Need advice-Sell now, or hold for future profit?

Question

Almost 10 years ago I invested into a single family home remodeling project, which was to be sold upon completion. That never happened, thanks to the recession of 2008. With carrying costs, my original $268,000 investment has ballooned to about $500,000. I have a chance to sell it now, but at a loss of about $315,000. However, it’s a strong rental market and it will rent for enough to cover expenses, and leave about$15,000 extra yearly. I’m tempted to hold onto it for up to four years to see how much more it might appreciate, but am unsure how to calculate my yield. Would I use my total overall investment of $500,000, or just the amount I’d receive if I sold now, which would be $183,000? I’m thinking it would be the latter, because the only thing that seems to matter is how much cash I’d have to use for alternative investments. My total investment of $500,000 is in a sense irrelevant because I can’t access it.

My options appear to be:Don’t sell, and base my future yield off the $183,000 I chose not to receive by not selling, or Sell now, take the $183,000 cash to invest elsewhere, and base my yield on that as a starting number. My future cash flow and any appreciation would be a percentage yield off the original investment. Correct?

If I keep and rent it for up to four more years, and with projections of 3% annual increases in income, expenses and appreciation, the potential gain at end of four years is about $234,000, not including any tax benefits.That appears to be a 32% annual yield, and if correct, seems to make a strong case for keeping it and hoping for a better time to sell than now. However, if my projections are off, the final numbers could be worse, or maybe even better. Clearly, the appeal is that it allows me to “convert” a $315,000 loss into a $234,000 profit—potentially. If I were to sell and invest the $183,000 elsewhere, I’d need to earn about 23% annually to accumulate the same amount at the end of four years.

I’d appreciate any opinions on which option might be the best one!

Thanks

Ed B. · Answer

Thanks, Dan, the tax savings on the loss certainly are a factor, but because I already have some unused losses from prior years, I could not immediately use any new losses. I should probably sit down with my CPA and hash all the details out just to be sure. Thank you again.

Dan Brewer · Answer

Ed, It appears you are not taking into consideration one very important factor - the tax benefit of your loss. Based on what I understand, you have a calculated $315K loss. Just using a simple example, if you are in the 30% tax bracket, that is a net savings on your taxes of 90K+. Then that money can be put to work as well, and you can earn return on that. If your net taxable income is not high enough to absorb the entire loss, there are loss carry forward (and backward) provisions. There are also limitations as to what type of income the loss can be applied. I would strongly encourage you to talk to your tax accountant to more fully understand this.

Ed B. · Answer

Brandon,I'm basing my appreciation figure based upon its current market value of $1,300,000, per a recent appraisal. 3% compounded annually for four years it should reach $1,463,000 in value. $1,463,000 -$1,300,000 =$163,000

Brandon Hall · Answer

You lost me on your appreciation number of $163,000. Can you explain where you are getting that from?

Ed B. · Answer

Thanks, Bill. Would you mind sharing with me your math how you came up with 36% for four years with a cap rate of 8%? I'm only getting 32%. $183,000 x .08 = $14,640 x 4 years / $183,000 = 32%. By the way, if I sell and cash out, any appreciation won't matter because I won't benefit from it. Unless I invest the $183k into another property that appreciates at least 3% annually. Maybe I should clarify how I came up with the $234k gain in four years. It is made up of appreciation, $163,000 + cash flow during that time of $71,000. So, $234k / 4 years is about $58,500 yearly. $58,500 divided by cash of $183,000 I didn't receive by not selling = 31.9% annual yield. If that's not right, please someone tell me.Will, getting better returns elsewhere is the big question. I think it would be difficult to improve upon 32% annual yield, which is why I'm thinking simply being patient and waiting for appreciation might be the best option to take.

Will Johnston · Answer

I'd keep it and rent it. Like Bill said, taxes are the only thing that that your $500k is relevant for.If you factor in 7% closing costs on the sale and 2-3% on the purchase of another property (assuming that's what you would do with the money), you'll end up being able to purchase a place costing about $165k.If you think you can get better returns on your $165k elsewhere or if you are in a high tax bracket and could use a big write-off, then sell. Otherwise, you're probably better to stay put until appreciation is such that your cap rate could be better elsewhere.If you want to access some of that cash now for other deals, you could always take out a mortgage on the place.

Bill Jacobsen · Answer

If you can cash out with $183,000 that is your starting point. If appreciation is 3% per year that equals 12.5% for the four years. An 8% cap rate will give you 36% for the four years. If you sell you will have about 7% selling costs either now or in 4 years.You just have to decide whether you can find rentals that can do better than your current ones. What has happen to the house is irrelevant except for the tax ramifications.Good Luck.Bill

James Wise · Answer

Can you afford to keep it? If yes then I would keep it.