In case you’ve been snoozing, many real estate markets are heating up. In fact, investors who were brave enough to buy a few years back actually have (are you ready?)….equity!
Yes, it’s true. Equity is happening again.
And whether you were an early adopter and have seen some appreciation, or you’re running a little late to the party, one of the questions you should be asking yourself is “Should I stay or should I go?”
What a great question! In fact, it was this very question (sent in to Ask The Guys™ by our faithful listener, Keith in Anchorage Alaska) that inspired this entire episode.
So behind the microphones in a secret location hidden somewhere deep within The Real Estate Guys™ think tank:
- Your super hot host, Robert Helms
- You not-so-cool co-host, Russell Gray
Keith’s questions was really about financial analysis. But in considering the question, we realized there are a whole host of things to think about when deciding to stand pat or move on.
First, the math.
Wait! Come back! Math is good. And math can be fun when it saves you THOUSANDS OF DOLLARS, don’t you agree?
Big shot investors monitor the frothiness of the market by the cap rate. In keeping with our no-investor-left-behind-policy, cap rate is simply the NOI (Net Operating Income – rent, less operating expenses BEFORE debt service) divided by the price or current market value of the property.
When cap rates FALL, it means investors are paying MORE for the SAME income. That means the income is MORE EXPENSIVE. Got it? And who wants to pay more for the same?
So, if you’re smart (and lucky), you buy when cap rates are HIGH (you paid LESS for the income, which is a good deal), then sell when cap rates are low.
There’s another way to do the math that we find a little simpler, but essentially tells the same story. It’s called GRM (Gross Rent Multiplier) or Rent Ratio. It doesn’t include expenses, so it isn’t precise enough for investment due diligence or loan qualifying, but it’s a great way to tell if a market is getting overbought (buyers bidding up the price…potentially to an unsustainable level or “a bubble”).
So, let’s say a property that generates $10,000 a year GROSS rents and sells for $100,000. This means it’s selling for 10 times gross. Make sense?
Now if that same property now sells for $120,000 but still only rents for $10,000 a year, it’s now selling at 12 times gross. Ergo (we always wanted to say that) buyers are paying 20% MORE for the SAME income. Great if you’re a seller (time to go?) but not so great if you’re the buyer.
If you’re watching a market and GRMs are generally rising- or if you already own property in that market – you need to dig deeper and find out why prices are going up when income isn’t. If there’s no rationale for it, it may mean there’s just too much money chasing too many deals (or worse. “dumb” money chasing deals), you may decide it’s time to sell (at a premium) and take your equity and head for a less heated market. Then hope the whole process repeats itself there!
Of course, all of this happens over the course of years, not hours like the stock market. So while you’re waiting, you’re collecting rents, taking generous tax deductions and enjoying your life.
And speaking of tax deductions…
Another reason why it may make sense to sell a property is because you’ve used up the tax benefits (primarily depreciation) available to you on that particular property. This has nothing to do with the market (it could be fine), and everything to do with you and your personal tax situation.
Remember, according to our good friend CPA Tom Wheelwright (author of Tax Free Wealth), a savvy real estate investor should be paying pretty near ZERO INCOME TAX (sorry to shout…we got excited).
Other reasons to consider selling are changes in the neighborhood, the physical condition of the property, the kinds of tenants you’re attracting, or local changes to landlord law.
The point is that you don’t want to develop LAME (Lazy Asset Manager Entropy…it’s a pseudo medical term that we just made up). Sometimes it’s easy to get lulled to sleep just sitting at home opening rent checks all day. We understand. But we don’t want you to be blindsided in slow motion if the market is telling you it’s time to move on.
So listen to the episode and consider your own markets and properties. Then ask yourself, “Should I stay or should I go?”
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