BiggerPockets Real Estate Podcast - Should I Sell My 4% Interest Rate Rental Property? ($300K in Equity!)

Episode Date: December 11, 2024

Should you keep, refinance, or sell your rental property? If you’re sitting on a low mortgage rate and plenty of equity, you’ve probably asked yourself this once or twice within the past year. Most people who bought a rental property before 2020 have seen unprecedented appreciation and rock-bottom interest rates and are likely sitting on a war chest-sized home equity position. But that equity could be better spent investing in new properties than keeping your old ones. This is Dave’s exact predicament. He’s got a property he bought back in 2016 that has over $300,000 in home equity. It’s cash flowing a solid $500 per month with a mortgage rate of just under four percent, but only producing a measly two percent cash-on-cash return. He’s getting four times the return on his recent investment property purchases, so should he sell? Not so fast; we’re doing the math to figure out whether he should keep, refinance, sell, or change strategies on this property. Got the same good problem? Stick around as we even drop a fifth option most investors overlook entirely, which gives you the best of both worlds.  In This Episode We Cover: Whether to keep, refinance, or sell a low-performing rental property  The obvious problem with cash-out refinancing in 2024/2025  Why we DON’T love doing 1031 exchanges (and a tax-advantaged way around them)  Converting your long-term rental into a medium or short-term rental (MORE cash flow!) How to access home equity WITHOUT refinancing your property or getting a new loan  And So Much More! Links from the Show Join BiggerPockets for FREE Let Us Know What You Thought of the Show! Ask Your Question on the BiggerPockets Forums Grab Dave’s Latest Book, “Start with Strategy” Get a Quote on Your Next Short-Term Rental Loan with Host Financial Find Investor-Friendly Lenders Keep or Sell? What to Do When Your Rental Doesn’t Cash Flow Connect with Henry Connect with Dave (00:00) Intro (01:20) Property Details (04:51) 1. Keep the Property (07:12) 2. Refinance the Property (10:29) 3. Sell the Property (17:12) 4. Convert Into a Mid-Term Rental? (21:10) The Best Option? (22:24) 5. Use Home Equity Instead Check out more resources from this show on BiggerPockets.com and https://www.biggerpockets.com/blog/real-estate-1055 Interested in learning more about today’s sponsors or becoming a BiggerPockets partner yourself? Email [e-mail]. Learn more about your ad choices. Visit megaphone.fm/adchoices

How do you know when to sell a successful property or should you hold on to successful properties or refinance them? This is one of the most common questions that I get these days. And as I was thinking about how to talk about this on the podcast, it actually occurred to me that I have a property that I am about to go through this process of thinking through. And I've invited on Henry Washington to join me to actually just talk through this property and this problem, this challenge, this question that I'm facing in real time. And although we were going to talk about one of my portfolio properties, I think this conversation is going to be super helpful to everyone because it helps provide a framework

for thinking through the best way to use your money and to optimize your portfolio over the long run. So, Henry, welcome. And thanks for helping me out on this portfolio management question today. First and foremost, this is really cool because a lot of investors either have faced this problem or will face this problem in the future. And I believe people need to be analyzing their portfolios at least once a quarter. But selfishly, this is fun for me because I love spending other people's money. So let's talk about how I would spend yours. I'm nervous now, but let's do it.

All right. So first things first, Dave, tell us about this property. Well, it's my former primary residence. As you might know in 2019, about five years ago, my wife got transferred to Amsterdam for work. So we moved from Denver, decided to rent out our primary residence. We bought it back in 2016 for $460,000. It's in a great neighborhood. I've been very fortunate. It has appreciated, I think it's worth sort of conservatively like $750. I sold the property just down the street for $800, but that was in 2022. So it was a little bit hotter then. And right now I'm renting it out for $34.50. I'm getting probably on average $500 a month in cash. after really truly all the expenses, because I have a really good interest rate on it,

refinanced in 2020 to 3,875. And so it's a solid rental property, getting $6,000 a year in cash flow. But as I just mentioned, I'm sitting on a lot of equity, which is a good problem to have, but it sort of brings up the question if I'm using my money efficiently. Yeah, well, I mean, yeah, you're sitting about $300,000 worth of equity, right? And so one of the things that I typically ask people when I'm faced with questions like this or when they ask me questions like this is what are your real estate goals over the next one to three years? Because your goals should dictate what you do with your current portfolio or how you choose to grow. That's a great question.

