Best Long Term Returns - Hold or Sell Investment Property?

[Jon O.]

Hello,

I would like your help in analyzing the long term investment potential of either A. Holding the rental unit or B. selling it and diversifying my assets.

Background:

3 Years ago I decided to hold onto a condo I owned, in Hoboken NJ, and turn it into a rental when I moved to a new primary residence.Although a stretch at the time it was the best financial decision I have made in my life.I see this as a great investment from a cash on cash investment standpoint, by holding the condo as a rental property the last 3 years I have had significant property value appreciation (~25%) along with great cash flow from the rental income.It's a great location, walkable neighborhood (1 square mile city), and I have found both tenants in <5days.

With that said my new financial advisor has raised some concerns with how I am analyzing my investment return on the rental property.In addition he has concerns with my assets being heavily tied to real estate (between this rental property and my primary residence I have ~70% of my assets in RE). He suggests I sell my rental property, locking in significant equity I have, and reinvest the money in the stock market.He suggested if I want I can take some of that equity and reinvest in a new rental property (only problem with that is in the area buying a new rental does not make sense, CAP are )% or even negative as property values have skyrocketed).He believes by selling rental property I would accomplish goal of diversify my assets appropriately and also give me better returns in longer run.

Below are some key numbers and I'd appreciate your thoughts on how to analyze long term investment potential of either A. Holding the property or B. selling and diversifying my assets.

Option A: Hold as Rental Property

Purchase Price (Dec. 2010): 375,000

Current Value:$615,000

Outstanding Loan: $208,000, (3.875% 30 Year Fixed – 50 of 360 payments made)

Monthly Mortgage/Tax/Insurance/Maintenance:$1,851(Occupancy has been 100% for past 32 months since I started renting).

Month Rental Income: $2,850

Monthly Cash Flow: ~$1,000(I have had no minor or major repairs.Building was newly constructed in 2008).

Expected Future Rent Increase: 3% Annually, Expected Future Property Appreciate: 3.5% (This is very much on the low end, property values in my area have been >10% annually for past 4-5 years, I just do not want to analyze based on a number I am not sure the market can maintain… then again it certainly may!)

Option B: Sell and Reinvest in Stock Market

Sell Price (615k) – Closing/Fees (~5%) – Outstanding Mortgage ($208k) = ~$376,250

Expected Market Return: 7% (could debate this all day long, but this is the number I want to use).

I'm having difficulty making this decision because I have seen holding the rental property as a great current and future investment. Maybe I am too tied emotionally to the rental property and not analyzing this properly. Can someone please help me understand what the future expected investment returns would be between the two options and which would be better returns?I am looking for a 5yr/10yr/25yr return estimate on both options.  Any help would be greatly appreciated.

Kind Regards,

Jon

[Hank A.]

If I were you, I would definitely NOT sell this property, and I would probably fire the new financial adviser. Say you bought your rental with 25% down (the numbers are better if your down % was lower), your down payment plus closing was just under 100K. Let's say 100K roughly. Your current cash on cash return is 12K per year which works out to 12%, probably better than the average investor's stock market yield, and this will increase as rent increases every year. The building is new and in good condition so you are not expecting major cap expenses anytime soon. So why would you want to give this up for a lesser yield?

You have about 407K equity in the rental (current price minus outstanding loan), which is money sitting there doing nothing for you. I would look into doing a cash-out refinance to pull out most of that equity and use that towards acquiring more real estate, or if you have to diversify put that into the stock market, or even do both. Your mortgage will increase a little bit, but that will be more than offset by the returns you make on the investment from the cash-out money.