There are many factors to consider when deciding whether or when to sell a rental property. You have to weigh the benefits of an immediate sale against the cash flow of holding onto it for a long period of time. For many landlords, this can be difficult. It takes SO much work to buy an investment property, and selling them can be an equally hard decision to make. But, there are a few scenarios when selling a property really does make sense, and we’ll be going through all of them below!
When to Sell a Rental Property
So you’ve thought about selling your rental property. Maybe another deal came up, you’re close to retirement, or even with the rental property apps you use, the landlord lifestyle has taken its toll. Regardless of your reason, here are a few reasons why I would sell a rental property.
1. You Found a Better Way to Make Passive Income
Passive income isn’t always passive. As most landlords know, managing a rental property, let alone a portfolio, can be challenging to say the least. So, if you’ve been given an opportunity to invest more passively through things like real estate syndications, or want to switch from residential to commercial real estate investing, now may be the time to start selling off some properties.
Remember, we’re in this game to make more money, so if you can make more elsewhere, it may be worth the pivot!
2. Your Property Needs a Lot of Repairs
A neglected property can be the cause of many landlord headaches even if you secured a rental property home warranty. You may have owned a property for decades and now problems are sprouting up in every direction. Or, you could have bought a property that the past owners took very poor care of. Either way, problem properties may not be worth the time to own, especially if you don’t have the cash reserves or maintenance experience to fix the problems yourself.
3. Being a Landlord is No Longer Worth It
If you’re close to retirement age or are self-managing a portfolio, you may be thinking of selling off your rental properties. If you can move into another passive income stream that has comparable returns, saying goodbye to managing rental properties firsthand may be worth it. But, if you are still making a phenomenal return on your investment property or simply need to build the right systems to optimize property management, I’d recommend doing what you can to ease the landlord’s burden before you sell.
4. When Depreciation Runs Out
Depreciation is a major tax write-off for real estate investors. On a residential property, you’re able to depreciate the cost of the property over 27.5 years. For commercial property, this is even longer at 39 years. This single write-off can often chop your taxable income in half, so once it runs out, it’s a smart idea to 1031 exchange this property for another!
Depreciation Formula
Calculating your depreciation is quite easy. Take your acquisition cost of the property, minus the land value (this value should be in your closing documents for the property) and divide that by the IRS’s depreciation period.
(Acquisition Cost – Land Value) / IRS Depreciation Period
Depreciation Example
Let’s say you have a residential property you bought for $400K. The land under the property is worth around $50K. That leaves you with $350K. Divide that by 27.5 years (the IRS’s depreciation period for residential real estate), and you have your yearly write-off!
($400,000 – $50,000) = $350,000.
$350,000/27.5 = $12,727.27 depreciation write-off per year!
That knocks off a HUGE amount of taxable rent income!
5. Property Taxes Have Spiked Too High
Thanks to new city, county, or town laws, property taxes can change throughout the ownership of a property. This means that the property taxes you calculated when you first bought the property could be VERY different from the taxes you pay now. If your taxes have spiked so high that selling this rental and buying another in a tax-advantaged area makes sense, it may be best to sell your property!
6. Your Return on Equity (ROE) is Too Low
When in doubt, return on equity is a fantastic formula to pulse-check whether or not an investment property should be sold or kept. In short, return on equity helps you see where your equity is being used best. This way, you won’t be sitting on $300K in equity in a house that only makes you $500 per month. That $300K could be used for other deals that could give you $3,000 per month!
What is Return on Equity?
Return on equity allows you to see how efficiently equity in a property is being used. It’s far more effective than using a calculation such as cash-on-cash return, because return on equity factors in the equity you’ve built into the home over years of ownership, NOT just the initial investment you put into it.
How to Calculate Return on Equity
To calculate return on equity, take the annual return of a property, then divide it by its total equity.
Annual Return (Cash Flow + Appreciation + Principal Paydown) / Total Equity
A Return on Equity Example
Let’s say you own a rental property. The cash flow on the rental property is $10K per year, it appreciates on average around $10K per year, and you’ve paid down $7,500 in principal this year. But, because you’ve owned this home for a while, you have $200K in equity in it.
Annual Return = $10,000 + $10,000 + $7,500 = $27,500
$27,500/$200,000 = 13.75% return on equity
That’s a solid return on equity, BUT, you may be looking at selling that property, taking the $200K in equity, and buying a $1M property. That $1M property would give you $100K per year in cash flow, appreciate around $50K per year, and you’ll pay down $12K per year of principal.
Let’s do the math on this one:
Annual Return: $100,000 + $50,000 + $12,000 = $162,000
$162,000/$200,000 = 81% return on equity (MUCH higher than the last property)
Now, this is a pretty extreme example (please someone send me a deal that matches the last calculation). But, it’s a great example to highlight that return on equity can show where your money is best put.
7. You Want to Cash Out on Equity
Like most homeowners over the past two years, if you have substantial equity sitting in your property, it may be time to sell. This is especially true if you aren’t terribly fond of a certain rental property. That equity could be used for a much better deal (like the last section showed) or it could help you pad your emergency savings or grow a truly passive income stream.
When You Should Sell OR Hold Your Investment Property
Selling a rental property is a personal choice, but that doesn’t mean it should be emotional. Remember to look at the math, see what your money is REALLY doing in that property, and evaluate whether or not the return is worth the effort. It is also important to note that if you do decide to sell your rental, make sure to avoid these illegal property management practices, to make sure the transition is as smooth as possible. But, if you own a property that is pumping out cash flow, has plenty of depreciation, and is low hassle, then there may be NO reason to sell it!
When to Sell a Rental Property FAQs
Still teetering between selling and holding? These frequently asked questions can help you make the right decision.
Many factors go into determining whether or not you should sell a rental property. The first thing to consider is your situation and your goals. Are you looking for more cash flow, more passive income, or something else? Do you need the cash right now, or can you wait for it? If so, how much time do you have? Ask these questions BEFORE you sell.
The general rule of thumb is that you should hold an investment property for at least a few years. This allows you to make your down payment back in cash flow and gives the property time to appreciate. But, if there’s a great reason to sell the property, you could hold onto it for as little as six months!
If you’re trying to sell your property and it’s a seller’s market, then why not! You’ll find plenty of buyers who are ready and willing to buy. If you wait until the market goes into a buyer’s market, though, then it could take months or even years before someone is interested in buying your property.
If prices are starting to tank, and you’re still cash-flowing, then selling may not be the best choice. But, if you have a bigger, better investment lined up and need the money from a rental to pay for your new property, selling may not be a bad option!
