Is now a good time to sell some of my investment properties?
I have a small number of investment properties with a property management company. We have been receiving offers to sell the properties due to the high real estate prices, including from the realtor division of the property management company we use. Is now a good time to sell investment properties?
Joshua is ranked the #1 adviser Nationally by Investopedia’s Advisor Insights audience.*
This is a more complex question than it may seem at first. From a simple perspective, you want to analyze what the true expected future rate of return is on the property including all costs such as maintenance, future upgrades, vacancy, taxes and more. Then compare that true rate of return with the other options you have for the money, accounting for differences in risk. Many factors, however, will impact the forward-looking expected return on the investment properties.
High Valuations = Lower Expected Returns
There is no denying that where we sit in 2021 real estate prices have recently increased rapidly. Nationally, real estate values have increased by 15.5% annually over the past year, 5x the long-term statistical average. The high valuations generally do not bode well for future return expectations (with any type of investments).
Lower Yield: Rental Income as a Percentage of Value
While rental rates are increasing, they are not increasing anywhere near as fast as the valuations of the real estate. This means you are likely receiving less rental income as a percentage of the value of the investment, even if the dollar amount of your rental income has increased. So the first part of expected future return, the income yield you receive on the property, is likely lower than it was in the past on many of your properties.
Lower Growth: Future Appreciation of the Property
Additionally, the current rate of increase in valuations is not sustainable over the long-term. Mathematically, prices are highly likely to correct and average out to the long-term historical return. This could take the form of a crash or a slower decline in prices over multiple years or even stagnant or slow growth over a prolonged period of time. No matter how it occurs, statistics tells us there is a high likelihood of a reversion to the mean - that is valuation growth rates being brought back down so the multi-decade average is attained. Keep in mind, this is not a prediction of what will happen next year. The math tells use we should see a lowering of future growth rates based on the recent run ups, we just don’t know how it will happen or when.
Lower Returns Don’t Necessarily Mean Sell
When looking at the current environment, it is reasonable to assume the returns on your properties may be less than you would like, and less than other investment opportunities with a similar risk profile. This doesn’t mean, however, you should definitely sell the properties. There are many other factors to consider.
Taxes & Other Transaction Costs
Another key factor is your tax situation. Despite what people who make their money from providing products and services to real estate investors want you to believe, real estate investing is not necessarily a tax benefit for you. While real estate can be an incredibly tax-efficient investment, it can also end up costing you more in taxes than other investments. Whether real estate investments are a tax benefit or detriment depends more on the details of the rest of your financial and tax situation than on the properties.
Unfortunately, this means there is no universal answer to the tax question. It is important you factor in the impact of your personal taxes on your decision. The sale of the property will trigger tax consequences and you want to factor the present and future cost of taxes into the decision. Keep in mind, if you don’t sell you will still have a tax liability built into the property. The key is understanding if you would end up paying more or less in taxes based on whether you sell now or keep the property and pay taxes later.
Talk to your CPA or a fiduciary financial advisor who is well versed in taxes to help you with this component of the decision. Ask for pro-forma projections of tax liabilities for selling the property now and in ten years. Then factor those tax estimates into the expected return.
Don’t Forget Transaction Costs
Just like taxes, transaction costs will reduce the benefit of selling a property. You can expect to lose between 6% and 8% of the property value in transaction costs. While this isn’t a deal killer, it is important to factor the costs in when comparing the real estate’s internal rate of return to that of other investments. An alternative investment will look slightly better than it truly is if you forget these costs, but also remember these transaction costs will ultimately need to be paid at some point.
One temptation is to avoid the cost by not using a real estate agent. This idea, however, brings with it additional risk of lawsuit if something goes wrong with the deal or with the property. And that risk will then lower the risk-adjusted expected return on the property. Even if you are a real estate agent it may be worth paying another agent to take on that liability for you. There is a reason lawyers hire other lawyers to represent them in court. As the saying goes: “representing yourself in court means you have a fool for a client.”
Your Life Trumps All
The final factor is the most important. Consider the lifestyle you want to have and how this real estate factors into it. You may have real estate in an undesirable location that no longer fits into your lifestyle. Or there may be properties which cause more stress than you like and could be worth unloading.
Also think about whether you want to continue to be a property investor. While owning property may have served you well, it may also have served its purpose in your life. If you want to remain a property owner and landlord, it may be worth it to have lower expected returns over the next few years. And if you are looking to move away from the work of managing rental properties, now might be a good time to begin that process.
With every decision, the first thing I do with clients is explore how the decision fits into the long-term vision of their life; not their money. Don’t let the numbers and the money overshadow the lifestyle and personal components of the decision. Your life and the life you want to build are the most important factors — money isn’t everything.