When my wife and I first got into real estate investing over 10 years ago, we figured that we’d hold each rental property for the rest of our lives. Why not, right? As long as each property was cash flowing, we figured that it was a good source of passive income and that we should just keep it in our portfolio to grow our net worth over time.
As it turns out, there’s a lot more nuance to it than that, and we didn’t wake up to this until fairly recently, within the last few years. And because we didn’t have a clear plan for the properties we acquired (beyond ongoing monthly passive income) until recently, we missed out on several years of potentially more aggressive and intentional growth.
This is something that we see very often with other real estate investors. Once they acquire a property, many investors don’t want to sell and continue to hold on to that property for decades, if not generations, even passing those rentals down to their children.
Some hold on long-term to avoid capital gains tax. Others put in a cash offer years ago and have no monthly loan to pay down on the property. Others do so because it’s also their primary residence and they’re renting out the extra unit(s) or to lower their income tax burdens or take advantage of ongoing depreciation.
Still others do it because they just haven’t yet figured out their long term financial goals and how the property fits into that vision.
If your goal is to create a life of financial independence, retire early, maximize your net worth, and create life-changing wealth for yourself and your family, is holding a property indefinitely truly the best strategy, or is there a better way?
How do you know when you should continue to hold on to a rental property, when you should sell the property, the tax implications, and the overall impact on your financial picture? That’s exactly what we’ll cover in this article.
When To Hold On To Your Rental Property
Before you ever acquire a rental property in the first place, be sure to figure out your goals for that particular investment. Is cash flow or appreciation more important? Do you rely on the property to provide an ongoing income stream? If the property needs a lot of work, how long will it take to stabilize, and what are your plans for funding the renovations? If it’s in the path of progress, what are your projections for rent growth in the coming years?
In addition to your goals for the property itself, be sure to take a look at the rental in the context of your greater financial portfolio. How does this rental property contribute to your overall financial and life goals?
Once you figure out the purpose each individual rental property serves, you’ll gain more clarity around whether or not the rental property is continuing to meet that goal during the time you hold the property.
Strong And Ongoing Positive Cash Flow
One of the first data points you want to look at when considering selling a rental property is how much monthly passive income it generates. After paying the mortgage, taxes, and expenses, how much money is left over?
Does that amount of cash flow still excite you as much today as when you first purchased the rental property? Or are there other rentals that could potentially generate more cash-on-cash returns?
As long as you feel good about the overall passive income that the property is generating, especially when compared to the amount of equity you have in the deal (more on this in a minute), then you should consider holding on to the property.
Low Maintenance
On top of strong monthly returns, another thing to examine is the amount of ongoing maintenance, time, and energy you put into the property. The last thing that an investment property should be is a second job.
Is your involvement in the rental property fairly passive? Or does it take up a fair amount of your time, energy, and mindshare on an ongoing basis?
If the latter, take a moment to consider whether a different rental property or a different investment vehicle altogether might be a better fit for your lifestyle goals.
Growth Potential
A third aspect to consider is the overall growth potential of both the property itself, as well as the market the property is in.
If you invested in the property largely because of the potential for market appreciation, you’ll want to continue to hold the property as long as that market continues to show solid fundamentals (strong job growth, population growth, and job diversity) and as long as vacancy remains low and rents continue to climb year over year.
For example, we hold multiple rental properties in Huntsville, Alabama, which is currently booming. This previously sleepy little town has seen incredible job and population growth over the last few years and continues to grow at a solid pace.
Once you start to see signs of a slowdown, it might be time to consider putting your money to work in another rental property or another market.
When It Might Be Time To Sell
Selling a rental property, particularly one that produces hundreds of dollars of passive income per month, might seem counterintuitive, which is why most owners continue to hold on to their rental properties indefinitely.
However, the question is not whether your money is working for you in that rental property, because if it’s throwing off ongoing passive income, it’s obviously working to some degree.
Rather, the question you should be asking is whether your money is working as hard as possible for you in that investment, or whether it could generate higher returns or growth via another property or investment vehicle.
Does the amount of passive income the property generates make sense in terms of the amount of equity you have in the property?
Low Return On Equity (ROE)
When most people invest in real estate, the main metric they look at to determine the success or viability of that investment is ROI (return on investment). In other words, if you were to invest $100,000, how much would you get in return to make that $100,000 worth it?
