How do you decide when it's time to sell a rental? What metrics do you use?

Question

I think ROE is the best metric for benchmarking a rental you've had a while. I have a rental in Nashville with a 3% ROE because it's tripled in value in 7 years. That seems really low.

So as I look for a replacement property, what metrics should I use? What would be the minimum you'd have to make it worth the effort of trading up? For example, 3.1% CoC return would technically be a better return, but hardly worth all that trouble of finding property, 1031e, and so on.

I should add, the main reason I'm considering selling is to trade up into better assets. It's a C class property and while my small prop mgmt company does it in house, I'd prefer to have fewer tenants, paying more rent each, in fewer more expensive units.

Joe Villeneuve · Answer

Easy.  When the accumulated cash flow equals your down payment (that means you got all of your cost back), and the total equity, paid for (down payment) and from appreciation, is double the original equity when you buy it.  That is the maximum value the property will ever have.  From that point forward, you are losing money.

Keep in mind that the cash you put into a property is what you pay for it, and the equity is what the property costs you.  What the property is buying is both the cash flow and the property value.

This is when you sell, and double what you started with when you originally bought the property.

Bill B. · Answer

You can fix ROE with just a cash out refi, so that’s not a good enough reason to accept a 10% cost of selling to exchange to a new unknown property, plus a boatload of taxes if you don’t do an exchange.

Personally I sold my first rental ever last month. It was my cheapest/smallest and lowest rent (1400sf for $2,000/mo, bought for $100k and sold for $370k after 22 years)

My buying strategy when I got in to this business was homes with stucco siding, slanted tile roofs, less than 10 years old, preferably less than 5. A perfectly maintained 25 year old home owned my the same couple the entire time still looks old. A rental looks very old. There’s a bunch of wear and tear that doesn’t get noticed or isn’t worth fixing.

I exchanged in to a $600k new build that will rent for $3,500. So it’s basically buying a $230k home that rents for $1,500 while magically making my existing home and all its fixtures 25 years newer. I also get some new depreciation. All this while also not requiring another door to make more money monthly.it also saved me more than $60k in income tax even living in a tax free state.

I plan to repeat this of almost every property I own over the next 5 years as tenants move out. But I’ve owned them all for 10-20 years. And old homes in old neighborhoods isn’t my target property. You’ll also find that the higher the rent is, the LESS work the tenants are, on average.

Marcus R. · Answer

Just dropping by to say good question @Allan Smith.  I have this same "good problem" on the first condo I bought way before I knew anything about RE investing.  I have a HELOC on it and that was used as a partial downpayment on another property but without that it the ROE would be ~3%.  Before rates shot up I had planned on refinancing.

What makes the ROE decision even harder is this thing is truly on autopilot.  Rents super easy, prime location, I have a very long term tenant in there, and the HOA is reasonable and handles a lot and I'm on the board.  One small justification you can make to yourself to help you sleep at night is how much time each property requires.  I've started to include that in my analysis on potential RE moves as life gets busier and if you have a W2 job.  If you're making more but working more then depending on your goals that tradeoff may not be worth it.

Bill B. · Answer

So if I put down 3.5% on $200k primary and rent it out after a year($7,000) as soon as I cash flow $7k and the property goes up $7k I should sell? That doesn’t sound right? Especially if it’s going to cost 10% ($20k to sell) even at 5% down that’s sell after it goes up $20k to $220k, then pay $22k to sell?

I’ve always considered the property I own to be the best return as it’s already providing income and doesn’t cost me a year or two of appreciation to sell.

Why is selling better than just doing a cash out refi to lower your equity? I guess that makes the previous calculation even worse. The less equity you paid for the sooner you should sell? To each their own but I don’t think any formula can be that written in stone. At least you’d never sell a property that dropped in value or had negative cash flow.

Nathan Gesner · Answer

When the ROE can be invested in a different property for a greater return. The longer you hold a property, the lower the return. This typically occurs after 5-7 years but can fluctuate due to a variety of factors, which is why it's important to evaluate the ROE every year.

