Leading property mogul, Ofir Eyal Bar shares his fascinating insights into selling investment properties.
‘At first glance, you may be wondering why you would ever want to sell an investment property. Surely, investment properties are desirable long-term assets that should never be sold? The reality is markedly different however. Every single type of investment has a shelf life; some are longer than others.
If you believed that holding onto a real estate investment for dear life is the only way to do it, think again. In this article, I’m going to share important information with you regarding selling investment properties. Believe it or not, it’s not always a bed of roses with investment properties – sometimes it’s a bed of thorns!’
Why buy investment properties to begin with?
Perhaps, you are starting out as a bright-eyed and bushy-tailed entrepreneur with a vision of becoming a property mogul. Congratulations! What better way to generate a fantastic ‘passive’ income stream than a real estate investment? As you are about to learn, there’s more to investment properties than meets the eye.
Allow me to preface this article with a rudimentary concept known as using other people’s money to make yourself rich. With real estate investment properties, you will be required to pay a down payment of 20% of the purchase price of the property. You may believe that’s a small price to pay compared to the ongoing revenue streams you will be generating by other people paying down your property.
If you are successful in this endeavor, you’ll have a fully paid off asset within 20 years. Better yet you surmise, the value of that investment property will have appreciated significantly over time, allowing you to comfortably retire and live out the rest of your life in grand style. That’s the theory folks. It doesn’t always work that way. You see, investment properties involve people, systems, appliances, maintenance, property managers, legal agreements, payment issues, and scores of unforeseen eventualities. It would be great if you could guarantee the perfect tenants year after year, with no burst boilers, broken AC units, flooded homes, damaged roofs, peeling paint, economic downturns, family emergencies, job exigencies, and the like.
Remember the famous quote: Life is what happens while you’re busy making plans. This aphorism certainly holds true with long-term investment properties. As you get older, you will learn that the perfect plan is often laden with challenges that threaten to derail you at every juncture. You will have to carefully assess the merits of holding onto an investment property versus selling that investment property based on a number of important considerations.
If you’re one of many budding real estate entrepreneurs, you’re probably thinking about amassing a portfolio of investment properties which you plan to hold onto to generate passive income streams down the line. What could be better, right? We are about to explore many valid reasons why the savviest real estate investors decided to cut their losses and sell their investment properties
Why Sell If You Can Have a Huge Portfolio of Investments?
Remember the concepts of risk and reward? If the reward outweighs the risk, or if the benefit outweighs the costs, you may be inclined to hold onto your real estate investment property. Once the opportunity cost of holding onto your investment is greater than getting rid your investment, it’s time to cut your losses.
This begs the question: Why would you sell an investment property if it is generating passive income? Passive income is not really passive income if you have to do a lot of work for it with investment properties. Think of all the challenges you will face with renting out a house, apartment, building, or piece of raw land:
- Dealing with tenants, leasing agents, and property managers
- Maintenance of the property, appliances, systems, and integrity of structures
Still not convinced? Okay let’s take a look at things that may occur in your life which necessitate selling an investment property. Perhaps you bought the property when things were going fabulously well with your business, home life, and family. Maybe, there is a new addition to your family which takes up all of your time and leaves you with precious little time to dedicate to maintaining an investment property. This happens. On the opposite end of the spectrum, there’s always the possibility that tragedy will strike and a loved one will pass.
This creates undue stress which is not conducive to maintaining a portfolio of investment properties. If you become ill, or unable to perform the physically demanding work required to maintain an investment property, it will soon fall into disrepair, or at the very least become unprofitable to maintain. Yet another possibility is your source of bread-and-butter – your job. What if your company closes down, or you’re required to relocate elsewhere. How will this impact your ability to maintain investment property?
Maybe it’s time to consider alternative sources of passive income?
Passive income is only passive when you don’t have to do anything to ensure that you’re generating income from it. The perfect form of low-risk passive income is a certificate of deposit, or a fixed deposit as it is known outside of the US. You simply deposit X amount into an account at a fixed rate of interest and you collect your return at a future point in time.
Other sources of passive income include government bonds, dividend investing, private equity, real estate crowdsourcing, and P2P lending, et al. The viability of each option is contingent upon the risk and reward associated with each passive income source. You may find that your best bet is one which is not associated with bricks and mortar assets like property; you may be better off generating passive income through an e-commerce store selling a product or service.
Sell if Cap Rate is Lower than the Risk-Free Rate
There are economic factors to consider in the equation too. The net operating income generated by your property less the expenses from gross rental will provide you with your cap rate. This is a little challenging to understand for a novice, but it’s an important equation since it evaluates the viability of a real estate investment. Let’s assume that the gross rental income you generate from your investment property is £100,000 per annum.
If your net operating income is £65,000, it would be fair to assume that the cap rate on a purchase price of £1 million is 6.5%.
Now, the risk-free rate of return is the guaranteed rate of return with a certificate of deposit. Assuming that that percentage is 4%, you are 2.5 percentage points above that, and it is a viable option to rent out your property. However, if the current value of the property drops substantially, and you have to spend a lot of money on maintenance, property management, or leasing agents, the cap rate may plunge below the risk-free rate, making it a bad investment.