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Rental Property - COC vs. ROE

2,528 Views | 3 Replies | Last: 5 yr ago by Tonyperkis
Ed Carter
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AG
so one of the draws to rental property is obviously the cash on cash argument when you use leverage to increase your return on say, a 10-20% down payment. My question for the people that have been in this game for a while though, at what point does it make sense to sell the property in regards to your return on new equity? The longer you hold the property, the lower your return on equity will be as the debt is paid down and the property (hopefully) appreciates.

Do you guys have a number or a metric you use to figure out when its' time to sell?
Tonyperkis
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I like to look at IRR of my property. I don't model in appreciation when making purchases, but it is obviously a property trait that I look at when considering a purchase. Before selling, I'll look at my property and think about the long-term appreciation potential and model out some different appreciation scenarios to see what the return would be (3%, 5%, etc...). I like to buy properties in development areas so I'm hesitant to sell if I think the there is still growth opportunity. One thing you will see, the modeled appreciation will greatly increase your ROE, but you have to remember you could get that same appreciation with your new purchase as well (so it may not really be a benefit).

I'm currently selling a property that I think has more growth potential, but there are other risk factors that are leading me to sell such as upcoming capital expenditures (bought the house new and it's now 7 years old) and the HOA management (potential increase in monthly fees, special assessment, etc...). It's got a 7-8% ROE which isn't enough. I calculate the ROE based on sales proceeds (after taxes and selling costs) as I want to compare current return to the actual amount of cash I will be able to re-invest after the sale. Another item to consider is whether you have identified a place to re-invest the money after you sell. You don't want money sitting around doing nothing.

It's pretty easy to find passive syndicate investments that are 15-20% IRR. When you look at my property above, that investment most likely beats my property, which is why I'm selling. Hope that helps.
mazag08
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Ed Carter said:

so one of the draws to rental property is obviously the cash on cash argument when you use leverage to increase your return on say, a 10-20% down payment. My question for the people that have been in this game for a while though, at what point does it make sense to sell the property in regards to your return on new equity? The longer you hold the property, the lower your return on equity will be as the debt is paid down and the property (hopefully) appreciates.

Do you guys have a number or a metric you use to figure out when its' time to sell?
It really depends on what your cost of debt is, as well as multiple other factors.

In most cases, your IRR will level off and start to decline between 5 and 8 years after ACQ. Cash on cash is still likely going up, so you're not in a bad position, but there is likely better opportunities for your investment funds. There is also more risk.
Premium
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AG
What no one here has talked about is the option to cash out refi if you've significantly paid off the mortgage, the house has appreciated, or both. The main question is - is the area getting a good rental rate in comparison to the value of the house. Basically, if you were to take the money after the sale would you buy the same house or would you buy something else - if it's heavily weighted towards something else then sell. Of course factor in selling costs, time, effort, etc.

One house we cashed out $75K for another investment and kept the house. 3 years later we are selling because the value of the house isn't in line with what we can get for a rental. So we are taking our $120K after the sale and rolling that into something else.
Tonyperkis
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100% agree with the cash-out refinance option. As you stated, it just depends on the value of the house as a rental. The one choice that really doesn't make much sense is leaving too much equity in an asset resulting in a low return on equity.

One random note for doing cash-out re-financing cash on investment homes, is it can impact your ability to claim 1031 tax benefits if that is your future goal with the property. Don't want to get off rails here, but it's something to consider.
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