So basically, I split up my investing into sort of three different buckets recently. So I do long-term rentals. I still buy long-term rentals mostly in the Midwest now. Then I invest sort of passively in larger value-add types of projects, either in syndications or passively into flips. And then I've started doing some private lending over the last couple of years. And so I like keeping it sort of a third, a third-to-third roughly. And so if I did sell or refinance this, I would want to fill up that bucket of long-term

rentals. So like more low risk kind of cash flowing properties, but I don't need them to cash flow today. I buy rental properties because I want to 10, 15 years from now to have them mostly paid off and to have a solid income that I could replace my full-time job from. Okay. So said differently, you would sell this or you would cash out of this and essentially take that money and buy more cash flowing assets. It's not like you take that money and use it to go lend more money. Yeah, yeah. I think that's sort of what I would think about doing here.

Okay, well, that's good information. I obviously am going to have more questions, but as I see it right now, you've probably got about four options. There's probably a couple of more, but typically they're going to fall in these four buckets, which would be one, you could keep the property, but try to increase the cash flow or monthly return that you're getting. You could look to refinance that property, which would give you access to some cash that you could use to go and buy more cash flowing assets.

Or you could sell the property, just straight sell it, cash out of it, and then use that money to go invest in more properties. And lastly, you could change the strategy. So maybe you could convert this property to a different rental strategy that might produce more cash flow for you. Yeah. So let's talk about a few of these options. Sound good? Yeah, let's do it, man. All right.

So starting at the first one, keeping the property, but trying to get a better return. How do you feel about that? So I think there's two parts of this. Like, can I get a better return? Probably a little bit. I think I could get rent up a bit higher because there's actually a two-car garage at the property that I don't rent out because I have, again, like, I never knew how long I was going to stay in Europe. So I kept a car there. So I actually have a car sitting there and just some stuff. So I could clear that out. and rent it out. And I think that could raise rents, 100 bucks, 150 bucks a month.

So that would help, but it wouldn't really fundamentally change the math here. I think the biggest question to me is like, should I hold on to it for future appreciation? Because Denver has been great for appreciation. And I guess maybe I'll just explain to you a little bit about the neighborhood. Denver, a couple years ago, built this light rail from downtown to the airport as this big project, super successful. And as part of that, they announced that they were going to basically convert this entire street into this really cool park. And so the only time I've ever been not so lazy and called around to find off market deals was because I was like, I got to get a house on that park. And so my agent found out where they did eminent domain.

He found out like exactly where the lines were. And I just called people on the line and got someone to sell me that house. That park is built now. It's awesome. It's obviously helped increase the value of the property. And there are some more plays that can happen there, but Denver's pretty flat these days. Like rent growth is flat, housing price is pretty flat, multifamily's overdeveloped there. And so I don't have feeling great that I'm going to get some huge appreciation boost in less,

not in the next year or two at least. Okay. So you're just assuming your average to national average increase in home value. Yeah. Okay. Okay. And in terms of rent, you don't think there's much more you can. do there, you're at the max unless you get a little creative and run out a garage space to an

existing tenant or something like that. Yeah, I don't see it going up that much more. Okay. The other question is, considering that you are considering tapping into some of these funds in order to buy more cash flowing properties, if you got rid of this property, which would, and in my opinion, refinancing it or selling it is technically getting rid of your cash flow, because you're going to refinance it at a higher price point, which means you're going to kill your cash flow. What's the cash on cash return you'd be looking to get in comparison to what you're getting on this property?

Yeah, so let me figure out what the cash on cash return is because you said it. So I owe $3.92. Let's just round out and say, after all, selling costs, I clear $700, right? So that's 308. So I'm only making, this is not good number. 600 grand divided by 308.

