Hold or sell my rental?

Question

Hi!

I invest in a pretty low appreciation/stable market (Pittsburgh), but my preferred investment neighborhood is doing quite well for the past few years (say avg. appreciation about 5%.) My strategy is buy low, improve, and hold to rent; eventually sell for long term capital gain and reinvest all proceeds. I've bought 7 and sold 3 over the past seven years; I'm closing on #8 now, and anticipate a 4 month renovation on it.. Currently holdings with #8 will be two triplexes and three SFR. I have minimal debt, and what I have is at favorable terms.

The deal I'm debating is a house which i have $200k into, getting $2100/mo rent. RE taxes in my locale are high: I'm at nearly 5.5k/ yr on taxes/insurance; I have no debt on it; the tenant pays all utilities. Based on comps, I can sell for about $340k and net about $315k after commissions and transfer taxes. Alternatively, I can probably increase rent to $2700/mo when it renews -- that's about max.

I have no crystal ball. The house could be worth $400,000 in two years ... it could be worth $280,000 if the market cools off. I'd use the proceeds to pay off the LOC I'll use for #10's rehab this spring ($100k @ 5% variable) and reinvest sometime within the following 6 months. I would not pay off my fixed rate debt, all at under 5%. I could do a 1031 exchange, but tax rates on long term capital gains have been so good, I have been choosing to pay the (minimal) taxes based on the fact that I'm in a favorable capital gains bracket now, and I believe taxes are going up.

I'm 48 years old; RE investing is my sole income. I quit work two years ago, when my rental income after expenses exceeded my work income. I invest for both cash flow and net worth.

So -- would you hold and enjoy the easy cash flow of the rental income and ride the appreciation -- or sell and lock in the profit, and reinvest? And why?  THANKS!

Karen F. · Answer

David -- brilliant observation! A tax on inflation....terrific!

Karen F. · Answer

Michael,

That's a post after my own heart! Yes, I can double my money and double my cash flow .... but it'll be alot more than double the work, since my work on this property is done! That is EXACTLY my thoughts ... with one purchase and rehab on the horizon, if I sell this to buy two more, that's two more purchases and rehabs ... I think that is the essential question. Is there a point where enough is enough?

On taxes.... I agree with you that it's not appealing to legislators, but realistically, it's a matter of time until we see drastic changes. We are at an unthinkable place, economically, when national debt exceeds our entire GDP. Based on a quick search, this only ever happened once before, during WWII -- and we went to marginal income tax rates of 90%. Similarly, during WW1, capital gains went as high as 73%. The $ has to come from somewhere (sales tax? income? corporate? estate? who knows where....all unappealing!)

David Krulac · Answer

@Karen F.

Sure anything is possible, LTCG could go higher, and the highest Federal rate on ordinary income is now 39.6% + 3.8%= 43.4%.  I can't see LTCG higher than ordinary income rates.

What has always griped me it that capital gains tax should be indexed for inflation.  you buy a property for $50,000 keep it 20 years and sell for $200,000, but to replace it with an identical house you have to spend the entire $200,000, what have you gained.

Capital gains taxes to some degree as now structured is a tax on inflation which the investor had no control over, and a devaluation of the dollar purchasing power due to inflation..

David Krulac · Answer

@Karen F.

The transaction costs of rotating in and out of properties, while saving on recapture and capital gains are high in them selves.  that's why i like 1031 or refi better than selling.  This presumes that property is a good property in a good area that meets your investment goals.  I've sold some properties that were perfectly good properties but be too far away, or too old, or too low return or too something else.  Did a 1031 letting go of some buildings from 1890 and moving up to buildings built in 1994 & 1996, over a century newer.

A friend of mine lived on the last street on the left off Forbes coming out of Frick. It was a great street narrow and windy and had great houses.  Another friend has several properties on South Side and is doing well.  Now I'm doing stuff outside of Allegheny Co.

Account Closed · Answer

@Karin F.   So this post is a little old however I thought I would throw in my two cents in a possible option for more cast flow.

