Selling Residential Rentals, Going Liquid

[Craig]

We own three rentals, two in Phoenix (huge appreciation in the last 18 months), and one in Portland, OR (healthy appreciation).

Reading the Shiller thread, and considering the natural, normal illiquidity of real estate, we're considering sale of all parcels.  Doing so would end our nice monthly net rental income of $1,900, and incur cap gains taxes of roughly $110K.  Would leave us with $900K in liquid assets, plus a paid off home (fmv $320K).

Torn.  The real estate appreciation has been great, they're paid off, so little downside in terms of cash flow, though having the personal home paid off and nearly $1M in the "bank" would be attractive.  And, rentals can throw a few curves at you.  Your views would be helpful.  Thanks.

 

[Nords]

It's only money.

What would you receive if you paid the taxes (28% plus depreciation recapture, is that right?) and invested the remaining money in a CD or a bond fund? Would it beat out the cash flow, or at least make you feel like you're ahead of the hassle of being a landlord?

How would you feel if you invested the chunk of money in a dividend-stock portfolio like the Dow Select Dividend ETF (DVY)?

What about a 1031 exchange into an undervalued property or a NNN commercial property?

The point is that you're eliminating a certain amount of hassle and giving up a big chunk of taxes to convert appreciation into realized gains. Then you're trying to replace the former rental cash flow for at least that much (plus the potential rent raises) without picking up anywhere near the hassle. Hassle factors aside, the whole discussion should resolve itself down to dollars.

 

[Mr._johngalt]

An observation. Landlording can be a huge hassle.
However, other than long term passive investments,
almost every way to make money carries a hassle
factor. That said, if I was going to do any "work"
(unlikely) it would be in self owned real estate.
But, even I would require a big premium (think
income/appreciation) before opting for real estate
over other venues available to me. In my case
the large % we have allocated to real estate is for diversification
and inflation protection more than pure "return"
expectations.

JG

 

[Delawaredave]

The $1,900 - assume it's after all expenses - is it before or after taxes ? That's 2.5% of 900K. If that's after taxes - then that's probably equivalent to 3-3.25% gross income/dividends

Historically real estate appreciates at 1-2% over inflation. Maybe recent bull real estate market means future value will grow only with inflation maybe 1% lower.

So you have pretty solid "inflation plus 3%" return, with probably low downside.

For the next 5 years, I see a 20%+ drop in US equities much more probable than a 20% drop in real estate.

So I don't see how you can match the risk/return profile you have - unless you're comfortable with international stocks/bonds.

Just some thoughts. Good luck !

 

[unclemick]

Vanguard Wellesley - there I slipped and said it again.

 

[Martha]

We sold our rentals after a run up in value. We sold because we knew we didn't want to be landlords forever. Also, people were willing to pay enough that the properties barely cashflowed for the purchaser. It felt like a local bubble in the rental market so we sold. However, we are still in real estate but in limited partnerships/LLCs where we are passive investers. We continue to like real estate in some form because we understand it.

A good portion of the gains from rental sales were invested in the stock and bond market. Currently, we are at about 25% in real estate investments, down from what was at one time about 80%. One of our passive real estate deals is closing on a sale and we really are at a loss as to where to put the money. Will sit in cash equivalents until a likely deal comes along.

Nords, the tax on the gain is at capital gains rates except for the recapture which is at 28%. The tax can hurt, but what the heck, it has to be paid some day. At least capital gains rates are currently low.

UncleMick's idea is good. Though I can't talk my husband into mutual funds.

 

[Craig]

Thanks for the feedback.

The $1,900 is net monthly rental income after all expenses other than income taxes.  Relative to our basis, it is a 17% return ... relative to net fair market value (after selling expenses and income taxes) it is nearly a 4% return.  Plus appreciation, certainly a decent return, and we know we've been fortunate.

I also like the diversification of this, and the hassle has been minimal ... though my gut tells me that won't go on forever.  But ... my wife also reminds me we've gone 8 years as landlords, with no major hassles.  She does an excellent job of checking out prospective tenants.

Selling is attractive, as we would be able to pay our home off immediately, and have significant liquid assets.

Still musing, but one probable fact may sway me.  I hear pundits commenting this is the best time in years to rent ... telling me that our net rental income is likely to rise over the next few years.  That probable increase should cover more and more of our monthly nut (we have a fixed rate loan on our home), and perhaps that is the wisest course.

Has anyone ever found a source for research on residential rental rates, history, etc.?

Thanks for helping me noodle this one.

 

[Mr._johngalt]

Hi Charles. The research you seek would have to be highly geographically specific to do you any good.

JG

 

[Helen]

I hear pundits commenting this is the best time in years to rent ... telling me that our net rental income is likely to rise over the next few years.  That probable increase should cover more and more of our monthly nut (we have a fixed rate loan on our home), and perhaps that is the wisest course.

Has anyone ever found a source for research on residential rental rates, history, etc.?

I would think when housing prices increase dramatically it would keep home ownership out of reach for many people. Thus, those who couldn't afford to buy would have to rent.

If this is true perhaps it would mean the opposite would also be true; when housing prices decline, more renters are able to buy and the number of people renting would decline ? Which means rental rates could fall.

-helen

 

[LRAO]

Charles,

Would you be interested in selling to a board member?

PM me, please.

 

[Craig]

Helen, that would be true, however ... the cycles are long, and I'd wager we see more of a stagnation in appreciation than significant declines. Sure could be wrong, but I would wager we'll see long rates / mortgage rates continue to rise, housing will become less affordable little by little, and then we'll see upward pressure on rent rates. We'll see. Have talked myself into and out of this numerous times.

 

[Helen]

Charles,

I can see that this would be a difficult decision to make. Either way it sounds like you are doing very well with your investments !

Best of luck to you !

