low mortgage rate? There had better be a great reason, such as an impending Great Depression.
10) When there are major upcoming repairs
You may want to sell your rental property due to upcoming major repairs. Some of the main recurring major expenses include a new roof every 15 – 20 years, new paint every 10-20 years, a new HVAC unit every 15-30 years, a new water heater every 10 – 15 years, repairing decks every 20-30 years due to dry rot, and remodeling kitchens and bathrooms every 20-30 years.
You may also have to update old electrical wiring to code. It can cost $10,000 – $50,000 to rewire your entire house. In San Francisco, if you own a multi-unit building over a garage, you may have to spend $100,000 – $300,000 to retrofit the building due to a new law that was past several years ago.
One of the reasons why I sold my rental property in 2017 is because I had leaks in the back windows which would have cost me $20,000+ to replace. Further, I had old knob and tube wiring. It would have cost me at least $30,000 to update my wiring to modern ROMEX wiring.
Remodeling a home always takes longer and costs more than expected! But if you remodel successfully, you can boost your rental income. I went through a 2.5-year remodel from 2020 to August 2022. It was so painful I have swore off remodeling ever again!
It's Generally Better To Hold And Keep Renting Out
After thoroughly going through the pros and cons of selling or renting out an investment property, I still believe the longer you can hold onto your rental property the better. Getting rich with real estate is like a war of attrition. He or she who holds on the longest generally wins the most.
Higher-than-average inflation generally isn't great for the average person, unless the average person is getting a bigger raise and owns a lot of real assets that are also inflating rapidly. Therefore, landlords might as well enjoy the benefits of higher rents while they can given their costs are also inflating.
Personally, inflation is affecting my family due to rising food, gas, childcare, and tuition costs. Meanwhile, both my wife and I don't have jobs, which means we can't take advantage of rising wages. How sad! My type of household is getting hurt by inflation the most, even more than the traditional retiree with lower expenses.
The only thing helping my family offset abnormally high inflation is our rental property portfolio. However, given two out of my three tenants aren't moving, I'm not benefiting. I feel too bad raising their rents so I eat my rising costs, which they don't understand or appreciate.
As you can see from the above chart, rent growth is very strong for single-family homes. It will likely stay elevated as more people permanently work from home. Therefore, I like Fundrise funds because they predominantly focus on investing in single-family homes in the Sunbelt for rental income. Investing in private funds also enables me to capture higher market rents.
Only Benefitting Slightly From High Inflation
I've only got one rental property in San Francisco that will now earn higher rents after I got new tenants in June 2022. I rented out the property to a new tenant relocating back to San Francisco from the east coast. They are paying 10% higher rent than what my previous tenants were paying.
My long-term game plan is to own a three-property rental portfolio until the year 2045. By then, my kids will be 25 and 28. They will hopefully have stable jobs, be in graduate school, or know what they want to do with their lives. If not, they can always manage the rental property portfolio until they do.
To me, owning rental property is not only a hedge against inflation, but also a hedge against a difficult life. I was lucky to land my job after college and escape 13 years later. I doubt my kids will be as fortunate, so I'm planning ahead.
Owning rental properties is one of my main retirement income generators. Without rental income, I'd probably still be grinding away in banking. Therefore, whenever I have an itch to sell, I just remind myself rental properties are what's keeping me free.
Recommendations To Build More Wealth
To invest in real estate 100% passively, take a look at Fundrise. Fundrise is the leading private real estate investing platform with over $3.5 billion in assets and 450,000+ investors.
Fundrise focuses on undervalued properties in the Sunbelt where cap rates are higher. I have $954,000 invested in private real estate to diversify and take advantage of a multi-decade trend.
For more nuanced personal finance content, join 65,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009.
Sam and all,
When selling a rental property that has been rented out for awhile (over 5 years), what strategies do you know about to reclassify it as owner occupied within the 2 out of 5 years to obtain the tax credit? Can it be changed to a second home and not rented out or partially rented out with owner occupying a room as a second home/vacation home? For a California home with significant appreciation of ~800k, that state and federal tax on capital gains could be around 33%?? At that amount it might be cost effective and savings to have it empty or not rented for 2 years in order to qualify for the tax credit? Appreciate any input or insights here.
I think you’ll enjoy this post: Clarifying The $250,000 / $500,000 Tax-Free Profit Rule.