Instead of selling the income property for approximately $340K, how about taking a heloc out against it.   Then use the Heloc money to invest in a note.  Here are some numbers off the above scenario:

Keep $340K income property  = Cash flow $2700.00 month

70% Heloc borrowed from this property =  $238K

Heloc Fee @ 4% =       -$793.00 (interest payment to heloc/month)

I0% Note off $238K =  $1983.00 month

Total income from rental property + Note income - Heloc Fee per month = $3890.00

Should be able to write off Heloc interest (Check w/CPA).  Also you get to keep your performing rental while invested in a performing note.

Rob Gerstenberger · Answer

@Karen F. I stumbled on your post here today and realized we have a lot in common - I also live and own property in regent square and have been for the past 4 years.  We should compare notes sometime! I own a duplex and can resonate with many of your comments above. Thanks for the post!

Michael Seeker · Answer

I don't think LTCG will go up to 40 or 50% in my lifetime, let alone in the next couple years.  The shock to the economy if that were to occur in the next couple years would be unprecedented.  Most of the tax laws favor activities that the lawmakers (and their friends/donors) are either directly or indirectly involved in.  They may creep up a bit, but a jump to 40 or 50% is not realistic.

That being said...even IF the capital gains rates go up that much, who cares?  You don't have to sell anything.  As long as you're generating income what do you need to realize the capital gains for?  As somebody else mentioned, why not just do a cashout refinance and access the locked up equity without having to sell or pay any capital gains?

LTCG aside, I would look at what exiting this particular property would get you vs what you get if you hold it.  The downside of selling to buy something new is that you're trading in an asset you know everything about for one that you know little about.  I have a building that I could sell for a nice profit and buy 2 others just like it, but it would take me years of work to get 2x the cashflow and would almost certainly have way more than 2x the headaches.

Karen F. · Answer

Thanks for the comments, everyone! Does no one think that capital gains taxes are likely to rise dramatically in the near future? That's my concern. So far, I've kept taxes on depreciation recapture low by rotating out of my properties in 2-3 years (this one will be 2 years in May.) I'd hate to defer taxes, only to find LT capital gains sitting at 40% or 50% in a few  years. Obviously, I have to balance that fear against the clear advantage of reaping several years' return on the cash that otherwise is going to the tax man today. If cash flow is strong enough, one could reinvest continually and transfer all the properties at death, but due to other interests, I am hoping to keep the business relatively small .... and have a more flexible exit strategy :)

For Jerry and David -- my fellow Pittsburgh investors -- I like lots of areas in Pittsburgh, but I know the East End best so I stay there. So I like Highland Park, Squirrel Hill, some parts of Friendship, Bloomfield, Point Breeze, and Greenfield. I like good neighborhoods getting better ... I don't care to invest in any high crime areas, anticipating a turnaround. I think Oakland is a sure thing for the student market. That said, ALL my investment properties so far have been in Regent Square. The pros: it's within about 6 miles of downtown, right on Frick Park, literally just outside the city limits - so 1% wage tax v. 3% for renters, close to hospitals, universities, public transportation and commuting arteries, plus safe/low crime. Cons: some unscrupulous landlords promote the surrounding areas in the heart of Wilkinsburg (not safe or low crime) as "Regent Square," which may erode the "brand" of a great neighborhood over time. The real estate taxes are quite high, and the public schools are atrocious. I find all my high end renters are single, DINKS, or they have the kids in private school. The housing stock is old (1880 - 1930) -- but I like to rehab, and the houses were originally well built and elegant with lots of architectural charm (appealing to renters/buyers.)

How about you, Jerry and David? Where do you invest in Pittsburgh? I'm always looking to connect with other local investors! We can learn alot from each other!

David Krulac · Answer

@Bill Exeter is right on except Pa State income tax is 3.07%.  If there i a good thing about any tax, it is flat rated and not graduated.

@Karen F.   Bill Exeter is right that the tax bite will taken a lot away from your proceeds.  If your proceeds are more than a couple thousand, then a Section 1031 tax free exchange, should at least be in the discussion as an alternative to preserve your proceeds capital to get another property.

Another alternative would be to refi.  If you could find a 80% LTV cash out mortgage that would be more net proceeds that a straight sale.

I've invested in Pgh also, which areas do you like?

Jerry Kisasonak · Answer

Congrats on your success in real estate Karen! I live and invest in the Pittsburgh market too. I am curious to know what area this property is in.

As for your question, I have nothing to add. Everyone else covered it pretty well!

Hold or sell my rental?

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