A savings account with an interest rate of 1% would give you $1,000 per year on that $100,000, making the ROI very low. A rental property, on the other hand, might produce $10,000 a year in cash flow, giving you a 10% ROI, which might be much more attractive.
While ROI is a fine and dandy data point at the start of the investment, it shouldn’t be your only measure of the success of the investment, especially as time goes on and as you build more equity in the investment. Over time, rather than looking at ROI, you should start looking at ROE (return on equity).
What Is Return On Equity?
Let’s take that same $100,000 investment as an example. Let’s say you bought a property five years ago. The property generates $10k a year in cash flow, giving you a 10% ROI. Your return on equity (ROE) at the time of purchase would also have been 10%, since the $100k was the full amount of equity you had in the deal.
However, over the last five years, you would have paid down some of the mortgage on the property, and if you invested in a growing market, the property value likely would have increased substantially. Let’s say that you now have $150,000 of equity in the deal ($100k original investment + $50k in appreciation and loan pay down).
Now, when you take a look at a $10k return on $150k, that’s no longer 10%; now that’s roughly a 6% return. Suddenly not so exciting, right?
The Impact Of Return On Equity On Your Investment
Continuing that example, now that we know the $150k is “lazy money,” you can start to evaluate other investment opportunities that might put that money to work harder for you.
Let’s say that you were to sell and reinvest the $150k equity into another deal that produced a 10% return, just like your original deal. That would mean that you’d receive roughly $15,000 in rental income per year (10% of $150k).
That means that you would be making $5,000 in additional rental income per year – $10k if you were to leave you money in the original deal, without selling, and $15k in returns per year if you were to sell and reinvest all the equity into another deal with a 10% return.
So then the question becomes, is your equity working as hard as possible for you in that deal, or is there some “lazy money” that could be pulled out and put to better use, either via a refinance or through selling the property?
If your return on equity is lower than you’d like, it might be the right time to sell.
Potential For Higher Returns Elsewhere
Before you sell your rental property, you should figure out whether your money can work harder for you in another investment. In other words, if you were to sell your rental property and re-invest that money into another investment property or another asset class, would that generate a better return? Would it help you meet your financial and life goals more quickly?
If the answer is yes, even when you factor in capital gains tax and the benefits of depreciation, then you should consider selling.
Your Tenants Are Moving Out
Another great time to consider selling is when your tenants move out. Vacant properties, especially properties that are comprised of four or fewer units, are significantly more attractive to potential buyers and investors. For buyers looking for a primary home, they can move in immediately without having to worry about displacing the current tenants.
For investors, they can make any needed repairs, upgrade the property, choose their own tenants, and generally have more control over the property when it’s vacant rather than when they inherit tenants as part of the sale.
Plus, a vacant property increases the pool of potential buyers. Whereas a fully occupied property is only really attractive to other buy-and-hold investors, a vacant property will attract buyers looking for a primary home, house flippers, and short-term / vacation / corporate rental owners, as well buy-and-hold investors.
So, the next time your tenants give notice, take that as an opportunity to re-examine your investing goals and tax strategy and determine whether to seize the vacancy as a chance to sell your property.
Cash Flow Is Hit Or Miss
Strong, stable, and ongoing passive income is one of the most compelling reasons to keep a rental property in your portfolio, so when cash flow tanks or becomes unpredictable, it’s a sign that it might be time to make a change or sell your rental property.
Perhaps the tenants are not a good fit for the property. Perhaps the local market is shifting. Perhaps there’s a good amount of deferred maintenance that needs to be addressed.
When cash flow is hit or miss from one month to the next, stop and take a closer look. Does it make sense to address the issues and aim to increase the income, or would you rather sell and hand it off? Depending on whether the issues you find are easily fixed, it might a good idea to sell.
Tightening Of Local Regulations
Something that’s often out of your control as a rental property owner is local government and regulations. This is especially pertinent here in Oakland and the Greater Bay Area, where rent control and continued tightening of local regulations make it difficult for many rentals to cash flow or provide a reasonable ROI.
If you’re investing in a market that’s more tenant-friendly rather than landlord-friendly, you’ll need to keep a close watch on the local regulations, to ensure that you’re abiding by the rules and to ensure that your investment still makes sense, particularly with any tightening of the regulations.
