Any value in holding expensive and appreciating non cashflowing property?

Question

Ok this may or may not be long, so if it turns out to be, please bear with me  :mrgreen:

I currently own a 3 unit building that I plan on converting into a 4 unit later this year (the garage will go and I will build a 2nd unit in the basement)

Buildings of this type on my street sell for about 14 times their revenues (yes you read that right!) and my revenues after building the 2nd unit will be at 36000$ per year.  Vacancy rate in my area is below 1%.

This puts my building's resale value at about 504 000$.  I currently owe 200 000$ on it.  So my equity is 304 000$.

That beeing said, I would like to know if there is any value in holding on to such an expensive piece of property that will never cash flow.  I've been keeping it because appreciation is good and will continue to be, but I can't help but tell myself that this equity may be able to earn me more if invested in cash flowing real estate.

I also have about 150 000$ in cash coming in later this year and would like to know the best way to invest it.  My ultimate goal is to own hundreds of units but I'm a bit unsure as to how I should start.

I was thinking of buying 3 cash flowing buildings of about 8 units each.

Any input is very much appreciated!

J Scott · Answer

How much did you pay for the property?  I'd be surprised if the numbers indicated that the property didn't cash flow for you.

Here are some things to think about:

- First, if you can sell for 14x revenue (which is about 28x NOI), you're basically able to sell at about a 4% cap rate, which is great.  
 
- It sounds like you're going to get a big chunk of equity added to this property as soon as you add the 4th unit.  Remember that your IRR (internal rate of return) on that added equity will likely drop the longer you hold the property, as IRR measures an annualized return, and it will be difficult to add the same amount of equity year over year.  So, if you're trying to maximize your IRR/ROI, then it's probably better to sell sooner rather than later.

- That said, you don't say what your goal with this property is?  Are you trying to maximize ROI?  Are you building a retirement vehicle?  Are you expecting much future appreciation?  Do you want to tap the equity and benefit from the tax benefits of the rental asset?  Depending on your longer-term goals, it may be better to hold the property.

- As for the money you'll be getting later in the year, why not use it to do what you're doing with this property.  Can you buy other properties below market and sell at a 4% cap rate?

One big thing to consider:  If you plan to own lots of units later, you may not want to sell your current property, but instead do a 1031 exchange into a larger building.  Improve the value there, do another 1031 exchange.  Rinse and repeat.

Before you know it, you'll have LOTS of units, and you will have avoided taxes along the way, increasing your purchasing power with each subsequent step.

Ben Wilson · Answer

Hey Khaled - sounds like a nice property.  You say it will never cash flow - even after you add the fourth unit?  What's the negative compared to the mortgage pay down.  Also when will it be paid off?  Remember, it WILL cash flow then for sure...

Nothing wrong with a negative, especially if it's going toward mortgage paydown, and IF you can handle it.  Although if appreciation is that good, I'd be inclined toward selling and EXCHANGING into some units that cash flow.  I only tolerate negatives when I'm paying down the mortgage more rapidly as a result.

As far as the $150 - start slow.  Learn to become an excellent manager or find an excellent manager.  I can't tell you the number of people I've talked to who jumped in and then HATED rentals and eventually bailed.  Take your time, study your market, and start slow.

Good luck,

Ben

Khaled Majouji · Answer

Thanks for the replies guys,

I actually messed up the numbers a bit, revenue will be 37 200$ so resale value puts me at roughly 521 000$

To be honest, I didn't really have a goal when I bought it 4 years back, my parents were divorcing and it was offered to me with a 100 000$ rebate, so I just jumped on it and told myself id figure something out.

221 000$ dollars of equity later and 1 year working in the middle east ( the 150 000$ coming in this year) put me in the financial position that I am in now, except that now I don't wanna stay passive anymore since this cash could work for me much more efficiently than it currently does.

Appreciation will keep being good for a while:  2 university campuses just opened 3 minutes from my places, 2 subway stations, 1 light rail line, access to major highways 1 minute away, and a whole new downtown area is also being built ( I live in a city of 350 000 people next to a major city of about 2 million)

My real concern is leaving 321 000$ sitting in a building and not working for me.  You are right that the property currently cash flows, but thats only because of the huge amount of equity.  I would ideally like to have only cash flowing properties, but those will never have the same appreciation as this one... So is it worth letting the money sit there or sell and reinvest elsewhere?

I can not do a 1031 exchange as I am in Canada (sucks!) so the closest i can do is refinance, pull some of the cash out to invest elsewhere, or sell and pay capital gains on the part I am not occupying (capital gains exemption on main residence is just like in the USA)

Any value in holding expensive and appreciating non cashflowing property?

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