How To Decide Whether It’s Time To Sell An Investment Property

September 12, 2018

A few years ago, I wrote a blog post about why I started investing in direct rental real estate. I recently decided to sell the first property I bought. This was prompted by my property management company letting me know that they were exiting the business and suggesting that I sell the property rather than find a new property manager because they felt the neighborhood was in decline.

In addition, I saw this article about rising foreclosures, which could indicate a downturn in the real estate market. For me, it’s time to get out of this investment. Here are the things I considered in this decision.

How much is the property earning?

One way to measure this is cash flow (rental income minus expenses) and a second is total return (cash flow plus growth in equity from a declining mortgage balance and real estate appreciation). The bad news for me is that vacancies and expenses were higher than I estimated with this property, so my cash flow was much lower than expected and ended up being slightly negative overall.

The good news is that appreciation was much higher than expected (at least according to the valuations on sites like Zillow, Trulia, and Redfin) so the total return might end up being pretty good. If the property continues earning at the same rate but appreciates at a more normal 2-3% a year, my future total return would be about 6-8%.

That’s not terrible, but it’s also not great, especially given the risks of a potentially declining neighborhood and a weak real estate market if interest rates continue climbing or the economy weakens. For me, the property isn’t earning enough by either measure to justify continuing to hold it.

What are the tax implications of selling?

The ability to write off depreciation in addition to the expenses has helped reduce my overall tax burden throughout the years I’ve owned. However, all that depreciation will hurt me when it comes to paying the capital gains tax by reducing my cost basis.

I can minimize capital gains taxes by waiting until the capital gains tax is lower to sell, selling when I’m in a lower (possibly even zero) capital gains tax bracket in retirement or just holding it until I pass away and allow my heir(s) to inherit it at a stepped-up cost basis, avoiding capital gains taxes altogether. Neither of those options appeal to me, so I will just pay the taxes and move on.

While taxes are important, don’t let the tax tail wag the dog. If your goal was only to minimize taxes, you could easily do that by minimizing your income and investment earnings. Instead, make your goal to maximize your after-tax return.

What else would you do with the money?

Once you know the rate of return, you need to compare it with what you could earn with that money instead. Many investment experts expect even lower future stock and bond returns in the future, given relatively high stock market valuations and low interest rates today. However, it’s generally a good idea to invest in what you know and I know stocks and bonds better than I know real estate.

What non-financial factors should you consider?

In the end, part of me wants to sell simply because I prefer having more liquidity, one less property to worry about, and one less state to file a state income tax form in. Remember, money is just a means. Happiness is the end.