That's 2% cash on cash return. So I can do better than that. I can do better than that. You know, some of the Midwest rentals I'm getting after rehab, stabilize them, you know, 8%, something like that right now. But I think those properties have as good of a chance of appreciating. And actually, at least one of them I bought is much better, a chance of appreciation. So obviously, if you go to refinance this or you go to sell it, you can take that.

capital and you can go buy more properties, how many properties would you be looking to buy based on the amount of money you could access on a refinance? Yeah. So the way this math works, I'll just sort of do it out loud for people, is if I think this property's worth $750 and that's what it would appraised for, I'd, as an investor now, have to put 25% down. And so 25% down would be $187,000. And my equity was $392.

So I could pull out like roughly $200,000, let's call it. So I think, you know, given the four units I've bought in the Midwest this year, I could probably do that again, four more units, roughly. I would basically be repeating two similar deals. And at that rate, I would be increasing my cash flow on that 200 grand to, let's call it, 9,000 a year. But I would have to subtract the negative cash flow because raising my interest rate would probably, and pulling out the equity would probably make my cash flow on this. property in Denver go negative. Absolutely. Yeah, I don't see how it wouldn't go negative if you were to refinance. That's why I don't really love option two for you either. So keeping it as a rental, not bad, but not great. Refinancing, this is my least favorite option so far is refinancing.

The only thing I like about this deal right now is that interest rate. If you refinance it, I hate it. I don't hate it. There's nothing very attractive about it anymore. So so far, Henry and I have talked about option one, which is keeping the property. Option two is refinancing and do a cash out refy for the property. We are going to take a quick break, but after that, Henry is going to walk me through the third and fourth scenarios he talked about, which was selling the property or converting it into a different strategy. We'll be right back.

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Yeah. So I think that I would net 700 is just kind of like a, maybe a little bit, probably around 700. Because I think the values about. 750. I sold a very similar house down, like two blocks away for 805. But that was in April of 2022. So time that one well. And I think this would probably, I think it's a little bit softer in Denver right now. So I would think, you know, 750, 760, you know, commissions, spend 15, 20 grand cleaning it up. I'd say 700. And then my loan's at 392. So what does that come out to? Three, yeah, 308 was the number I was using before. And I probably do a 1031. So like I, I, or I think I would. I mean, maybe we need to talk about that. That's my assumption. If I'm going to put it into another rental property, I'd probably do a 1031. Yeah. So that was going to be the next question is obviously

there's going to be capital gains taxes, right? Because you haven't lived there two out of the last five years since you've been in Amsterdam. Correct. Zero of the last five years. Zero of the last five years. You've lived there. And for those of you who don't know, you as an investor, if you sell a property that has gone up in value, if you have lived there two out of the last five years, you actually do not have to pay capital gains taxes. But since Dave has not lived in this property, two out of the last five years, he would have to pay long-term capital gains, which is at what percent right now? I think it's 20 percent. So not terrible, right? But it's a chunk of change when you're talking about putting $300,000 in your pocket. So yeah, your options are sell it in 1031 or sell it in

not do a 1031. Here's my unpopular opinion about 1031 exchanges is I don't love them. They're so stressful. They're so stressful. In theory, they're amazing. But in practical application, oftentimes, they're not executed well because what happens is you get yourself into a time crunch. Do you want to talk about the time windows that you have in a 1031 exchange real quick? I think that the rules, and I will look this up as I'm talking, is that you need to identify the properties that your replacement properties within 45 days, which is tight. And then you have to close on them within 180 days. So closing is actually not hard at all. Correct.

