How to exit a real estate investment with highest ROI?

Question

Dear All,

I would like some advice about my current investment. I own a condo in Washington DC. I bought it for $450K, paid 10% down and got a 30yr mortgage for 4.125% for the remaining amount ($405K).

I bought the condo as a means of building my asset base and attracted by high ROI thanks to leverage. I break even in terms of cash. The condo has a cap rate of about 5% ( originally thought it would be 6%, but was too optimistic) and increase in condo value is between 2%-3%/year.

My question to you is what to do now to maximize asset build-up? Right now I am making an ROI of 34% (if I am estimating it properly - details below).

a) Return through rent: 5% annual return over $450K – 4% interest rate over $405K = $6.3K, which is a 14% return over my investment ($45K)

b) Return thanks to value increase: The place is worth $450K. Throughout the year its value increases 2%, so it is now worth $459. The bank owns $405K, so I now own $59K. I made $9K, a 20% return over my investment ($45K)

As a result, in total I made a 34% Return on investment.

So - great, I am building my asset base nicely and should not use my savings to prepay principal to avoid lowering my ROI. Maybe I can put them in an index fund (let me know if you disagree!). However, if I try to exit this investment now, I will get hit by the real estate sale fees. I need to keep the condo for several years, until the value of the place builds up. The problem is that the ROI will fall with the years (because I need to pay back the principal too as per the terms of the loan). At some point I may as well refinance (to keep the ROI high), or exit and put the new assets in an index fund.

Does anyone have any ideas on how / when to make that decision?

Thanks!

Olatunbosun Idowu · Answer

if you decide to sell instead of using agents to execute the sale you can sell yourself,to save the cost associated with selling through agent  as in FSBO, For Sale By Owner and as rightly mentioned you can also reduce taxes or avoid it completely using 1031 Exchange  by reinvesting profit into similar investment.

However i would like to stress it here that  paying down on mortgage loan is good because it often time serves as a buffer to your investment in times of unexpected  market free fall and uncertainties which may lead to reduction in cashflow and income which of course can make mortgage payment difficult. If you ask me i think it is reasonable to pay down on rental property mortgage  while you can to give you some leverages in times of economic downturns.

Turner Monroe · Answer

It sounds like what you're trying to calculate is the IRR, so you might look into that to gain some clarity on when to exit. You could also think about a 1031 exchange in the future to minimize your tax loss. Of course, you'll still be hit with the cost of selling and buying another, so make sure to factor that in.

Manuel Bueno · Answer

Thanks, Tom.  This is good advice. I always thought in terms of cash break-even, but I just realized that my ROI is not that great (low value appreciation), and actually becomes negative taking into account real estate fees (buyer and seller agents). I will run the analysis you suggest.

Tom ONeil · Answer

For me, if the cash flow is breaking even, I would hold onto it.  Regardless of what your paper ROI is, in this scenario if you sell now I would imagine you would take a net loss due to all your selling expenses.

The other way to look at it, see what you would net from your sale and analyze putting that amount into an index fund for five years or so.  See where you think this property will be if you sell in that same five years from now.

Just my 2 cents.