Was your rental property once a great source of passive income, but now it’s a constant headache? Do you find yourself stressed out with maintenance and tenants and actually losing money? Maybe you’re not breaking even but actually in a black financial hole?
One of the smartest things you can do as a rental property owner is periodically evaluate your rental options to buy, hold, or sell. This is especially true if you rely on a rental portfolio as a primary investment vehicle to fund your way of life and your retirement. Holding onto a rental property for too long sometimes creates a risk.
Ask yourself, what makes the most sense for you and your financial goals in the long run? After all, your money could be invested elsewhere, maybe in another property in a better location. But what do you consider, what are the right questions – how do you know when it’s time to sell? There are several factors to consider, so we’re going to answer common questions real estate owners ask when deciding if now is the best time to sell a rental property.
Should I Sell My Rental Properties if…
…there’s a Seller’s Market?
Yes, if the profit is guaranteed to outweigh future property value growth as well as the passive income you might have earned if you kept it. In a seller’s market, conditions favor the seller with housing price increases, adding to your equity, potential bidding wars, fewer price cuts, and faster sales.
…I have substantial equity?
Absolutely! If you bought your investment property years ago for an affordable price, and it’s significantly appreciated since then, by all means, cash out, BUT ONLY if market conditions are good. If the market does not favor sellers, then you have to evaluate, based on your property situation and cash flow, if it is better to wait, so you can access your full equity, or sell to avoid continuous loss due to the property needing repairs or remodeling, non-paying tenants, or tenants that damage the rental.
…rent prices drop?
Yes, but try to get ahead of price drops. Keep a watchful eye on local market trends, so you can predict when rent rates will drop too low to cover the mortgage, taxes, and maintenance costs for your investment property.
Rent growth typically stalls when there’s an overabundance of rentals in your area, and supply outpaces demand. Watch for an influx in new residential construction. Once all those units flood the market, growth may stagnate or worse drop. Another sign to look for is low interest rates, making homeownership more affordable, so rental demand goes down.
…there’s a low cap rate?
Yes, a low cap rate is persuasive, since it’s the cap rate that indicates how strong an investment rental property is and how much cash flow it’ll yield.
What is a Cap Rate?
A cap rate is a calculation of an investment property’s profitability. If, for example, you bought a rental at discount but then rent it for a high price, that’s a high cap rate, thus a great deal. It also depends on where you live: in the city, rental costs are high, but in rural areas, they tend to be lower.
How to Calculate Cap Rate?
Cap rate is the net operating income (NOI) of your investment property divided by its purchase price. The NOI is your gross rental income (from all your renters) minus expenses. Operating expenses include insurance, taxes, maintenance, repairs, and property management fees.
As an example, let’s say you paid $110,000 for your rental property. Gross annual rental income is $22,000, minus annual expenses of $9,000. So you have an NOI of $13,000.
$13,000 divided by $110,000 gives you a cap rate of 11.82%. Of course, this cap rate is based on a 0% vacancy rate; if your rentals are vacant, your cap rate lowers.
The higher the cap rate, the better. Keep in mind, cap rates also fluctuate based on market conditions.
…if it needs repairs?
Yes, BUT ONLY if the cost of repairs is too much of a financial burden. Most cosmetic improvements and routine maintenance are manageable, but if you measure both expected and unexpected repairs and find it outweighs your gain, it is probably time to sell.
An example is when you need to replace the roof or HVAC or make other expensive repairs to the property. Or you know that the property is starting to show foundation issues or any other underlying issues. If the cost of repairs and maintenance is too high, it may be worth selling.
…if property taxes are high?
Yes, because property taxes are part of your annual expenses, and thus a factor in calculating your cap rate. High taxes minimize your profit. If you sell, you can then invest in another market with lower property taxes.
…if I have bad tenants?
Depends. Let’s say you have one rental with bad tenants. These tenants do not pay the rent, and they damage the property. If the rental has property value growth and is certain to turn a profit with good tenants, it may be worth it to evict the bad ones. You can then make repairs and interview new tenants.
Evictions are expensive. So if the rental house is losing value and costs more than it’s worth, it wouldn’t make sense to go to all the trouble of legal action and spend more money on a lost investment. You’d be better off selling it to a real estate investor “as-is”, with its bad tenants still living there.
At SolidOffers, we meet and work with hundreds of landlords, eager to sell for one reason or another, and they often ask us the following questions to inform their decision.
Will I owe Capital Gains Tax on My Investment Property?
Chances are, yes, you will owe capital gains taxes when you sell a rental property. Depending on how long you held the property in your investment portfolio, you’ll pay a short-term or long-term capital gains rate.
Short-term capital gains apply if you own the rental property for less than a year. The tax rate is the same as the normal income tax rate, and the maximum you’ll pay is 37%.