It's that you have 45 days to find, negotiate, and put under, you don't actually have to put them under contract, but in practice, you kind of do have to put them under contract to make it worthwhile. that could be stressful, especially in a really hot market. Now it's a little bit cooler, but it's still as stressful. And the other hang up with that strategy is not only do you have to stick to this time window, but you have to be buying something of like value or higher. So that property has to be a more expensive property or a more valuable property than the one that you are selling. Now you can package properties so you can buy a couple of them. in the Midwest. But what I find often is because of the time crunch and because people are so

scared about the tax hit that they're going to take is they go and they buy something that's not necessarily the greatest of numbers because they'd rather avoid paying the capital gains taxes than to wait around and find a deal that financially makes the most sense. Yeah. And so I would just say that if you choose the 1031 strategy, you're going to have to truly, find something that works or else, you know, or else you could end up still paying that money. You're just now not paying it in taxes. You're just paying it in less cash flow because you bought a deal that doesn't make as much financial sense. Yeah, that totally makes sense. Also add one other rule is that you have to take on as least as much debt too. So you can't with a 1031 just like,

I can't just buy a property for cash. Like that was something I would think about with a 1031. if I could just buy something for 300 grand cash, that would be great. And then I would refinance it later. That would work, but that's not allowed under a 1031. And the story I was going to tell is from 2018, like, things were just going so crazy in Denver. I did a 1031. And I was like, you know what? Even if I have to do an okay deal, like the market is giving, had such strong tailwinds.

And I was so confident in them. I was like, it's fine. Like even if it's not the best cash flow market, I was buying in a great neighborhood. but that worked out great. I don't feel that confidence anymore. So still, given that tight time window, I still think this is the best of the options we've talked about so far for you. Same. Another option to think about in terms of taxes. Now, I am going to give the caveat that we are not tax professionals who do, please consult a tax professional before you make any decision like this. But there's also the option of just selling it, not doing a 1031, but then buying rental properties that

are currently in service, meaning they're not properties that you have to do a big renovation on. They're actually ready for tenants and you can put them in service quickly. And by doing that, then you can do a cost segregation study on that property and that cost segregation study can help you offset some of the capital gains taxes that you will have to pay when you sell. Yeah, that's true. I would need to think a little bit more about the 1031 versus not strategy. But I agree so far selling is the best option.

of the three. And I don't know, let me just ask you. Like, so many people say that they buy properties and never sell. You don't believe that, right? I, you know what? No, I don't believe that. And it's, it's like, I would love to. I would love to be that old guy in like 20 years. It's like, I never sold anything I bought. And it's a, you should never sell it. Like, it sounds, all that sounds amazing until you need money. And then you have to sell something. Like, it's a business that needs funds and holding properties, as we are discussing here, it's not big bucks we're talking about being a landlord. We're talking this, this $750,000 property is making you $500 a month, right? Like, you need to be able to turn real estate to make money. Yeah, absolutely. I bought this deal,

not for cash. I bought it to live in it and I thought it was appreciate it. It appreciated. It's done its job very well. Thank you. Need to use that money for a new job. All right. We've covered three options so far, which is keeping the process. Refinancing the property and selling the property. And the fourth option we have here is converting the property to a different strategy like a short-term rental or a mid-term rental. This can seem daunting. But from a portfolio perspective, what I like about an option like this is it forces you to look internally within your current portfolio to see if you can find returns similar to what you might get if you were to sell. but you could get them in your same portfolio.

So what do I mean by that? I have a duplex right now that is a long-term rental, and it does fine as a long-term rental. But we have recently had three short-term rentals that we converted to mid-term rentals, and they are kicking butt. Nice. And so instead of us going and buying another duplex and using it as a long-term rental, we looked internally within our own portfolio and said, what do we have that we could convert to a different strategy and increase the cash flow. So we're taking that duplex. We're going to furnish the units and then we're going to put them up as midterm rentals and take the rent from

$1,200 a month up to around $3,500 to $4,000 a month based on what we're doing in our other units. And so it's going to cost us some money, probably around $10,000 to furnish the property. but that $10,000 is going to net me a much better return in terms of monthly rent than if I were to go take that $10,000 and try to buy another property with it. And so I'm not saying it's the best strategy, but I'm saying it's worth a look into your portfolio to see if I just spend a little money on this property, can I increase the return from 2 to 3% up to 8, 10, 11, 12%. percent cash on cash return without having to get rid of the property or tap into the equity.