Use the Search box on this site to ask about anything and there’s a high chance I’ve written about it. And don’t forget to subscribe to my weekly free newsletter.
Hi Sam, for cities with strict rent control laws like San Francisco, what do you recommend if you live in one unit in a multi-unit building and decide to move? You’ll likely get a higher price for the building if one unit is empty than if they’re all tenant-occupied.
I guess it depends on whether you own the entire building or not too and also what is the rent.
I have rental properties that I won’t sell for reasons you listed – effective negative mortgage rate (sub 3% on all of them), tax depreciation, I want to hold them for kids. But the cons are all relevant, too.
In the last few years I’ve had so many major issues, including delinquent rent issues during covid, a busted pipe in one unit and then a portion of the roof collapsed in another unit due to extreme weather. In both cases the damage was estimated at just under the deductible.
Some tenants and their pets are destructive and the damage exceeds the deposit. I self-manage the properties and at times it is a lot of work and stress. I no longer consider owning and managing multiple properties to be a form of passive income like I thought it would be when I got started.
I hear you. The difficulties can be painful indeed. With each difficulty, I remind myself it is partly due to the rental income that enables my wife and I to stay unemployed and raise our kids.
Hey Sam…
Love your blog, and I’ve been on the same page as you about most financial planning decisions for decades.
Just wanted to point out one little hiccup in the real estate investment decision for some right now…
I own two multifamily properties in a large city that, in normal times, puts a rent control cap on rent increases. However, currently (and for the past couple years and foreseeable future), they have made ANY rent increases illegal. This was ostensibly due to Covid, but as the pandemic recedes the city council continues to renew this restriction with no reasonable explanation as to why they are doing so. In normal times this would be frustrating enough, but in a high inflationary period, where costs are going up rapidly and dramatically, it ends up being highway robbery. All of my rents are well below market and there’s nothing I can do, and I anticipate that, by the time the ordnance is lifted, I will have gone 4 years in a high-inflation environment with zero rent increases. (Tenants are also loathe to move as their rent falls farther and father below market.) All this while costs for property tax, insurance, repairs, maintenance, utilities, etc etc are skyrocketing. And when allowable rent raises DO return, they certainly will be restricted and not allow tenants to be moved anywhere near the market rent.
I’ve owned the properties for a while and do incredible cash flow with them, especially since I refinanced last year at rock-bottom rates, so I can weather this. Many other landlords I know in this city, though, are struggling to make things work as costs go up with inflation but rents are not allowed to. Just wanted to point out this issue because, in some places, it may change the calculation of when/whether to sell an investment property.
Great issue to point out. Thanks. Which city do you own?
Perhaps tenants will eventually move one day and you can get market rate again.
Hopefully your costs aren’t going up too much due to the fixed nature of the mortgage. I haven’t noticed my insurance costs go up yet. SF property takes forever up about 2% a year.
I own in L.A. Units under the city RSO are still under a rent increase moratorium for the foreseeable future. My best guess is it will end in May, 2024 (more than 4 years after it started), but they could always find some way to extend it beyond that.
My tax increases are capped as well at around 2%, but insurance went up 20% this year! Repair costs are through the roof, major capital improvements were required in the last year, and tenants at home more means more water & more wear and tear.
That said, I’m fine…I bought a the right time, did some improvements over the years to increase value, and refinanced at rock bottom rates. Would always like to maximize returns (which this policy is stopping), but my cash flow rate on the properties is ~50%…really. But I know several other landlords whose numbers don’t work as well, and this rent situation is making things tough. I can see some of them selling because of it, even in this inflationary environment.
Hi Sam, my husband and I have a rental property that the previous tenant totally trashed. We have a very low income from a small pension and a retirement distribution, around 21000 per year. I have had it with renting and I was offered an “as is” sum that is very enticing. We would make a pretty good profit since properties have gone through the roof and we bought this house in 2009, when nobody was buying. We are in the 0% capital gain bracket so would we have to pay capital gains on the sale? Also, we are on the ACA due to our lower income. Would the sale effect our eligibility?
Will your income be enough without the rental income? Check out this post for long term capital gains.
Once you are past the bottom threshold, you will have to pay long term capital gains tax. But it’s not a big percentage. Your ACA subsidies could be at risk b/c you can’t make more than 400% of the Federal Poverty Limit.
