Need Advice: Refinance or Sell

[Michael Jones]

Hello BP family,

I have a investment property finance question. I own three investment properties in downtown Washington, D.C., that I have held since 2003. Each generates positive cash flow. In 2014, I refinanced all three at 4.25% for 30-years. Debt-coverage ratio is a healthy 1.30.

It was my plan to hold these assets until retirement (I am 44) and pay them off. However, property values in DC have skyrocketed, like in San Francisco and New York, so that my current LTV is roughly 50% and my imputed returns (after-tax cash I would receive from selling the assets) are therefore 4-5% cash-on-cash and 7-8% when you include amortization.

Three paths to consider.

One is simply to do nothing. Stay the course. Keep managing wisely. Live with the low returns. Yes, they are better than stock and bond returns, tax-advantaged, and inflation protected. But they are illiquid as compared to other instruments.

Second, I could liquidate the assets. Tax rates on capital gains are 20% for real estate professional (spend more than 750 hours per year). This option locks in today's gains and provides maximum liquidity. I am not eager to sell because I think the location has more "room to run" over the long-term despite the fact that I am certain we will see a pullback on prices as interest rates rise, when they start climbing. Remember, at 4%, a move to 5% is a full 25% increase in borrowing costs. That's a lot.

Three, my lender offers a 3.9% 10-year interest only loan that converts to a 20/20 loan in the 11th year. This would covert my current returns of 4-5% cash-on-cash and 2% amortization to a 7% cash-on-cash, 0% amortization yield. Similar I suppose to 7% 10-year coupon. I have analyzed the effect of the reset in year 11 at various interest rates (i.e. 7%) to see what the I/O and PITI payments would look like and they are not too bad, but certainly far greater than the PITI payments today. I would like the extra cash flow, however. That would make the next ten years more enjoyable, give me emergency cash, allow me to seek out better returns (if they exist) versus having those principal payments get buried in paying down the mortgage. This option also allows me to leverage up slightly to 60% LTV and pull some cash out while maintaining a healthy cash flow and DSCR.

Any thoughts would be greatly appreciated. 

I am stuck deciding between these three options.