Taking the idea of trying to time the market out of the equation, how do you know the best time to sell a house with equity? I get this question from even the savviest investors all the time. I was just reading some articles from an experienced investor who I know well and have a high level of respect for. He mentioned something that got me thinking — I don’t know for sure if I agree or disagree, but it is 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 it this year and leverage that into two or three properties in the city where he lives. His arguments are:
• The $200,000 in equity is not growing. In fact, he is losing money on that equity because of inflation. Investing that equity into more properties will help him reach his financial goals much faster.
• He does not want the hassle of owning out-of-state properties. He’d rather invest where he lives.
There is no argument from me on his second motive to sell. I own properties in several states and can tell you that my best, least stressful investments are all within 45 minutes of my office. My out-of-state properties perform fine when they are rented, but they can be hard to manage, even with a property manager. Regardless of the help you have, as the owner you just need to show up from time to time to get things done.
It was his first argument that made me stop and think. I do agree with the basic concept of not holding equity in real estate. I believe this for a few reasons: First, I agree that equity in property is producing zero returnb and if your goal is to grow financially, you are slowing that process down by not leveraging. That is pretty straightforward, but there are a lot of investors who want to own property free and clear. One advantage of a free-and-clear property is that you can have a higher cash flow, meaning you need fewer properties to reach the same income goal. There is also something very comforting about owning property without debt.
With that said, another reason I don’t like a lot of equity in houses is that you risk becoming a target to lawsuits. I am not an attorney, but I have friends and colleagues who are who’ve expressed agreement with me on the risk here. Some attorneys get paid on what is called a contingency fee, which means that their fee is contingent on them being able to win or settle a case and collect. Knowing this, how many attorneys would take a case where the defense appeared to be broke? You cannot collect from a dry well. To analyze their ability to collect, attorneys must look into your assets. There is no asset more transparent than real estate. Anyone can look and see what you own and how much debt you have. Even an LLC that owns one house could be at risk if there were to be an accident on the property. If an asset is leveraged, it at least appears as if there is not much in the way of assets to pursue. Obviously, insurance is your first line of defense, but many complications arise out of mistakes that are not covered by insurance. Free-and-clear properties could create a target on your back.
So you can see why I would agree with this investor’s position of selling his property to buy others with more leverage. But there are a few augments against it, too, that come to mind.
First, much more information is needed to determine if money is being lost and if selling would accelerate income growth. If I owned a property and I was considering selling, the first thing I would think about is what I would do with the money and how much it would cost me to get it. The returns would need to be high enough in the new investment to cover what I was earning previously and cover the cost of the transfer (real estate agent fees, for example). Personally, I might want to have the return high enough that I can recoup all my costs in 18-24 months. Everything after that would be profit above what I was receiving from the old investment. I hear investors occasionally mention that they want to sell a property and cash in on their investment. Great! But what are you going to do with the money? If you don’t have a plan in place to reinvest proceeds, you will end up with a much lower return than just leaving the money where it is.
The other argument I would challenge with is that this investor could potentially keep the property in question but still cash in on the equity. I love to use lines of credit on my rentals: This way there is a lien on the title, so it appears to be encumbered, even if I am not using the money. It also costs less, because I only pay interest if and when I use the funds. Setting this up in advance allows an investor to make quick decisions and take advantage of opportunities without keeping a bunch of cash in the bank. One downside is that with a line of credit, you would be limited to a percentage of the value, so there is only so much equity you can access.
It is important to point out that each and every situation is going to be different and based on the individual investor’s goals and needs. There are also many variables that go into this type of decision, and it can be tricky to navigate. It’s always a good idea to have a trusted advisor look over your strategy to help you make the best financial decision for you.