Right. Yeah. Yeah. That's a great question. So I actually, I looked into this a little bit. In Denver, there is a ban on short-term rentals unless it's your primary residence. And although this is technically mine, I do plan to buy a new house as a primary resident soon. And so that is not like the spirit of the law. And I'm not going to mess around with that. So I can't do that. Midderm rental is kind of a new house. interesting. And I do think I could probably get rents from 3450 to let's call it 3,800, because it's in a really good location. It's really nice because it's right near the train. And it's also walking distance to a lot of offices and stuff. So if people are there for corporate work or you just, you know,

wanted to come work out of Denver, it could be appealing. The problem is just logistical and my, it's not laziness. Sometimes I joke that I'm lazy. It's just operational. Like my, property manager doesn't do midterm rental management. And so I don't know if I want to another one. I already have a short-term rental manager in Colorado. I have a long-term rental manager in Colorado. I don't want a mid-term rental manager in Colorado. It's just like a lot of work. I guess I would consider it, but that is sort of the one reason I would second guess it. Yeah. Well, I don't know if that reason is financial reason enough for you not to consider this option. But I would say that if you're only going to go from 34 up to $3,800, then it's definitely not worth it, right? I think if you're going to go from a

long term to a short or midterm strategy, you need to be two to three Xing what you're making per month for it to make sense because your property management for a midterm is going to cost you a lot more than 8%. Yeah, and you're going to have vacancies. Like, you know, it's just, yeah, it's going to get like if you spread out 3,800 over 12 months, I might lose money. So I don't know. It's also like I've thought about can I put a dadu in ADU, but it's a pretty small lot. That's a lot of work. Yeah. So out of all of these, I'm kind of like in selling the property, to be honest.

Yeah. I mean, after reviewing that, again, I think the only getting about a $400 a month boost by carrying it to a midterm definitely isn't enough. So I would say that takes this option off the table for you. Now, for somebody else in a different market, that may be a very wise thing to do. But in your market, you're not going to get that return. And so I don't like that option for you either. So that leaves us with the option to sell it.

But what if there was a fifth option? A super secret ninja fifth option. Oh, an Easter egg. An Easter egg option. Are you going to buy it for me? I am absolutely not going to buy Dave's property. But after the break, I am going to give him some more advice on what he could do as a super secret option number five. We'll be right back.

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I'm on the edge of my seat. You made me wait through the whole ad break. One of the things people don't think about when they think about tapping into their equity of a property, a lot of the times is they think refinance, but that's not your only option. You can also tap into the equity of a property by getting a line of credit against the equity. And what I like about this strategy, the old HELOC strategy, is it does not require you to get a new loan at a higher amount. You keep your current mortgage payment, but you can access the equity. And so the bank would essentially take a look at the property, doing appraisal. And then if they say, hey, the property's worth 700 and you owe 400, you've got $300,000. So equity will loan you between 70 and 75% of that equity on a line of credit.

And so you could then access that line of credit, but you don't have to use it all. You could literally only use what you need. Now, you will be paying interest only payments on the money that you use. But if you factor that into your underwriting of the property that you're buying, you can technically have that property work to pay back your line of credit through the return that you're getting over the first couple of years, and then once that line of credits paid off, then your cash flow increases substantially. I kind of like that idea. What are Helock rates right now, just so we can talk about this? I bet they're about a point above prime. So eight,

eight and change right now probably. We're recording this towards the end of November. Honestly, for a rental property, no, that's not that bad. Especially, like, what I'm thinking about this is like, if you remember, the original scenario here was, I could probably get the rent up a little bit if I cleaned out that garage and did something with it. So if I got a little bit more rent and then did a helock, then I'm getting, you know, I'm going up to seven grand a month. And then if I can earn money above and beyond what I'm paying an interest on that

helock, then this becomes interesting and give myself potentially some upside here in Denver. So there's basically this just like a lot. long shot appreciation play that I'm kind of holding on to. Yes, that's what you'd be betting on. So right across the park, there's this old, like, industrial site, which, like, every developer now is just, like, salivates at these old industrial sites. And it's incredible. It's this amazing, beautiful old property.

