Need Advice: Sell and Reinvest or Hold

[Brant Jones]

I am looking for some advice on my next RE venture. 

I have a small 2/1 SFR in southern California that currently rents out for $1,295 per month with very stable tenants. The property is financed with a 30-year fixed note, and after expenses yields a decent 17.5% cash on cash return. I have owned the property for two years and have realized about $81k in appreciation since acquiring it.

The tenants have inquired about purchasing the property, and after all expenses, the sale would put $83k in my pocket, or a net profit of $51k after taxes, expenses and return of initial investment. I have $95k saved up for my next acquisition and do not necessarily need the cash from the sale of the property, but see this an opportunity to move into a larger multi-family unit or several SFRs, to better diversify my portfolio, increase cash flow and mitigate risk. 

I am still in the cash flow building phase of my overall investment philosophy, i.e. financial freedom, so I would be targeting markets that yield better cash flow rather than rapid (and precipitous) appreciation. I have only invested in raw land outside of CA (no tenants), and like the idea of self-managing my properties, but with CA real estate not yielding great cash flow, I am open to exploring other markets like Memphis, Birmingham, St. Louis, etc.

Appreciate any advice from those who have parlayed smaller investments like this into financial freedom!

[Jonathan Twombly]

@Jack B.  You only lose money if you have to sell at a down point in the market.  The point about cash-flowing properties - and why I always emphasize them to my students - is that the cash flow allows you to carry the property through the downturn and back into the upswing, since the property is not costing you money out of pocket.

The key is that you want to buy properties with sufficient cash flow that there is a cushion - a margin of safety - for when things go bad, as they always will.  You want to know that, for instance, you can lose half your profits and still be cash-flow positive, so that you can ride out the bumpy times.

If the property "loses" money during a downturn, but you are not forced to sell because you have adequate cash flow, that "loss" is unrealized - it's just on paper.  It doesn't mean anything.

You also want to have long-term financing and a long-term exit strategy so that you can hold through the downturn without being forced to realize any losses.

If you invest only for appreciation, by buying cash-flow negative properties in the hopes that they are going to rise over time, then when the downturn comes, you are holding onto a property that is worth less than you paid AND you are paying out of pocket for the privilege.  Then, if a circumstance happens in your life - loss of a job, divorce, death in the family, new baby - that prevents you from paying out that cash to support the property, you will be forced to sell or even hand back the keys and lose everything.

So, focus on cash flow!