Category: Business Strategies
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Posted on: 11/09/2008
Posted by: RiyahsDream12
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When and Why You Need to Sell Your Property
Before we get into the best reason to sell, here are some other common reasons you may want to sell your property.
1. You are having problems with the property. If you did your homework before you bought, this reason should not be a factor. The only exception would be a drastic market turndown where everyone is suffering, regardless of how they invested their money.
2. You need some instant cash. Selling under those conditions is both difficult and costly. A better approach may be to refinance the property, if you can, and get tax free cash out if it that way. Selling under distress circumstances will bring in the real bargain hunters who want to steal your property (kind of the approach you took when you bought it).
3. You also might be facing the same type of problems the seller had when you bought the house. You may have to move to another city or state due to your business. In any event, there are various reasons investors must liquidate a property before the ideal time arrives to sell.
All of that aside, we want to explore the primary reason the vast majority of investment property owners sell their property.
You’ve decided to keep your property and rent it out. There are several things you need to do that are fully explained in our investment course.
1. You need to stay on top of market conditions. Make sure you are keeping your rents at market rates. I’ve seen landlords who feel sorry for a tenant and never increase their rent. If you intend to run a non-profit organization, that’s great. If, however, you are tying to build your own financial estate, you need to remind yourself that you own a money making machine and not a support center.
This does not mean you need to be a cruel, hard nosed landlord you use to see in old movies. You need to use empathy (you’ve heard that used before in the book, right). The difficult part is to understand that tenants have problems too and you can sympathize with them, but if you start giving rent concessions, they will eventually need to console you when your investment starts to lose money.
2. Along these lines, you will want to increase rents whenever a lease is due for renewal. This, of course, has to be tempered with the current market. If rental are in demand, increase rents. If the market is soft with a high area vacancy rate, you may have to forgo any increases for a few months until the market strengthens. The nice thing about real estate as opposed to the stock market is you have some control over your asset.
When was the last time you called the CEO of General Motors and told them they need to do something differently?
3. How much of a rental increase should you get? Again, it depends on the market. You need to keep your rents in line with the competition in the area with comparable rental units.
Generally, in a good market, a ten percent increase each year is not unreasonable, as long as the economy is strong. As a practical matter, a home renter or an office tenant cannot afford to move and go through all of the trouble it take in the hopes of finding something as good in order to save a few dollars a month.
If, for example, a tenant is paying $1,000 a month rental and refuses to pay $1,100 next year, he must pack, move, change mailing addresses on everything, change over his phone service, electric and water service, voter registration, driver’s license, etc. All for $100 a month savings and he may not find anything better for less money.
4. Keep track of expenses. Your mortgage payments will probably be fixed, but taxes, homeowner insurance, repair costs, utility bills, etc. keep increasing. This is the reason you need to prepare an annual financial analysis on your property.
Now that we have covered some of the basics thing you need to do if you keep the property, the next consideration is:
When Should You Sell?
If you want a simple rule of thumb, you should sell when your equity is about double what you originally invested. The problem is, you did not put any money into the property to begin with, so what is double Zero equity?
The answer is this: You did put money into the property. Through renovation you created instant equity value by bringing the home up to fair market value. In our continuing example, the home is now worth $145,000 and you paid $112,000 including your cost in renovation. So, in theory, your investment property started out with equity of $35,000.
Let’s carry our rule of thumb out a few years, using $35,000 as our equity going into the property. Here is how our investment looks the first year:
Market Value : $145,000
Mortgage(s): 112,000 (rounded)
Equity $ 33,000
Less: out of pocket
Renovation costs: 2,000
Equity Year 1: $ 35,000
Rental Income/ Yr.: $ 14,400
Less Expenses: $4,200
Less Mortgage Pmts. $10,224
Profit (loss) <$ 24>
The property will lose an estimated $24.00 the first year. That’s good. It is usually difficult to get a single family home rental that will come close to breaking even the first year.
You are banking on future rental increases to get the investment into a positive cash flow position.
Now let’s see how it looks at the end of five years, assuming we were able to increase rents only six percent per year and our taxes, insurance and other expenses will also increase by six percent.
Rental Income, Year 6 $15,264
Less Expenses: 4,452
Less Mortgage Pmts. 10,224
Profit: $ 588
Still not much, but we didn’t have anything to start with. Now we’ll take a look at five years from now, but let’s be very conservative with the expected appreciation rate. We’ll only use three percent. In other words we reasonably expect our investment property to appreciate three percent per year for each of the next five years.
That is less than the inflation rate.
Assuming we increased rents by six percent per year, we are being ultra conservative in using only three percent appreciation. (The value of any income property is directly proportionate to the income it produces).
We’ll also show what the mortgage balances are at the end of five years.
Market Value End of Year 6
Based on 4%/Yr. Appreciation $166,911
Balance on Mortgages: 95,535
Equity: $ 71,376
Our equity is now about double our initial equity in the property. It’s time to get out of it and into another property. Why? You are no longer making maximum use of leverage (remember that)?
You started out with $ 35,000 in equity and now have over $71,000. Your initial investment allowed you to purchase a $145,000 property with the $35,000 equity (that was the fair market value after renovations, not what you paid).
You should now be able to purchase a property almost twice the market value of your first one, using the current equity you have after five years. Instead of owning a $145,000 property you could own a $290,000 property.
Instead of getting three percent appreciation on $145,000 next year ($4,350) you could be earning three percent on a $290,000 asset ($8,700).
That ratio keeps increasing each year. With no additional cash investment, you could be earning an additional $4,350 a year in property appreciation or double what you will earn on your present investment.
Not only that, but your cash flow increases with a larger property and your are paying down a larger mortgage, so your principal reduction keep increasing as you get into larger properties.
You have three ways of earning money on a real estate investment:
1. The cash flow or profit you are left with after paying operating expenses and making mortgage payments.
2. The amount your mortgages are paid down each month, thanks to the rent paid by your tenants.
3. The appreciation your property is realizing provided you keep up with the current market and increase your rents accordingly. Even a modest increase in rents and a modest increase in appreciation can, over a few years, increase your net worth by a considerable amount.
That one key factor alone is what professional investors practice to build multi-million dollar estates for themselves through real estate investing.
You are now on the road to the same success. In chapter twenty-three we’ll discuss the practice of Pyramiding and you will discover the true secret to building wealth in real estate, beginning with one small investment and never adding another penny out of your pocket.