Here are more details: i got another 4 properties. 2 of them still with a mortgage. both mortgaged properties have doubled in value in the last 5 years. Both of them generate in rent above the monthly morgage pay. If i sell any of them i can payoff both mortgages
If i sell the apartment and buy the newer one, i increase my rental income but also my debt.
With the apartment sale i could also payoff both mortgages on the other which would significantly increase current income. maybe i could wait for another oportunity in the future.
What would be an optimal course of action?
I have an appartment in a very desirable zone. fully paid, have always been rented over its morgage price, and its price has gone up 3fold since we bought it, but it wont go any higher as the building is over 30 years, not very well mantained and new developements are beginning to spawn near.
Im considering selling, and invest in another property in an even more desirable zone (many hospitals and medical schools, very nice neighborhood); The property is not new but its in excellente condition and very big and im getting it below market price, but i will still have to get another mortgage to cover the cost. If things go relatively well, i could get 2.5x the rent i get now minus the mortgage, which would leave at 1.5x current profits ont that property.
would you pull the trigger?
Great post! I would like to sell but my basis is super low, hence a huge tax hit. But doing a 1031 in this market is almost impossible with the limited time allowed to identify a 1031 exchange property.
Is there an easy way to do a 1031, say like with a Fundrise sort of company?
Any other creative ways to do a 1031?
We are currently in contract to close on the sale of a duplex we have held for about 21 years in Central Ohio. We are in our mid 50s and after the sale of the property we will still own 16 units throughout the area. Our lions-share of net worth is captured in long term real estate holdings. However, we have been active managers for years and I am trying to gain more “life” back!
I recently have begun looking at our rental returns in terms of “return on equity”. As you state, when one nears retirement the focus shifts to cash flow. I should say that we have lived 100% from our rental property income for 10 of the last 17 years. I did have a w2 JOB for about 7 years in that period. The focus on return on equity has me re-evaluating some things. As I often tell my friends and family, “you can’t eat a house!”
Because of the considerable appreciation our properties have seen over the last 25 years my focus now is to free some equity and reinvest back into other RE assets that are 100% passive. Doing this in a tax efficient manner is the challenge. 1031 exchange remains to be an option whereby my focus would be on turnkey, fully managed properties. If I had been more savvy a year so ago I would have begin pulling cash from existing properties with low interest rate loans. We own many units outright without debt. But, my goal is to increase cash flow while preserving the capital.
So this is my plan at this point. We also made some larger institutional private placement investments (1031 DST) last year. We should be able to carry forward suspended passive losses from them to help offset gains from the sale of property this year. I am battling this out with our accountant currently. The key is “professional real estate” status to unlock all of the passive losses. We clearly meet the safe harbor recommendations regarding this designation.
This is all very confusing and anxiety triggering stuff! The last thing I want to do is risk the equity/capital that we have gained over so many years of investing. We, too, are focusing on areas that offer better cap rates and I am laser-focused on finding recession resistant property.
Thanks for listening…
There is a third option, the 1031 exchange.
it allows you to pass your basis, tax free, onto a new property. Basically you can sell the building tax free as long as you “roll over” the gains into a new property.
This lets you climb the investment property ladder and reduce the number of buildings under your management. You also get to capture additional depreciation if the new building is more expensive.
The final benefit to this is that the asset “rebases” when you die, so your heirs can effectively turn around and sell the asset tax free as the new basis is its market value.
Is this right? I’m not the judge. It is the current state of things and I plan to take advantage of it.
Indeed. I mention 1031 Exchange in point #8 for why to sell. But going from one PITA or expensive property and rolling it over to another expensive or PITA property may not be the best move. So you’ve got to really assess the reasons for doing so.
There’s also the time crunch of identifying a new property to roll over to. Forcing it may also be a bad move if you can’t find a good deal.
Hi Sam, the guideline on 30-70pct of house value as a % of net worth probably is pretty challenging in the current environment with stocks tanking and housing appreciating ( 100pct in certain areas). I prefer your other guideline on home affordability, triple test.
It always starts off as a challenge in the beginning. But that’s why it’s a challenge. Your first home’s percent of net worth will be extremely highly – maybe well over 100%. But over time, the goal is to get it down to 30% or less of net worth.
One way to lower to 30% is to cash out refi and use proceeds to invest elsewhere, apartments or stock (consult your accountant for tax consequences). I’ve owned my house for 20 years and try to refi to 70% LTV each except lately my house value has gone up faster than my income so the back will only lend to 50% LTV.
