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Selling Rental at 10 years or less, you miss the real upside and significant profits.


As an owner of a Riverview Property Management company, I've noticed the tendency of rental property owners to sell in 10 years or less.There can be a lot of valid reasons to do this such as the property has appreciated enough to sell for a good profit, you have need for the profits you would receive, or you don't want to lose out on the profits already earned by hitting a severe recession.

As a Riverview Property Manager, I'm often asked by my clients my opinion of whether to sell or not. I always reply that it depends on your situation.If you really need the money for something, then selling can make a lot of sense.I've too struggled with whether to sell my own rentals or not especially when the real estate market is hot.So, I thought I would explain my thinking if you own a specific type of rental property:a property with 30-year fixed financing.

Let's say you bought a home a $200,000 house in nice neighborhood with a good school district.You lived in the home for 4 years and had to move out of state.Let's assume you put 5% down to purchase the home leaving you an initial mortgage balance at day of purchase of $190,000. 

190,000 mortgage at a 5% interest rate = payment is $1019.96.

  • Let's assume taxes are $250 and insurance is $150 = $1419.96
  • The home rents for $1600 a month giving cashflow of $180.04
  • Let's assume you can pay for all repairs each month for $100
  • 8% management fee = $128 per month
  • Negative Cashflow of -$47.96 per month

You aren't selling because the property hasn't appreciated enough for you to pay a real estate commission and still pay off your mortgage balance.Now imagine 5 years go by.You've lost money every month…or have you.

  • Your mortgage balance = $158,942 = $31,057 = $287.56 per month principal pay down.
  • You depreciated the value of the home not including land = $152,000 (value of home) divided by 27 ½ years = $5527.27 tax deduction each year
  • Let's say your tax rate is 25% which equals $1381.82 of taxes you didn't pay or $115.15 per month
  • -47.96 (Negative Cash Flow) + $287.56 (principal pay down) + $115.15 (depreciation) = $354.75 month profit over that 9 years or $38,313.16

Unless we are in a recession at the end of the 9-year period the property appreciated 2.5% each year which would equal $249,772.I'm trying to be very conservative with the appreciation rate.

  • $38,313.16 (principal pay down + depreciation – negative cash flow) + $49,772.59 (appreciation) = $88,085.75 of potential profit

When the owner gets an estimated value and realize that she can sell for a potential of $68,000 after commission, closing costs, and concessions it looks like it is time to sell, or does it?

This is where most people stop thinking about future profits and say, "good enough", but if you take a moment to do the math, you'll see something very interesting.

What happens at 20 years?

  • Mortgage balance is $98,163.31 = $93,836 of potential profit
  • Rents have risen substantially in 20 years and instead of -$47.96 a month in negative cash flow, rents have risen from $1600 to $2377
  • Now insurance, taxes and cost of repairs have also risen but let's say you are now making $250 a month in profit, conservatively instead of losing -$47.96 per month.
  • Depreciation has netted a real tax savings = $27,636
  • Appreciation at 2.5% = $127,723
  • Total profit - $27,636 (depreciation) + $98,163 (principal pay down) + $127,723 (appreciation) = $253,522.40 potential profit
  • You go from $88,085.75 potential profit at 9 years to $253,522 at 20 years.

I don't have a lot of space so let me give you the 30-year profit

  • $190,000 (principal pay down) + $219,513 (appreciation) + $38,000 (depreciation) = $447,513
  • Keep in mind these numbers are quite conservative

Can you see how holding on to a good rental for 20 or 30 years can completely change your retirement?Imagine if you bought a good rental property every 4 years in a recession or a flat market.You could become quite wealthy.Now I realize I have a vested interest in managing your property for that long, but that is not the point of this article.

The point is the real money is made in the long term.Most people don't really consider this because the calculations above or not in anyone's mind.We all understand the mortgage will pay down but haven't done the math to understand the total impact of appreciation, depreciation, and rent growth.I know this numbers are boring but the "devil is in the details."

I must remind myself of this math constantly throughout my investing career.I own several rental properties where I've been paying down the mortgage 10 to 15 years at this point. Somewhere around the 7-10-year mark is when rental properties really start making you money.At the 20-30-year mark they make you a fortune, if you can hold on.Food for thought.

PS Keep in mind you put down $10,000 to make $447,513 in potential profits at 30 years.Now I know you had costs at closing and selling but let's assume the rent growth paid for all that and your original down payment.Not a bad return. 

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Saturday, 13 April 2024
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