Buy and hold forever or sell after several years?

Question

Hello.   My name is Chris and I am an Investor.

I am curious about long term strategies.  I am a buy and hold investor that is curious about long term strategy regarding holding forever or close to it or selling after a period of service and reinvesting equity.  I have 11 rentals now and all have been bought and likely will be bought in some form of distressed fashion.  I've bought everything from a duplex on MLS in ok shape that I put some money into before renting to my 3rd townhouse that caught fire 4 years ago and just sat there.  My question is specific to single family real estate.

I have some rentals that I have around $50-$60K invested in that rent for $760 - $825/month.  These units appraise for $50-$75K and thus don't have tons of equity in them yet as I have leveraged them in the last two years at near 80% ltv.  The value in these units lies in the good cashflow.

On the other hand, I have two...and intend to buy more....single family units that are in better areas and school districts.  They are the bread and butter 3/2/2, 1500 sq foot house.  Again, I bought both of these as flips but rehabbed them for rental and once vacant and cleaned up would be in good condition to sell.  The problem with these two is that I generate less cashflow with them but they have way more equity.   For these two units, I have one with about $80K invested that rents for $975/month and another with about $78K invested that rents for $1000/month.  But the first one is worth around $115K and the second closer to $120K.

These are my nicest units in the best areas I own and I intend to get more.  With the level of rehab in them, especially the one that rents for $1000/month....if I were to sell them in the next 3-7 years, I am only looking at new carpet and interior paint and can really not worry about Capex spending as it has been rehabbed with all new inside and out etc.  Now....were I to hold onto it for 10 - 20 years, even if I sold then, I am likely looking at exterior paint again, perhaps new privacy fence and even roof and condenser, appliances etc.  If I sell at 1 year and 1 day, I get the preferred tax treatment of 20%.....I don't anticipate messing with 1031 for a while so let's exclude that for now.   But I can sell the same house 5 years after I put in new windows, roof, siding, fence, appliances, hvac etc and get the benefit of 5 years of cash flow vs just 1 without having to worry about replacing those things....(due to wear and tear of course.)

Am I better to treat these higher end properties like long term, tax advantaged flips or should I hold these better properties (lower cash flow)  properties in my portfolio for the long haul and be diversified?

Sorry for the long post....just like to be thorough.

Mike Dymski · Answer

Lol, sorry.  I'm recommending that you calculate your estimated return on investment for a $60k property and compare it with the $120k property.  Let's make the following assumptions:

$60k property: $800 rent, $400 expenses, no appreciation = 8% year 1 ROI ($400/mo cash flow x 12 months / $60,000)

$120k property: $1,000 rent, $500 expenses, 3% appreciation per year = 8% year 1 ROI ($500/mo cash flow x 12 months + 3% appreciation x 120,000 / $120,000)

Financing can impact returns but let's assume that they both can be financed similarly to keep that out of the equation.

Let's also assume that the $120k property attracts a better quality tenant that requires less of your time.  Let's assume that both properties have equal risk (of cash flows and appreciation).  If they both generated 8% returns and the $120k property required less time and had equal risk, the answer is clear.

Substitute real figures and use the BP (or another rental property) calculator for more accuracy and returns over multiple years.  Some investors use IRR and project rent and expense increases but that's tougher to model in a post.

Hope this helps.

David Faulkner · Answer

Agreed ... to add detail, project the future income and expenses (including appreciation and rent increases based on long term historical averages, sale if/when applicable, taxes, transaction fees, everything) under a variety of scenarios, then run IRR (excel function) on these projections to compute your rate of return ... the results will be enlightening and inform your optimal strategy. Of course, reality will not turn out exactly like your projections, but it will be the best educated guess you can come up with. I'd revisit this analysis periodically to see how things are performing vs your projections and stay flexible with multiple profitable exit strategies to adjust course as you go. Mike, if you were suggesting an alternate calculation method, please do tell as i'd like to learn that as well.

David Faulkner · Answer

Sales prices are public record ... you can get them almost anywhere ... rents are a bit trickier. If you have access to mls you could get them there. Zillow has sales history ... zestimates are garbage but sales history should be solid. They have rent estimates there too which aren't to bad if it is not a multi-unit. Any property manager or appraiser who has been in business awhile should be able to tell you both. If you've lived in the market you invest and pay any sort of attention you should know too ... if you are investing in a market you are not very familiar with, you should not be doing that in the first place IMO.

