Taking the idea of trying to time the market out of the equation, how do you know when the best time is 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 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 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 the condo this year and leverage that into two or three properties in Denver, 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 wants to 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 okay when they are rented, but they are hard to manage without jumping on a plane, even with a property manager. Unfortunately, you just need to show up from time to time to get things done.
It’s his first argument that made me stop and think, although I do agree with the basic concept of not holding equity in real estate. I believe this for a few reasons. First, I agree with him that equity in property is producing a zero percent return, and if your goal is to grow financially, you are slowing it down by not leveraging. No one can have a good argument against that, but there are a lot of investors that want to own free and clear property. One advantage of a free and clear property is that you can have a higher cash flow, meaning fewer properties to reach the same monthly income goal. There is also something very comforting about owning property without debt. There won’t be a creditor or lender that can take it from you if things get financially challenging. From that prospective, it is very safe to own debt free real estate.
With that said, another reason I don’t like a lot of equity in houses is that you become a target to lawsuits. I am not an attorney, but I have friends and colleagues that are, and they agree with me on the risk here. Many personal injury attorneys get paid on what is called a contingent fee. This just means that their fee is contingent on them being able to win or settle a case and collect. A fee might be 40%-50% of the collected amount. Knowing this is true, how many attorneys would take a case where the defense appeared to be broke? You cannot collect from a dry well. On the flip side, if you got in a car accident, even if it was not your fault, and the other party wanted to sue, the opposing counsel would first look into 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 one house could be at risk if there was a slip and fall on the property. If the asset was leveraged, it would at least appear as if there was not much in the way of assets to pursue. Obviously, insurance is your first line of defense, but many lawsuits take place from 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. There are a few augments that come to mind on reasons I might not agree.
First, we don’t have enough information to make that call. 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 is it going to cost me to get it. The returns would need to be high enough in the new investment to cover what I was making and pay me for the cost to do the transfer. For me, I might want to have the return sufficiently high enough that I can recoup all my costs in 18 to 24 months, and everything after that is additional profit above what I was getting with 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 this investor on, is that he can potentially keep the condo but still cash in on the equity. I love to use lines of credit on my rentals, this way there is a lien on title, so it appears to be encumbered, even if I am not using the money. It is 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 keeping a bunch of cash in the bank. He might say that he can access more of the equity if he sells and can potentially buy more Denver real estate, which is true. With a line of credit, you would be limited to a percentage of the value, so you are limited on how much you can access.
It is important to point out that each 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 would be a good idea to have a trusted advisor look over your strategy to help you make the best financial decision for you. Please feel free to reach out to our office if you ever want to bounce an idea off us. Obviously, we would love to make a loan to you on your next project, but we are also opened to helping if you need a little hand holding.