-helen

PS - I just read that rental vacancies are the lowest they've been since the stats were first recorded. So I think my theory is out to lunch.

 

[Mr._johngalt]

Commenting on something that Martha mentioned..............I still keep track of properties
on the market around here. Many (maybe most)
multiunit housing could never show positive cash flow if purchased at or close to the selling price. This makes me wonder who ever buys them. I can usually tell at
a glance if a property will "work". I know the market,
rents, tax issues, employment issues, all very important
if I was still investing. I suspect some of this property
is sold to people who have no clue. Someone told them to
buy rental property and so they do. Otherwise, I
don't get it. What other explanation could there be,
other than buyer ignorance?

JG

 

[Martha]

They are banking on appreciation and on increasing rents.

 

[Mr._johngalt]

I always tried to "make my money when I bought it".
Probably why it took me so much time to find one to
buy. Probably also why I never lost any money
on rental property.

JG

 

[Delawaredave]

Figure appreciation at 2% over inflation and rents after costs of 3-4% of house value.

So that's total return of 8-9% (assuming inflation is 3%).

Better than bonds, not as go od as stocks - BUT one hell of a lot less risk and volatility over stocks.

I wouldn't use positive cash flow against a mortgage as the test - few properties meet that, probably none these days.

My father had 40 units growing up - decent investment - but the "hassle factor" made me swear as a kid I'd stick with equities. But boy he was good with a plumber's snake....

Maybe your best answer is to sell one property - the one in Oregon (rains too much there anyhow....). Would help with diversification and cut your "hassle factor" in half.

 

[ER@40]

Reading the Shiller thread, and considering the natural, normal illiquidity of real estate, we're considering sale of all parcels.

You don't need to bail just yet, that is unless you own property in an over-saturated area with excess new developments, or in a less desirable area, or you're sick of RE.

There will be clearer local warning signs, and a sharp drop in home starts, plus the Fed isn't raising rates as aggressively as it could be. Recommend having agents value the properties and keep in regular touch to have an ear to the ground.

If you check out of RE now, there's isn't any clear vehicle to put your $ into. It doesn't sound like you favor funds. and while CD rates are going up slowly but surely its still too early, plus the rates even on FISN.com won't protect your capital from rapid inflation.
Recommend you key an eye on your local market, and keep a call option on early termination of leases..

 

[LEX]

Charles:

I live in Phoenix metro (Paradise Valley in an older house but great lot near the Camelback) and suggest that the two Phoenix properties are worth holding on to for more appreciation unless (or until) the following:  You want to have the personal freedom not to worry about real estate mangement, or in the case of the Phoenix market, the market actually slows down.  Right now the real estate sharks are in a feeding frenzy. I have had several realtors actually be stupid enough to ring my door bell and attempt to buy my house on the door stoop, claiming they 'represented a buyer'. I let each one know what I thought about being solicited with easy to follow directions off the property.  I can be a complete **** when the situation calls for it and sometimes when its "just plain wrong", but I do it anyway, as I find it recreational. Its a hobby I am developing now that I no longer have to suck up to anyone in ER! I have since taken to locking the outside gate to my front entrance and allowing my ill tempered dog free access to this area.  He is just as happy barking at real estate drummers as he is with postal workers or UPS delivery workers, so this has kept him very busy and provides him free entertainment.  I also want my dog to feel that he provides the family a vital service.

Phoenix proper is in a speculative land rush similar to southern california, and there is still easy money to be made.  Give the two properties at least another year or so and they will most likely go up to the point where even the 'investors" from out of state will start thinking that the bubble has gotten out of hand.  Then sell and run straight to the vanguard offices on Northsight in scottsdale, and buy as much of the Wellesley and windsor funds as you can...and then take a nice long cruise and forget about broken windows and tenant calls for maintenance.

But as I have been told by others who have made much more money than I ever will, no one ever went broke making a profit! Sell if the price makes you laugh after the closing and the cash is in your account

 

[daddyboy]

Charles -

Don't forget - you *could* just sell one property and invest the proceeds, then see how you like the results before continuing with the others...

Just stating the obvious...

DaddyBoy

 

[Martha]

We are in real estate investments in the Phoenix area. One of the investments is selling this spring. Another is going to be converted into condos. Apparently this is very popular right now in the Phoenix area. The general partner in our investment is hoping for a 10 fold increase in profits by doing the condo conversion.

I am wondering what all these condo conversions are doing to the rental market in Phoenix.

 

[Craig]

Thanks ... appreciate all the brainstorming. Food for thought.

Re: the condo conversions ... always interesting to see the wind change. When the markets are rough, we rented condo's in Phoenix, back in the late 80's, early 90's.

 

[LEX]

IMHO: treat Phoenix Real Property with the same strategy you would use for LA and Orange county, but with a lot more upside due to population trends in maricopa county. Thats what I am doing.

 

[P.S.]

Not familiar with Phoenix or Portland markets, but aren't they a popular retirement destination? And Boomers are just starting to retire?

 

[unclemick]

Portland was a great place to party and chase girls - ah er ahem - in the early 60's. Don't know how many stayed to become retired Boomers.

 

[Craig]

Let me update with some additional arguments, based upon increasing buzz about the "bubble".  I swear every financial magazine and news show now contains some comment along those lines.

Many of the homes changing hands now are apparently being bought up by investors to flip or rent, or by folks wanting second or third homes.

Question ... if we are adding significant housing stock that is potentially "excess" to population needs, that could depress rents for years, while also affecting values.  Do you believe we may be loading the market with supply that will outstrip demand soon?

One consideration in our decision is whether the status quo with our net residential rental income could actually be optimistic for the next few years.

Also wondering if commercial real estate is a better bet for the next decade ...

Still noodling ... appreciate brainstorming with you.