Long-term capital gains apply if you sell your rental property after owning it for more than a year. Tax rates are 0%, 15%, or 20% and apply according to income and filing status.
You might be able to Avoid or Lessen Capital Gain on an Investment Property if you…
- Complete a 1031 Exchange
- Offset capital gain with losses
- Convert rental home into your primary residence
When does Selling a Rental Property Make Good Financial Sense?
Financial sense is a concern for every rental property owner. You want a rental property that provides a steady cash flow but is as little trouble as possible. So what are additional considerations when deciding to sell real estate investments?
Has the Depreciation Expense Run Out?
In the context of a rental property, its depreciation is a tax deduction. You can deduct expenses used to purchase and enhance the property. Only the building depreciates, not the land.
The Depreciation Formula is as follows:
- Purchase Price – Land Value = Building Value
- Building Value/27.5 = Annual Allowable Depreciation Deduction
*You depreciate the rental over its useful life, which according to the IRS is 3.63% of the cost basis annually or 27.5 years for a straight-line depreciation method.
- Annual Rental Property Income – Annual Allowable Depreciation Deduction = Taxable Net Income (excluding property tax, maintenance, and HOA fees)
- Annual Allowable Depreciation Deduction x 0.25 (if you’re in the 25% federal tax bracket) = Total Tax Savings
You can try to select accelerated depreciation instead, which front loads the depreciation costs for a bigger reduction. And even if the property value grows, you can still claim depreciation.
What is a Depreciation Recapture Tax?
For each tax year you own your real estate investment, the depreciation deduction lowers your tax liability. But when you sell, you’ll owe depreciation recapture tax. Depreciation recapture is a gain from the sale of a depreciable capital property and reported as income for tax purposes.
Could the Money I’m Investing in One Property Earn Higher Returns Elsewhere?
It depends on rental market conditions and where you are. One example might be, if headquarters for a major industry are relocating, its people are going to move with it. You’ll lose tenants. Maybe then you should sell and buy where demand has shifted.
Another example is, if you bought a rental property in an area that is growing, you’d do well to hold onto it and profit from higher rent prices.
Do You Need Money Fast?
Sometimes a major life event demands your immediate attention. Whether it’s a relocation, job loss, divorce, or other emergencies, you need money fast, and rather than sell your primary residence, you can profit from selling your rental.
Is Maintaining the Property Putting a Strain on Your Lifestyle?
The goal of owning investment real estate is to earn a passive rental income. But if being a landlord is too much of a hassle, and the rental has too many expenses, it may be time to sell off your problem property. If you’re losing money hand over fist in repairs, renovations, constant maintenance, or it’s become a tax burden – you pay tax but market rents are low, and you don’t break even – whatever the reason, it’s costing you. The rental has become a source of negative cash flow, and you’d be better off selling than keeping.
Are You a Remote Landlord?
Rental property ownership can be tricky if your rental is located in a different market than the one you live in. How do you handle maintenance, tenant complaints, and the day-in-day-out requirements? Maybe you have a property manager who takes care of things in your absence, but even that additional help is not enough sometimes.
Is Your Rental Property Worth More Now than When You Bought It?
Part of the real estate investing game is appreciation. If your property is worth more now than when you bought it, selling it could earn more than renting.
Is Your Net Worth Tied Up in One Portfolio?
In investing, asset diversification is also key, whether it’s in real estate or the stock market. If your net worth is tied up in a single property or one portfolio, it’s time to diversify your holdings.
Did You Inherit the Rental Property?
Rare as it is, it is not so unusual for one rental property to be left to a beneficiary. If you’re not interested in owning real estate, you can sell the inherited property for cash and be free of its responsibilities.
Are You Ready to Move On?
That’s the big question! Maybe it comes down to do you still want to be a landlord? If there’s another opportunity calling your name, or you’re just tired of the strain of managerial responsibility, it’s okay to throw in the towel and sell.
Or Are You Ready to Expand?
Maybe the next chapter means more growth. Sometimes a rental property owner sells because they want to build a real estate investment trust, but rather than start up where they are, they’d like to start over someplace else.
What is a real estate investment trust? A REIT is a company that owns and operates income-producing real estate. REITs own several types of commercial real estate, including office and apartment buildings, warehouses, shopping centers, and hotels.
How to Sell a Rental Property in Less than a Week
If you’re looking to sell an investment property fast and cash out, consider selling to another real estate investor. Most investors pay cash for a rental “as-is”, whether it’s damaged, mid-renovation, or still has bad tenants living there. No evictions needed, nor appraisals nor inspections. Closing can be in 7 days or 7 months – whenever you want to be rid of the property. Moreover, the investor will cover closing costs and additional fees, saving you money for capital gains.