Jack B. · Answer

I think the logical answer to this is to calculate the IRR, NPV, and ROI as well as take into consideration your CoC return and the risk free rate. If you're earning 3% for a million dollar asset while you risk being sued, you are better of selling and putting your money into treasury bonds or a REIT index fund like VNQ.

I think you have to take a numbers based approach. Can you make similar if not more money elsewhere with equivalent if not less risk? I think if you crunch the numbers and see what you'll have after taxes and what your return will be in an alternative investment you can make a better decision.

At all times remember, at the end of the day, quality of life is why you do this, so don't hold onto property that makes you miserable. Make your money and go be happy. No one is promised another day.

JD Martin · Answer

Forever is a very long time, my friend :)  Ideally, you would sell any non-appreciating property at the peak of the sawtooth, which is going to be the maximum income to expense point. If you imagine a property's income to expense ratio to look like the teeth of a handsaw, either pointed up or down (depending on your market), you want to select the tips of the points for consideration of where/when to sell.

If your sawtooth is pointed perpetually upward - i.e. a rapidly growing area where property values and rents are increasing faster than the house is deteriorating - you might keep it "forever", or for a very long time, as each sawtooth tip will be higher than the previous. If you are in a declining area, however, then you might want to determine the point at which the tip of the sawtooth has swung below the line of profitability. The IRS, for example, figures a rental property completely depreciated of value after 27.5 years. Maybe your area is going to lose a very large employer within the next 10 years, putting lots of houses on the market and simultaneously depressing rent levels. You might not want to hold the house longer than that.

Obviously all of this takes a little bit of crystal ball future vision, which is why you should always buy right on the front end irrespective of where things are in a cycle, upturn or downturn. Just as you cannot accurately forecast any stock long-term (who would have believed in 1960 that GM would be bankrupt in 50 years and stock would be worthless?), you cannot with certainly forecast how much your investment will be worth that far down the road. However, you can look at trends and make some reasonably accurate guesses. If I lived in the old manufacturing Rust Belt, I would have a much shorter exit plan than where I live, where factors favor continued growth for at least the next 20 years or more.

Mike Dymski · Answer

Well written post and good question.  I'd recommend calculating your future expected returns for both types of properties that you are buying, include appreciation, and bench mark them relative to one another.  The numbers will not lie if you are honest with them.  This exercise can be eye opening for some investors because the result is not always as expected.  The same thing happens in the business world when you drill down and track product, location, or line of business profitability.  Property owners are 100% commission, tied directly to the performance of the unit.  Capital and time are scare; so, ROI is important.

This exercise could also be done later in the life cycle of your properties.  Markets and portfolios are not static and an investment that made a good return at one point may be average or bad now or there may be better opportunities than what is sitting in the portfolio.

I'd recommend including time and risk into the equation as well, even if they don't fit into your quantitative spreadsheet...factor them in qualitatively.

Alan Grobmeier · Answer

I have A and A- SFRs in good neighborhoods with good schools.  My average tenant stays 3-5 years.  I've had one for 8 years.  Holding those 'forever', 30 years plus.  AG

Johnny Kang · Answer

@David Faulkner

Yes, getting sales trend is easy so I was wondering about rent trends. Thank you for the feedback.

Jeff B. · Answer

A typical scenario is to sell after about 7years.  This is the time period where the depreciation & capital gains will reduce your net return badly.

I intended to pass my 6-plex to the children tax free via the Living Trust approach, but being an absentee LL but still actively managing the asset the work is too much now so we liquidated this spring after holding for 19yrs.  The taxes will be brutal (and yes I knew of other tax defer options).

Johnny Kang · Answer

@David Faulkner

I've seen you mention getting long term historical averages on rent increases before; can you share some links you use with us? I tried FRED, the US Census, Fact Finder, but couldn't really come up with a robust platform that has this info categorized by city for any decent length of time... Much appreciated.

Buy and hold forever or sell after several years?

Most Popular Reply