Perhaps this has been done before and is too simplistic for FS but a post about demystifying the process for first-time landlords would be interesting. Maybe this type of thing is readily available elsewhere, but with all the experienced landlords here, a post about the pitfalls to avoid for first-timers like how to properly list, screen prospective tenants, etc., might be interesting.
“Earning stock dividend income is completely passive. However, the yields are usually under 2%.”
Someone I know told me about CLM – a mutual fund that invests in growth and value. The dividend is over 17%. He’s had it and has been collecting for years; seems pretty good and 100% passive.
I opened up a small position.
All interesting points to consider, Sam. We have a (Sacramento, California) condo that went from $100k to $250k. We bought it with cash. Selling would result in capital gains of $35k. Alternatively, we could add some cash to that pot and do a 1031 exchange for a nicer rental property. Besides avoiding taxes and getting a tad more cash flow, the benefit of doing this would be attracting better tenants. However, it seems to me we’re buying top of the market and we’ll lock in high property taxes too. I feel prices will deflate the next couple years especially in secondary markets like Sacramento. What would you do in this situation?
I have two duplexes in a desirable location that I intend to eventually pass on to each of my kids. I’ve competed all the major repairs you listed over the last five years, and it’s nice to be down to just a few little expenses that pop up here and there. I’m not sure I’ll turn over ownership to them before I die, but the supplemental income can definitely defer the cost of raising children, and if they want to move to our back to our home town when they are young adults, they’ll have a place to live (not with us).
Solid post Sam. Your article is timely. My in laws came to visit us. The uncle advised us that one of his biggest regrets was selling his properties. He owned over 10 properties over the years and sold them after holding for 2-5 years. He preached that his lesson for us is to buy and hold as long as the system we are in creates inflation.
I currently Own 5 rentals and invest in Fundrise (thanks Sam) and by far real estate is the best asset class. I’m in my early 30s and view these as my “mini pensions”. One day, I’ll get to retire and live off them, even refi and live tax free!
Mini-pensions each! Great way to look at them. Thanks for reading and sharing your thoughts.
This post really comes in handy as me and my wife are debating so hard whether to sell our last primary resident in NYC! Now it seems to me the better choice is to sell especially we saw the nice appreciation in the past two years even though we get positive cash flow and 5+% Cap rate from renting it out.
With over 70% of our asset in real estate, it further supports the idea to sell and we can use the proceed to invest in other assets.
Maybe your kids will be like mine and exceed your income and net worth early in their lives. My wife and I certainly weren’t hurting early in our married life, and had steady jobs in healthcare. Both of my kids are doing better than we were at that point-which makes me happy BTW.
Maybe! I just hope they find purpose, happiness, and life partners. With shelter and/or a base level of income, these things are more easily achievable.
Here’s the math though. If you are in the top 10% of income earners, then by definition, you out-earn 90% of the working population. So if you have children, it’s a high hurdle to cross.
Good thing money isn’t close to everything! Part of the reason why I’m almost always happy and satisfied is because I have low expectations. I wasn’t supposed to be here, so I feel blessed every day.
Really solid post Sam. Thanks for so many helpful insights and things to think about. I have one rental property I co-own and manage with my brother. We’re lucky to have good tenants right now who’ve lived there for the last three years. We plan to hold on to the property and find at least a couple more rounds of tenants whenever the next turnover event happens. After that, our plan is to hire a property manager when we’re older and then consider selling if the market timing is fair and it’s becoming too much hassle. I’ll definitely come back to this post when that time comes, thanks!
A good property manager would be huge. But a bad one who is not on the ball where you also have to pay is not.
You should consider holding on until your kids are old enough. Then, there will be new energy to takeover as yours wanes.
I have two rental properties managed by a property managment agency. I can’t imagine not having them or the service…it would be a nightmare and not worth the time nor investment….I would just invest in REITs at that point. With property management, it works out decently.
That’s good. Are your rental properties within driving distance of you?
HI Sam,
What do you think of holding a rental property in a Self-Directed IRA?
I rarely see this in my market but wonder about your opinion. Specifically in regards to a legal vacation 2-4 bedroom rental at the beach (condo or villa in my market here on Amelia Island, FL). Vacation rents and luxury resort occupancies have gone-up substantially here the past two years!! Thanks! John Raker
If you can do it, it makes sense. Anything to shelter tax liability and eliminate tax filing hassles is great.