If you’ve spent any time on real estate forums or on social media, you’ve likely heard people tout the idea that you should never sell your rental property.
While holding an asset over a long-term time horizon can produce more consistent results for an investor, every real estate investor uses a different strategy to make money from a rental property. Some investors focus on cash flow, while others focus on return on investment over the long term.
As the real estate market moves through its normal cycle, there may be phases when the time is right to sell, and other periods where hanging onto a property makes more sense.
In this article, we’ll look at six reasons why an investor may choose to sell a rental property, and explain why “never selling a rental property” isn’t necessarily the right decision for everyone.
- Real estate markets historically move through normal cycles, with housing prices rising and falling over time.
- Reasons for selling a rental property include rising property values, diversifying into a different asset class or real estate market, and avoiding making major repairs.
- Selling a rental property at a profit can result in a taxable capital gain, although investors can conduct a 1031 exchange to defer paying capital gains tax.
Is “Never Selling” Always the Right Decision?
Sometimes it seems like there is an overwhelming consensus in the real estate investing business that a rental property should never, ever be sold, no matter what.
At first glance, that argument may seem to make a lot of sense. After all, single-family rental (SFR) investments have been enjoying unprecedented success.
According to the most recent Q2 2021 Single-Family Rental Investment Trends Report from Arbor Realty Trust, Inc., record demand has been sending rents and values soaring. Occupancy levels on SFRs rose to 95.3%, vacant-to-occupied rent growth surged by 12.7% (setting an all-time high), and cap rates dipped to 5.8% as property values continued to rise.
Investing in rental property offers the potential for rental income and capital gains over the long-term, equity from one rental property can be used as a down payment for another, and income from tenant rents is often enough to pay operating expenses and the mortgage, ideally with money left over at the end of each month.
However, there are times when never selling a property can be a flawed argument. Because every real estate investor and rental property is different, there may be times when an investor may decide to sell a rental property for a profit (or even a loss).
6 Reasons for Selling a Rental Property
There are several reasons why an investor decides that the time is right to sell. Sometimes a rental property can be sold for a profit, but there are also times when a rental is sold for a loss.
Here are some of the key indicators when the time might be right to sell an investment property:
1. Rental Property Value is Changing
Over the last several years, it seems like housing prices are only moving in one direction. According to Zillow, home values in the U.S. grew by 16.7% last year and are forecast to increase by another 12.1% over the next year (as of July 2021).
However, home prices can also decline, depending on the real estate market cycle.
As the Federal Reserve reports, during the Great Recession of 2007-2009, the median sales price of houses sold in the United States declined by about 20%. Ten years after the Great Recession began, as many as 10 million mortgage borrowers may have lost their homes, according to a report from the St. Louis Fed.
While housing prices have long since rebounded, not every real estate investor has the time, money, or patience to hold an investment property through the historical 18 year real estate cycle. Rather than waiting for the next peak, some investors decide to sell instead, even if it means selling at a loss.
2. Invest in a Different Property Type
Another good reason for selling a rental property is to invest in a different asset class or property type. Common types of residential rental properties include single-family homes, townhomes, condominiums, apartments, cooperatives, and small multifamily buildings.
An investor may begin with a small condominium, then sell the condo and purchase a three unit multifamily building, and then sell the multifamily property to buy a few single-family rental homes. While it would be nice to never sell, sometimes an investor needs cash to move on to the next rental property.
Sometimes selling a rental property can result in a taxable capital gain. Based on an investor’s income tax bracket, capital gains tax is either 0%, 15%, or 20% of the profit earned. However, the IRS gives real estate investors a way to defer paying capital gains tax, along with tax on depreciation recapture.
By conducting a 1031 tax deferred exchange, a real estate investor can defer paying capital gains tax by acquiring a replacement income property within 180 days of selling the relinquished property. In fact, some commercial real estate investors are selling assets like office buildings and shopping centers, and investing in portfolios of single-family rental homes instead.
3. Accidental Landlords
Sometimes people become real estate investors by accident. Accidental landlords are people who inherit a rental property and homeowners who need to relocate and decide not to sell.
Often, people who get into real estate investing by accident realize the rental property business simply isn’t for them and decide to sell to another investor instead.
4. Maintenance is Increasing
Real property requires routine maintenance. Fixing leaky plumbing, faulty electric wiring, and major items such as the roof and HVAC (heating, ventilation, and air conditioning) can be costly and affect an investor’s bottom line. Sometimes real estate investors reach the point where they would prefer to cash out their investment than to spend time and money making needed repairs.
While rental property that needs a lot of work may not sell for top dollar, there may be other real estate investors looking for good deals and willing to put cash into buying and renovating the right property. In fact, Roofstock Marketplace has a special category for cash-only transactions for landlords who want to sell quickly without having to make costly repairs.
5. Tenants Aren’t Paying the Rent
Even with a thorough tenant screening system in place, it’s possible every now and then for a landlord to end up with a tenant who can’t or won’t pay the monthly rent in full and on time. After a while, some investors get tired of having to chase down a non-paying tenant every month for the rent.
Although evicting a bad tenant is one option, the cost of evicting a tenant can be as high as $5,000 or more. Of course, a landlord can always try to offer a tenant cash for keys in order to get them to leave. But throwing good money after bad can quickly eat away at any profits that a rental property generates.
Sometimes rental property owners who have tenants that aren’t paying the rent decide the prudent thing to do is to sell the home. One option for selling is to wait until the existing lease comes to an end. Or, an owner with a home occupied by a slow-paying tenant might sell to another real estate investor who has experience dealing with bad tenants.
6. Invest in a Different Real Estate Market
Today, the best potential opportunities for investing in rental property are often found in smaller secondary and tertiary markets such as Columbus, OH or Waco, Texas. The cost of living is reasonable, property prices are still relatively affordable, property taxes are low, and states like Nevada and Texas have no state income tax.
Investors who own rental property in expensive urban areas like Los Angeles, New York, and San Francisco sometimes discover that there’s enough available equity to use as a down payment for an affordable rental property in a smaller city.
According to Zillow, the typical value of a home in Columbus is $211,646 while the typical value of a home in Waco is $178,532. Over the past year, home values in Las Vegas and Waco have increased by 21.4% and 18.8%, respectively (as of July 2021).
Final Thoughts on This Topics
Every real estate investor and rental property is different. So, saying that a rental property should never be sold doesn’t always make sense. People have different goals, and the right choice for one investor may be absolutely wrong for another.
Sometimes investors have to sell due to a death or divorce, while other times real estate investors strategically sell one rental property and buy another, while conducting a 1031 exchange to defer paying tax on capital gains.