Unsure how to figure out at what point it’s not worth keeping a rental property?
Deciding if you should sell or keep a rental shouldn’t be any different from deciding whether you should buy an investment property.
In order to make an informed decision, you have to answer the following questions:
- Is your rental property cash flow positive, neutral, or negative?
- What is the future forecast of rental income?
- What is the future forecast of home prices?
- What is the population growth trend for the area?
- What is the employment forecast for the area?
- Tax considerations: renting vs selling.
- Does your property appeal to less transitory renters?
- Where would you invest your money if you sell?
Is your rental property cash flow positive?
The reason we all have rental properties is to make money, preferably every month. Do you know if your rental makes money? Use our rental calculator to determine the annual cash flow and the cash on cash return of a rental property.
This is probably the most important consideration when trying to decide whether to keep or sell an investment property.
If your rental sucks money out of your bank account every month, it’s a no-brainer decision.
Subsidizing your rental property and waiting for appreciation to make money is risky. In certain situations, it may be worth keeping a neutral or even negative cash flow rental but this is a more advanced investment strategy.
For most real estate investors, it’s a risky proposition. If you have a negative cash flow property and you rely on income from your job to support it, what happens if you lose your job? Would you be able to continue supporting your rental?
Some investors think that the tax deduction will offset the negative cash flow. Because rental income is considered a passive income and loss from a rental can only be deducted from other passive income, that’s not a good strategy for most landlords. There are some exceptions for real estate investors who actively manage their properties and have an adjusted gross income of $ 100,000 or less.
Past and future forecast of rental income
No one can predict future rental income with certainty, however, historically rent prices have increased by 8% annually (not adjusted for inflation). Of course, it’s a good idea to use a more conservative number, 3% to 4%. Residential rent prices are not as volatile as property prices can be. During the Great Recession, while sales prices decreased by 40% to 50% in some areas, rents continued to move upward.
The graph below shows historic gross rent prices from 1940 to 2019. Real estate investing is not a get-rich-quick scheme. It required patience and time.
Past and future forecast of home prices
Property investors should be aware of the real estate cycle in order to maximize their returns.
Real estate prices are influenced by the existing supply (the number of homes on the market) and demand (the number of buyers looking to purchase properties). Anything that changes the supply or demand will change the market.
Real estate typically goes through four phases:
- Recovery
- Expansion
- Hyper-supply
- Recession
In order to decide if you should keep or sell your rental property, you should determine where in the real estate cycle the market is in right now. This will indicate if there is still more appreciation left or is it time to cash out.
To get a real understanding of the market don’t listen to the media and just watch the numbers, especially inventory and DOM (days on market). I remember in 2010, we were still in a deep recession I noticed that the supply of homes was slowly decreasing and the days on market number was going down as well. It was hard to convince people then, that the market was turning because the media was all gloom and doom. Luckily I acted on those numbers and I made some money for myself and our investors.
Population growth forecast for the area
This number is easy to forecast based on historical data and trends. If your rental property is in an area of population growth, rents and real estate prices will most likely keep going up long term.
Employment forecast for the area
Buy or keep a property in an area of strong employment growth especially if the growth in jobs comes from diversified industries. According to Ron Witten, president of Witten Advisors, a one percent increase in the unemployment rate leads to a roughly one percent decrease in demand for rental homes.
Tax considerations: renting vs selling
Have you considered the tax consequences if you sell your rental property? Some landlords are not aware of the depreciation recapture gain, which can be significant and it’s taxed as ordinary income.
It’s important to note that everyone who sells a depreciable asset will have this gain, even if they didn’t deduct depreciation from their taxes.
One way to avoid paying taxes is to do a 1031 Exchange and buy a property that has a better cash flow and is generally a better investment.
Consult an accountant or tax professionals in order to get a full understanding of your tax liabilities if you sell.
Does your property appeal to less transitory renters?
Vacancies are the largest expense for landlords. A rental property can sit for a month or two vacant and all of the expenses for to get it rent-ready, commissions, etc can really eat into the profit. So it makes sense to buy rental properties that appeal to less transitory renters, properties that will easily accommodate a medium-size family.
A 3 or 4BR/2BA home with a minimum of 1800 sq. ft. can appeal to families and retirees.
Where would you invest your money if you sell?
The last question to ponder is what will you do with the cash you receive if you sell. Do you have a better place to park it where it will bring you better returns?
Resources:
IRS Publication 925 Cat. No. 64265X Passive Activity and At-Risk Rules