If your current ROE is 3%, you should consider cashing out and investing in another property for higher returns. If you have enough equity, you may consider investing in multiple properties and increasing your return dramatically.

I believe in the buy-and-hold policy. Only sell property when you can invest the money in a property that moves you closer to your goals. If you don't have a solid plan for that, hold onto it until you do.

Allan Smith · Answer

Your example of trading up to the 14 Plex is exactly what I want to do. The problem is prices have gone up so much the best I could do is sell my duplex and get another duplex. And in order to cash flow I would have to use all the net cash as a down payment and do 50 or 60% down just for positive cash flow.

Eliott Elias · Answer

When I have an opportunity to make more money or grow my portfolio. This really depends on your long-term goals.

Sam Yin · Answer

@Allan Smith

To a large degree, I have to agree with Bill's math.  But I would add that there are a few other nuances to each person's formula.  It all depends on your personal goals. Are you trying to create a stable portfolio with minimal risks or are you trying to scale up by leveraging your equity?

I personally do not follow any specific math but I do take I to account some general rules of thumb. The biggest one I use is the realistic sales number and what the net proceeds would be. On top of that, I also account for the current costs of available inventory in the market I'm investing in.

If the net proceeds are over 5X the annual income, I think it's safe more me to say that it would be wiser to cash out and reinvest. If not, then I better have an upleg ready to go that would allow higher leverage with upside.

Recent example, I had a really good performing 6 unit (all 1/1), plus 1 unpermitted studio. I purchased June 2021 for $700K. It cost about $240K to cost that deal. It produced about $50K cash flow. It had enough room to grow to about $70K cash flow in next few years. That $240K came from a 1031X SFR that I purchased summer of 2015 with about $30K down payment. It was a live in for 2 years.

I sold it for $900K last month. It was grossing $7903/month in rent at the time of sale and I helped increase it by another $400 to get the new owners even more income. After the dust settled, I net about $400k in the 1031. I found an upleg that is 14 units for about $2M. I will use $400K as down payment and finance the rest. The 14 units had a better mix... several 3/2s in the mix, spanning 7 parcels. Additionally, I also included a large vacant lot. The gross on this new purchase is about $18500/month. There is some upside left, may be bring up to $20K/month.

But here is the fine print, it in the same area. The price per door for multi-bedroom multifamily units in the area are about $180K/door. For regular units, its $220+/door.

These are the things that go into the decisions of whether to refi some equity or sell and exchange. Your personal goal will dictate the strategy and the speed in which to employ these tactics.

There is nothing wrong with refi to use tax free equity to purchase more either. It's just slower and less efficient.  I did it a few times. I fact, I did it with the SFR that is used for the exchange I mentioned above. I had extracted some equity before to purchase a 2plex in 2018.

Bill B. · Answer

@Allan Smith

Your trade up problem of the better properties going up even more than the cheaper properties is common. That’s why I never worried the 250 times the “crash is coming” people have posted in the last 13 years. Of course it turned out they were wrong every time. But if they had been right, your cost to do the swap in to better properties would have gone down.

Ex: I owned about a dozen $250-$350k properties 10 years ago. I wanted to swap to the nicer $500-$600k Properties. Of course today mine are $400-$550k and the ones I want are $800k. Instead of a $250k difference it’s $350-$400k. If that mythical magical crash ever gets here so the geniuses that have been wrong for 10 years and 100% appreciation can finally say they were right all along. (When prices drop 10%.) It will actually save me money if I choose that time to do my swap. (10%. Being a bigger drop on the more expensive property and the more expensive properties tending to drop more.) I’ve been waiting, but I doubt it will ever happen.I finally bit the bullet this year and swapped my oldest property (25 year old property owned 22 years) for a new build in the middle of the price gap. I get more income in a newer neighborhood while reducing expenses and “work”.

All that was a long way of saying I would never sell to pay taxes and lose income. Either you do a tax free cashout refi or a tax free swap.

How do you decide when it's time to sell a rental? What metrics do you use?

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