If there are creative ways for you to pivot (for example, turning a long-term rental into an Airbnb), then perhaps it makes sense to continue holding your investment property. However, if it feels like you’re fighting an uphill battle, it might make sense to sell.
You Don’t Want To Be A Landlord Anymore
Being a landlord can be a lot of work. Between the surprise repairs, tenant turnovers, bookkeeping, and ongoing maintenance, being a landlord and rental property owner can require a fair bit of your ongoing time and attention.
If you’re going through a major life change – you just had a new baby, gone back to school, gotten a promotion or started a more demanding job, ready to retire, or otherwise have entered a new phase of life and no longer have the time or interest in continuing to be a landlord, then perhaps selling makes the most sense.
You’re Moving Out Of The Area
First, you should know that it’s entirely possible to manage rental properties from afar. When we first moved out of Washington, DC (the place where we first started investing in real estate), we held on to our rental properties.
Over time, we found a great property management team we trust who takes care of the day-to-day and who bring us in for strategic decisions.
However, if you’re not comfortable managing your rentals long-distance, don’t want to deal with the hassles of filing taxes in multiple states, or are just ready to use this as a fresh start, then perhaps it’s time to make a change and sell.
One thing to note here is that if your rental property is also your primary residence (i.e., if your rental is a duplex and you’re house hacking – living in one unit while renting out the other), you may qualify for some long term capital gains exemptions, based on how long you’ve lived in the home.
Feel free to schedule a call with us to discuss further, or talk to your CPA for further details.
You Want To Trade It In For Something Else
As mentioned above in the ROE (return on equity) discussion, if you realize that there’s some lazy money in your investment and that your equity is not working as hard as it can for you, you may find other investments that produce a better return.
Perhaps your rental is a single-family home, and you want to upgrade to a multifamily property. Or perhaps you’re ready to diversify and invest your capital in another market or asset class to help lower your overall risk. If so, you can consider a 1031 exchange to make a like-kind exchange while helping you defer your capital gains taxes, as long as you buy another property within 180 days (6 months).
Perhaps your rental is also your primary residence, as in the house hacking example above, and you’re ready to move to a different neighborhood or upgrade to a larger multifamily property.
Or, perhaps you want to take on a more passive role and have someone else do the heavy lifting, as in the case with passive investments through real estate syndications (group investments).
To Hold Or To Sell? That Is The Question
As you can see, there are a lot of things to think about when determining whether or not to sell your property – everything from lifestyle choices to overall returns and growth potential to local regulations and tax implications.
Be sure to find a great real estate agent, if you don’t have one already, and use them as a sounding board throughout the process. See what your realtor says about the state of the market, the value of your property, and whether now is the optimal time to sell.
Speaking of which, one thing you might have noticed is that nowhere in this article do we talk about timing the market. That’s because trying to time the market is notoriously difficult, and even seasoned experts often get it wrong.
Rather than trying to time the market, when you’re trying to decide whether to hold or sell a rental property, look inward and reflect on your own personal real estate investing goals for that property. This is one of the most important things you can do for your portfolio as a real estate investor.
The bottom line is, if the rental is continuing to satisfy your goals or is on track to help you meet your overall goals, then you should continue to hold it in your portfolio.
However, if the property performance is lackluster compared to previous months and years, if return on equity (ROE) is much lower than you thought, if your tenants are moving out, if you’re moving on to a new phase in your life, or if you’ve found a better investment vehicle that better suits your lifestyle and financial goals, then it might be time to sell the property.
One thing to remember is that as you navigate your decision on whether to sell, be sure to consider the tax side of the equation as well ans see what your CPA says about your tax rate, capital gains taxes you might be on the hook for, depreciation recapture, and any other tax implications of the sale.
Related: How To Prepare Your Home For Sale In Oakland And The East Bay
We’re Here To Help
If you’d like help navigating your options, plotting out a timeline that makes sense, hearing about our experiences with buying and selling rental properties, learning about investing in real estate out of state, getting a better understanding of tax implications or capital gains taxes, or just getting a sense of what your rental property might sell for in today’s market, schedule a call with us.
We’re avid real estate investors ourselves and own multiple investment properties both here in Oakland and the Bay Area, as well as in other markets across the country. We invest in both rental properties as well as passively through other types of real estate investment vehicles like syndications, so we’re happy to discuss our experiences and help you on your investing journey.
