When to Sell vs Hold Rentals?

Question

Im 36 years old and have built my business on sales. Im a real estate broker by trade and have spent most of my career helping builders and investors buy and sell houses. In the past 5 years my business parter and I started selling turn key rental properties to investors. We take a run down house, get it cash flowing with a tenant then sell it and usually retain the property management after the sale. We have an inventory of about 50 rental properties now that we are constantly using for sales and enjoy the rental returns in the process for those that don't sell. Seems like our best houses sell right away and we are usually left with the least desirable houses or those that are still being renovated which don't bring income.

At some point in the last year or two we noticed its been harder and harder to replace the houses we sell with new fixer uppers at a decent price. So we have now decided to go out and get portfolio loans to hold some of the properties long term. These are 5-10 year loans and have some pretty big penalties if you sell early. (I have more questions on which loans we should take but will save for another thread)

Heres my question: How do you decide which houses are best to keep long term or sell for a profit now? Do you use a mathematical approach (using ROI) or more gut instinct for which ones you think will appreciate long term? Hybrid of both?

One of my best clients when I first got stated told me that he keeps his portfolio 50/50 mixed between sales and long term rentals. He said too heavy in sales and you don't have consistent cash flow and too heavy in the hold model and you wont have cash on hand for larger repairs or acquiring good deals when they come along.

Thoughts on how to determine which houses to sell now and which one to hold long term?

Joe Villeneuve · Answer

When your free equity (from the tenant's rent paying down your principle and appreciation) = your paid for equity (your DP), I sell. Why? I'm losing money if I don't.

Example: Original property starts out with 20% DP (Paid for equity) on a $100k PV. So the actual equity = $20k. Free equity builds up and equals the paid for equity = $20k.
1 - Hold Original Property - Total equity is now $40k, and Property Value is now $120k.

2 - Sell Original Property and invest $40k into next property - Total equity is still $40k, but Property Value is now $200k.

Mike D'Arrigo · Answer

@Rick Venetico keep in mind that if you put them all under a portfolio loan, it will make it much harder to sell them off individually. Talk to your lender about that first.

Rick Venetico · Answer

Thank Joe I will certainly DM you. I only used the 50% expense comment for brevity on a hypothetical deal. We always calculate actual expenses when evaluating our houses.

Joe Villeneuve · Answer

You realize that you wanted me to be more math..., then you went and "assumed a 50%" expense cost.

The BRRRR method will lose you money. It's kind of an illusion in a couple of ways.

When you analyze using more math, you also need to include where that money you would get from selling would go, and how fast that money would make more money...over the 1-2 years you would be waiting for the CF to = the profits.

I would love to discuss this with you in more detail. This format isn't the best for that. PM me if you're interested.

Rick Venetico · Answer

Thanks @Devin Redmond for the response. In relation to your comment

"What really matters is: How does your projected return (cash flow + expected appreciation) on the current equity value compare to the projected return from redeploying that equity elsewhere?"

What is your number or percentage that once it hits you sell vs hold? Or do you wait until you have a new investment already lined up to purchase then compare it to what you currently hold at that time?

Rick Venetico · Answer

Thanks @Joe Villeneuve! I was looking for something more mathematical to analyze each deal. For example when we decide to sell a house take a look at what we would make in profit at closing and determine how long it would take us to make that same profit while renting. I realize there are other factors like appreciation involved that can skew the decision.

So to use easy numbers here if we have a house we want to sell for 50k and we make 10k profit when we sell now. If we are renting the same house at $800 a month it would take us about a year to make that 10k in rent, and if we use the 50% method to assume half our rent collected will go to expenses it could take about 2 years to make the same 10k profit if we sold today. Sometimes we have opportunities to sell a house and make multiple years worth of profit in one day.

How much profit is enough to justify selling now so we can reinvest as Joe described and how much is too little that we should just rent the house for 5 years on a portfolio loan? Then re-evaluate when the pre payment penalty has been lifted on the loan...

As inventory continues to get harder to find I agree with the BRRRR method of just continuing to refinance and never sell. Although there always seems to be a number on every house that if a buyer actually paid it you would be willing to sell now.

Should we create a formula that says if you can ever make (X months) worth of profit by selling today we unload the house and if not put it on a 5 year portfolio loan?

Devin Redmond · Answer

I totally agree regarding making use of the 80/20 rule. That's an approach that pays off across nearly all endeavors.

While lifestyle and broader overall business strategy considerations should probably come first, I always rely on return on equity (ROE) rather than return on investment (ROI) for hold/sell decisions. The difference is subtle but important. What you've invested in the property to date is essentially irrelevant when considering what to do going forward.

What really matters is: How does your projected return (cash flow + expected appreciation) on the current equity value compare to the projected return from redeploying that equity elsewhere?

You're right to ask specifically about how to factor in gut instinct about long-term appreciation. That's something that many key metrics and ratios ignore, but it can often be much more powerful than the cash flow received along the way.

Joe Villeneuve · Answer

If I just refi I get far less cash to move forward with.

Example: PV = $100k; Equity = $40k

REFI - Only 60% LTV = $60k leaving $20k cash to move forwardSell - $40k moving forward

REFI usually has higher closing costs

Either way works, however if this is a strategy you repeat, you will be adding a property with every repeat. Selling allows you to have the option of putting all the cash from the sale into one property, or more than one.

Joe Villeneuve · Answer

Go back and read what I wrote. I did include equity gained through appreciation as one of the "free" equity gains.

Will Dixon · Answer

@Joe Villeneuve

So you sell when principal pay down equals your down payment? What about equity from appreciation? And why choose to sell rather than refinance at that point? If you were only measuring on principal pay down I guess you’re guaranteed to hold for about 7-8 years before you sell. I like the idea of redeploying the equity so your greater portfolio value can grow, but the act of selling seems a bit arbitrary when a refi would accomplish the same outcome.

When to Sell vs Hold Rentals?

When to Sell vs Hold Rentals?

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