Taking the idea of trying to time the market out of the equation, how do you know when is the best time to sell a home with equity? I get this question from even the smartest investors all the time. I was reading some articles from an experienced investor in the Denver area. I know this investor well and have a high level of respect for him. He mentioned something that got me thinking, I don’t know if I agree or disagree, but it’s an interesting topic. He mentioned that he has a condo in another part of the country that has a little over $200,000 in equity. He plans to sell the condo this year and put it to use on two or three properties in Denver, where he lives. His arguments are:
- The $200,000 in capital is not growing. In fact, you are losing money on that principal due to inflation. Investing that capital in more properties will help you reach your financial goals much faster.
- He doesn’t want the hassle of owning state property. He wants to invest where he lives.
There is no argument on my part about your second reason for selling. I have properties in several states and I can tell you that my best and least stressful investments are within 45 minutes of my office. My out-of-state properties work fine when rented, but are difficult to manage without getting on a plane, even with a property manager. Unfortunately, he only needs to show up once in a while to get things done.
It’s your first argument that made me stop and think, although I agree with the basic concept of not owning real estate stock. I believe this for a few reasons. First, I agree with him that equity in property yields a zero percent return, and if your goal is to grow financially, you’re slowing it down by not taking advantage. Nobody can have a good argument against that, but there are many investors who want to own a free and clean property. An advantage of a free and clear property is that you can have a higher cash flow, which means fewer properties to reach the same monthly income goal. There is also something very comforting about owning a property without debt. There won’t be a creditor or lender that can take it away from you if things get tough financially. From that perspective, it is very safe to own real estate debt-free.
That said, another reason I don’t really like home equity is that you become the target of lawsuits. I’m not a lawyer, but I have friends and colleagues who are, and they agree with me about the risk here. Many personal injury attorneys are paid what is called a contingent fee. This just means that their fee depends on whether they can win or settle a case and get paid. A fee can be 40% to 50% of the amount collected. Knowing this to be true, how many lawyers would take a case where the defense appears bankrupt? It cannot be collected from a dry well. On the other hand, if you were in a car accident, even if it was not your fault, and the other party wanted to sue, the opposing attorney would first investigate your assets. There is no asset that is more transparent than real estate. They can look and see what properties you own and how much debt you have. Even an LLC that owns a home could be at risk if there was a slip and fall on the property. If the asset were leveraged, it would at least appear that there were not many assets to search for. Insurance is obviously your first line of defense, but many laws are caused by mistakes that are not covered by insurance. Free and clear properties could create a target on your back.
So you can see why you would agree with this investor’s position to sell your property to buy others with more leverage. There are a few raises that come to mind for reasons I might not agree.
First, we don’t have enough information to make that call. If I had a property and I was thinking of selling it, the first thing I would think about is what I would do with the money and how much it will cost me to get it. The returns would have to be high enough on the new investment to cover what I was earning and pay me the cost of making the transfer. For me, I might want to have a high enough return that I can recoup all my costs in 18 to 24 months, and all that follows is an additional profit on top of what I was making on the previous investment. From time to time I hear investors mention that they want to sell a property and make a profit on their investment. Excellent! But what are you going to do with the money? If you don’t have a plan to reinvest earnings, you’ll end up with a much lower return than just leaving the money where it is.
The other argument I would challenge this investor with is that they can potentially keep the condo but still profit from the equity. I love using lines of credit on my rentals, this way there’s a link in the title, so it looks like it’s encumbered, even if I’m not using the money. It’s also cheaper because I only pay interest if and when I use the funds. Setting this up in advance allows me to make quick decisions and take advantage of opportunities without having a lot of cash in the bank. You could say that you can access more capital if you sell and you can potentially buy more real estate in Denver, which is true. With a line of credit, you would be limited to a percentage of the value, so you are limited in how much you can access.
It is important to note that each situation will be different and will be based on the investor’s individual goals and needs. There are also many variables that go into this type of decision, and it can be tricky to navigate. It would be a good idea to have a trusted advisor review her strategy to help you make the best financial decision for you. Feel free to contact our office if you ever want to share an idea with us. Obviously, we’d love to lend you a loan on your next project, but we’re also open to help if you need a little help.