3% return on equity - should I sell or hold?

[Ryan Fortier]

I need advice on whether I should continue to hold onto my investment property or sell and "buy up".

Here is the scenario. I own a condo in Brooklyn, NY, which I purchased at the end of 2008 for 940k.  Today it is worth 1.65M, so it has appreciated roughly 10% a year.  My positive cash flow is 2k a month.  My current equity in the property is 845k, which makes my return on equity a miserable 2.8%.  I ran numbers on if I sold it and repositioned that equity as a 25% down payment on new property. After commissions and fees, I'd probably walk away with 750k, which would buy me 3M in real estate. If I purchased the new 3M investment at a 10% cap rate, my pre-tax cash flow would be roughly 13k a month. I'm also leveraged into 3M in value, so if the market goes up 10%, I make 300k on paper vs. 10% on my condo, which would be 165k.  Selling seems like the smart move, but I hesitate because of the possibility of continued strong market appreciation for the area of Brooklyn my condo is located in.  Am I crazy to continue to let all this equity sit and only generate 2k a month?

[Llewelyn A.]

@Ryan Fortier

I have been investing in Brooklyn for the last 20 years and have several multi-family building in several neighborhoods that you probably know very well including Ditmas Park, Clinton Hill, Bed-Stuy, and Windsor Terrace.

What I find on this Blog is that there seems to be a lack of the understanding of "Cashflow."

When someone mentions Cashflow, they tend to only mean the Cashflow that is calculated from taking the current Expenses away from the Current Revenues and then make a comparison by the Invested Capital, something that is typically called the Cash on Cash Return.

However, in places like NYC, that really is not the ONLY metric one should use. There are actually at least 3 OTHERS.

The first of the 3 is your Tax advantages. If you consider that properties at a higher price will maximize your business expenses including your Depreciation Expense and your Mortgage Interest Deduction, you can generally even off-set your non-Rental Income.

The second is that if your Renters are at least paying down your Mortgage even if you don't receive a positive cashflow, you are still building Equity in the Mortgage Reduction. Typically I have mortgages well over $1 Million. For a 30 year Mortgage, if you just take a simple calculation of $1 Million / 30 years, you are returning $33,333 per year for 30 straight years on just ONE property. You don't have to receive the Cashflow to make money.... that's the point of the Mortgage Balance Reduction.

Third is that there is no point on evaluating a property for it's Return on Investment (ROI) if you cannot evaluate the FUTURE CASHFLOWs. FUTURE Cashflows are actually more important than current cashflows. How does Future Cashflow works? In exactly the same way as your current Brooklyn Property.

You bought your property for $940k, let's say at the beginning of 2009 instead of the ending of 2008. If you sold today, you would get back $1.65 Million.

Since you have  current Equity position of $845k, you have a loan balance of $1.65 Million minus $845k = $805k. At time of Purchase, let's say your Mortgage must have been around $850k at least.

Here is a mini Analysis of your Scenario:

So basically, if you calculated your TOTAL RETURN in a Simple Calculation, you get 57% annual Return for every single Year for 7 years straight. That represents a total ROI of 400%

That didn't even include your Positive Cashflows.

If you don't want to use simple calculations like the one in E11 to E16, then you should use the Internal Rate of Return Calculation which we can see if 29% per year for every single year of your 7 year holding period.

I would say there are a lot of people on this Blog who will not understand these calculations and because of that, miss these incredible returns.

My own several multi-Family properties returned even higher than yours.. ALL OF THEM.

But despite how wealthy one can get from investing in places like Brooklyn, I keep hearing the skepticism as if this was a fluke each and every year that I have been investing in Brooklyn for the last 2 Decades. No matter how much money I or any of my partners make..... because our Cashflow is low (and your $2k is not low but others justify that by comparing it to your FMV), their seems to be a cult like fixation on just Current Cashflow calculations rather than Future Calculations like the ones above.

Even my own friends that I have known for decades and are themselves RE Investors continue to believe that high Value Cities like Brooklyn are bad investments because they cannot get current cashflows.

One such friend, Steve, bought Cashflowing properties at the same time as I did in 2006. He made around $1k per month or for 120 months over that 10 year period, made a total of 120 x $1k = $120k. He got ZERO appreciation. It's also possible his property is below what he paid for it today.

However, contrast that to one of my properties bought at the same time with approximately the same investment amount, I literally made Millions.

Unfortunately for Steve, he got priced out of Manhattan and moved to a cheaper place in NJ. So what did the $120k really do for him?

Anyway, the readers of this post should consider that there are other calculations that need to be taken into account. In fact, if you look at the BP Tools, the BRRRR Calculator is a great Tool if you don't want to understand all the detailed calculations such as the calculation I presented in a mini-form.

You will find the the BRRRR Calculator has a Report that does all the Future Calculations for you, including Rent and Expense Appreciation as well as some fixed Appreciation for the building.

I personally advise to learn all of these Calculations. There is a really great book called "What Every Real Estate Investor Needs to know About Cashflow" by Frank Gallinelli. It's a great book but it will not make the top seller's list because most people cannot get past the 1st few chapters because of all the Math involved. However, this gives you the kind of mentality, knowledge and understanding you need to understand Future Cashflow calculations. And best yet, it's only $15.