But the financing always falls through. And I kind of just, like, I know if it gets built, it would be one of these, like, mixed use developments with retail and restaurants. and it would be super cool, but I'm losing my patience on it. But this might be a good hedge where if I'm earning seven grand a year in cash flow and I could wait and see if in like the next cycle this is realistically going to happen, maybe I'd take that bet. But I don't know.

Maybe I think I'll have to do the math on selling versus a helock. Those feel like the two right options here. So here's my personal opinion based on this is based on what I know about you and your goals in your portfolio. In other words, this may not be what anybody else in this situation should do or what I would recommend, right? I don't think that you, Dave, are in a position where you need $300,000 in your bank account, right? I feel like it would be nice, but you're probably surviving just fine, right? So I feel like you taking a very educated gamble, quote, air quotes on appreciation.

while still being able to meet your goals of buying more cash flow seems like a good option for you versus just selling it. Now, if somebody was in a position where the cash is much more needed for them, then selling it's probably the best option in that situation. But it sounds like you can reach your goals, keep your property, keep your cash flow, and hopefully get even more appreciation in the next one. to five years. Yeah.

So if it were me, that's the option I pick. I do like that. It's because I think it would change if all of a sudden in the Midwest or some opportunity came up where it was like a screaming deal and I wanted 300 grand. But like they're better cash flow deals. But like I said earlier, I think depending on the deal in the Midwest, they have an equal opportunity to appreciate in the next couple of years. So maybe you hedge a little bit and spread it between the two.

and although Denver's been flat, I do think Denver is like one of these markets like Austin and Boise where it's like it got oversupplied, it got too hot, it's still a popular city, it's a great place. You know, like I still think that it's going to grow in the long term. It's a very, there's a lot of job growth there. And so I do think it will pick back up, but it might take a couple years. Well, thanks again, man. I really appreciate it. This is really great information.

And hopefully for all of you who own properties, you can see some of the things. thought process and the math that goes into this equation. Because a lot of people ask me this question. I don't know if you get this too, Henry, but they haven't like done any of the math or really considered what they would do with the money if they sold. And that's really the whole game, right? At least to me, it's just opportunity costs. Like, yes, it is costing, I am making money on this property. But it could be costing me something because it's not the most efficient use of my money. But I only know that because I've run deals in other markets to see what else have. I could be doing with that money. Yep. And I think the cornerstone of being able to answer this question

appropriately for yourself is having a good understanding of what your short-term and long-term goals are. I think a lot of time people make decisions and they don't necessarily have their goals mapped out or flushed out. And that could cause you to make a decision that you end up, you know, regretting later on when you do finally flush out your goals. And so said differently, I don't know that you have a terrible option here with this property, which is a good position to be in. But you've got to have your goals mapped out and know where you're going so that you can make very educated decisions with your portfolio that are going to help you get to your goals faster. I mean, you've essentially got this property, which is giving you a big stepping stone into getting to your goals faster. But you've got to leverage it the right way.

Totally. Yeah. And it just goes to show, like, although people say, hey, you shouldn't buy primary residence back. investment. It can be a good investment. It can be pretty awesome, actually. It actually could work really well. I don't know if you've done this. I know James, our friend, James Dananer, has done this too. Like, if you, if you buy your primary residence, it can be a great stepping stone, especially given the tax benefits Henry was talking about before too. About my property in 2020 right before the market popped off. I have a 2.3% interest rate. No. Are you serious? Yeah. And about $300,000 of equity myself. So I love. of this.

Never get rid of that 2.3. Right. That's like an heirloom. You should pass down through the family. That's the new family heirloom. Yeah. No watch. No jewelry.

Anything. Just pass down your 2020 interest rates to your daughters. All right. Well, thanks again, man. And thank you all so much for listening. We'll see again soon for another episode of the Bigger Pockets podcast. Thank you all for listening to the Bigger Pockets Real Estate podcast. Make sure you get all our new episodes by subscribing on YouTube, Apple, Spotify, or any other podcast platform.

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