Last Updated on April 14, 2021 by Mark Ferguson
Rental properties can be a great investment if they bring in cash flow and are bought below market value. I bought 16 rental properties from the end of 2010 to the middle of 2015. I stopped buying rentals in my market because prices increased so much that it became very tough to cash flow. I bought my properties well below market value, and prices in my area (Colorado) increased tremendously. I put a lot of thought into whether I should sell the properties, keep them, or refinance them.
I decided to sell a couple of properties, refinance a few more, and keep the rest as they were. The reason I decided to sell some of my properties was I had $100,000 of equity in some of them but was only making $500 per month. That means I was making about 6% cash-on-cash returns on my equity (I was making much more on my initial investment since it took around $30,000 to buy each house). Even though I was making close to 20% on the money I had initially invested, I could make much more by taking my equity out and buying more houses. So when does selling your rentals make sense?
Should you sell your rental properties if they are not making you any money?
My readers and podcast listeners constantly ask me when or if they should sell their properties. Many people are not making very much money on their rentals but have a lot of equity. Here is an example:
- The house is worth $200,000
- The house rents for $1,500 per month
- The investor has a loan of $125,000 against the house
- The payments are $1,100 per month
On the surface, it looks like this rental is making $400 per month, which is great. However, the investor has not accounted for any maintenance or vacancy expenses. Those expenses usually add up to 10 to 20% of the rents every month, which would equal another $150 to $300 in expenses. The investor is only making a couple of hundred dollars per month on this rental but has $75,000 of equity in the property. That is only a 3% return on your money. There are other advantages to rental properties, like depreciating the property, equity pay down, and increasing rents. However, which opportunities are the investor missing by keeping the property and all that money tied up? I think the investor should sell the property and invest the money in more houses or apartments.
If you sold this property, you would not be able to keep all the equity. There would be selling costs and taxes you have to pay unless you do a 1031 exchange. The selling costs could end up being 6 to 10% of the cost of the house. If the house sells for $200,000, that would be $12,000 to $20,000. Taxes on the sale of a rental property would most likely be 15 or 20% depending on which tax bracket you are in. You only pay the taxes on the profit you made on the property and any recaptured depreciation. We will assume the investor bought the property for $150,000 a few years ago, which means they would pay around $6,000 in taxes. That leaves the investor with about $50,000 in cash to play with if they do not do a 1031 exchange, which could reduce the taxes to nothing.
How much more money could an investor make?
Rental properties can be expensive, which is one of their downfalls. With $50,000, you could buy a better-performing rental property that generates more money. Not only could you buy a rental that generates more money, but you could also buy the property below market value, which will make up for all that money you lost selling the other property. Here is an example:
- Buy a property for $100,000 that needs $10,000 in work
- Put $20,000 down on the property, with a house payment around $600
- Repair the property and rent it out for $1,200 per month
- If you bought the property correctly, it should be worth at least $140,000
You now have a house with $60,000 in equity (almost as much as you had before). You are making more money every month. You even have $15,000 in cash leftover ($20,000 down payment, $10,000 in repairs, $5,000 for miscellaneous costs).
Some of you may not think this is an awesome deal, but you have more cash in your pocket that can be used to buy additional rentals in the future. You also have a property that generates much better income every month. If you have some extra money to buy a second property right away, the equity and cash flow would double, and the investor would be much better off. If you have a property with more equity than my example, you would buy more rentals right off the bat without using any extra cash and be way better off as well. If you are trying to decide whether you should keep or sell some of your rental properties, analyze how much cash you could get from them and how much you could make with that money.
What did I do with my rental properties?
I got really good deals on all of my rentals, and our market took off in Colorado. I had properties that I bought for $100,000, put $20,000 of work into, rented out for $1,3000 a month, and are now worth $220,000. I had properties with $120,000 in equity but were only generating $7,000 per year. I was making 6% on my money, which is good for some investors but not what I am used to from investing in real estate. I always wanted to make at least 15% cash-on-cash return on my rentals. I knew I wanted to make more money, but I was not sure how. I ended up refinancing some properties, selling a couple and keeping others as they were.
I refinanced properties because I could take cash out of them and still make money. In the example I first used for the investor with a $200,000 house, he could have refinanced as well. You can usually refinance a house at 75% of what it is worth. The investor could have taken a loan out for $150,000 on the $200,000 house and had payments around $1,100 per month after taxes and insurance. If you are wondering why that payment is the same as the payment I used for the $125,000 loan balance above, I assumed the investor had the loan for a while and the original balance was $150,000 at a higher interest rate than we have now. When you refinance a house, you have to pay closing costs again, which can add up to 3% of the loan amount, or $4,500 in this example. By refinancing, the investor would get $20,000 back in cash with a similar payment as he had before. That is not a bad deal, but I do not know if $20,000 is enough to buy another rental. If so, the investor may be better off refinancing than selling.
I had more equity in my properties than in the example we used. I was able to take out anywhere from $25,000 to $50,000 in cash from many of my rentals and still make decent cash flow. By refinancing my properties and selling a couple of other ones, I was able to get all the money back out that I had used to buy my 16 properties, and I was still making $7,000 per month from them. I sold the properties that were the least desirable to me and kept the ones I liked.
How do you buy new rental properties if there are no good rentals in your area?
The problem I ran into when I wanted to sell my properties and buy more rentals was I could not find good rentals in my market. Prices had increased, but rents had not increased nearly as much. I had to use much more cash to buy houses because prices were high, but I made less money on that cash. I decided to stop buying properties in my area and look in other markets. I went to Florida and found good rentals, but I ended up not buying any properties there. Instead, I started to flip more houses, and that is where I invested my money. I have historically flipped from 5 to 10 houses per year, but in the last three years, I flipped 12 and 18, and this year I will come close to flipping 30 houses. I want to buy more rentals. In fact, I have a goal to buy 100 properties. I am not going to buy bad investments to reach that goal, so I have switched directions with my investing. If I find the ideal place to buy rentals or my market changes, I will be set up to invest a lot of money into rentals thanks to the flipping business. You can watch the video below to hear more about investing in expensive markets.
I have not bought any residential rental properties since 2015, but I bought two commercial properties this year and have two more under contract to buy. Commercial properties are completely different from residential ones but can be great investments as well. I bought a small shop for my flipping supplies earlier this year, and I just bought a 7,500-square-foot commercial property that I will write about later this week. Not only can you buy different types of rentals when prices are too high in your area, but you can also buy out-of-state rentals or even turn-key rentals.
Should you sell your rental property if you are not making any money on it?
Many people buy rental properties without any cash flow, hoping to make money through appreciation. Some people end up being accidental landlords when they turn a property into a rental because they could not sell it. I think, in both instances, owning a rental that does not generate any money is very risky. Betting on appreciation is tough because of all the selling costs we talked about, and if you are not making any money, it makes it tough to get a new loan on properties. I would suggest getting rid of rentals that don’t make any money and focusing on investments that do. This advice assumes you are not ultra rich and have so much money that you do not care if a property makes money or not.
Many investors have seen their properties go up in value over the last few years. It is tough to know what to do with all that equity. Should you leave it and let it earn a small return? Should you refinance? Should you sell? I chose to do all three, and it has worked out well. I do not want to max out the loans on every property I own because it would hurt cash flow and be risky. I also do not want to leave unused equity in my properties. I sold some properties to take advantage of the hot market and clean out some of my poorly performing assets. If you are thinking of selling some rentals, run the numbers to see how much money you would get, see what properties or other investments you could put that money in, and maybe selling will make sense. If you would like me to look over the numbers of your rental property for you, you can post them on the InvestFourMore Insider.