“Most people are too fretful, they worry too much. Success means being very patient, but aggressive when it’s time.” — Charlie Munger
How do you know if it’s time to sell or refinance your property?
You’ve got some equity, so it’s only natural to think about refinancing or selling.
Or should you keep the property and pay everything off?
I know people who take their rental houses or properties and want to sell them right away.
I think this is a terrible idea.
I know everybody loves equity.
People can understand equity.
When you pay something off, you’re not using capital as efficiently as you could.
The term is return on invested capital.
If you have more equity in a property, your return on invested capital goes down versus if you pull some of that money out and use it elsewhere.
Today, we’ll get into the times when you should consider a refinance and when you should sell.
We’re gonna go over everything in three easy steps!
1. Examine Your Equity
Let’s start with an example:
You have an appreciated property.
That means 20% down on your property.
As my friend Russell Gray says: Equity happens.
Equity can rise due to various things such as inflation or the printing of more money.
Let’s say you have a 20% increase in the value of your asset.
That actually doubles the equity there.
Isn’t that incredible?!
If you have a $400,000 house, you need to put 20% down.
Imagine having a 20% value increase in the property now valued at $480,000.
You now have $160,000 equity versus the $80,000 that you started with.
You’ve actually doubled the equity.
If you wanted to switch to apartments, you could swap the numbers for a $40 million deal.
So that would be $8 million down.
You have now a $48 million value and $16 million in equity.
That’s pretty nice, right?
When we see an appreciation, a lot of these deals are worth substantially more.
It is very attractive because we use leverage.
So what are the options?
What can you do with your apartment or house?
What does that look like?
Let’s get into it!
2. Consider Your Options
You have options on what you do with your house.
When you go out to eat, you choose between filet mignon or sea bass.
Most of the time I choose sea bass, but filet mignon is also great sometimes.
In terms of property, there’s three main options.
You can refinance the equity out of it, you can sell it, or you can keep it.
There are variations of each, but if you’re refinancing…
What does that look like?
Remember the earlier house example?
The house is $400,000 appreciated at 20%, now it’s $480,000.
You’ve now got $160,000 in equity.
You can take out about $80,000 in equity.
I still want to keep about 20% in the property to meet the property equity requirements.
One option is to take that money out and reinvest it.
Maybe you can go find another house and put some other money into it.
You can get a similar size house to get more cash flow.
All while continuing to buy more stuff!
I’m a big multifamily guy for a lot of reasons.
Typically, I find the cash flow higher and it’s more scalable versus individual houses.
You may not want to refinance because sometimes there are stipulations that don’t allow you.
We had a property we bought last year in Jacksonville, Florida for $27 million.
9-10 months later, it was worth $37.5 million.
We ended up selling it.
If we would have refinanced, there would have been big penalties because of the terms of the loan.
Some commercial loans don’t allow you to go in and refinance when you want.
So we ended up just selling that one.
We actually used a 1031 into a larger deal, which I will get into later!
If you choose to refinance, what happens if rates go up?
That’s a real issue.
If rates go up, refinancing may not make as much sense.
My friend George Gammon says when you can get a 30 year loan on a house, the asset is not necessarily the house.
It’s actually the loan.
If you have a 3% loan and inflation is 7% or 10%, you have a super low interest rate on this debt…
It may just make sense to hold it rather than to sell.
So that’s definitely an option!
You should always ask yourself:
Does it make sense to refinance?
Does it work?
Does it not work?
A HELOC is a home equity line of credit, which allows you to pull money out of your house without refinancing.
You can keep the loan there.
Obviously you are subject to the loan terms, but you can pull money out and then it’s kind of like a bank.
You only pay for money as you need it.
If you pull the money out, then you start accruing interest.
You return it, you basically are not accruing interest anymore.
There’s a lot of creative things you can do with refinancing.
Whether with houses or apartments, it’s important to look at second option:
You can just sell.
You can sell the property and go buy a boat, right?
No, don’t sell it and buy a boat!
There are ways you can actually pay for luxuries.
You can pay with cash flow.
There was a great story about a friend of mine, Ken McElroy.
He wanted to get a new Ferrari.
So he found this piece of land that had a billboard which he paid about $250,000 to buy.
He subdivided and renovated the billboard.
After all that, he got $3,000 worth of cash flow from the billboard by selling off these other two properties.
Selling those ended up paying for his purchase of the entire property.
Now he’s got something that has gotten all his money back after a year.
He’s still getting $3,000/month that helps pay for his luxury Ferrari.
That’s pretty cool!
We should all be more like Ken. Also, because Ken’s a pretty amazing guy for many other reasons.
Avoid buying the boat until you get cash flow to cover the cost.
If you sell your property, you have the option of also getting a bigger place.
You do have the option of selling that property…
The issue is taxes.
They could be 20% or higher depending on what your taxes are for the long-term gains.
There may be some ways around paying taxes on your property when you sell.
Especially if the property is small, so one to four units or a single family house.
If you live there two out of five years, then you’re able to potentially defer some taxes.
You would need to consult with a tax professional, but it’s a real option.
Another option is a 1031 exchange.
This can be done with single families, larger properties, and commercial properties.
A 1031 exchange allows you to roll the property into a larger property while being tax exempt.
I know somebody who has been doing this for years.
They started with a duplex and now they’re doing multimillion dollar projects.
It’s really impressive!
They’ve been able to defer taxes continually down the road.
There is a risk with a 1031 or with a sell:
You can’t find another deal.
Not finding a deal is definitely a concern that you should be aware of.
The last option is that you can keep the property.
It might be easier to not deal with all of this and just keep it.
So those were three options of what to do with your property.
What is the best decision for you?
How would you evaluate when you should sell, refinance, or keep a property?
Let’s get into that next!
3. Sell, Refinance, or Keep?
Should you sell, refinance, or keep the property?
Those are your three options.
We’ll break each down and what you should do.
The first thing it really comes down to is return on invested capital (ROIC).
It’s important not only how much real estate you have, but how the equity is working for you.
Is it just sitting there and not doing anything?
That’s one of the problems with owning a house or a property outright:
The return becomes much lower versus if you had those in other properties working well for you.
Returns change as your equity grows.
Your equity goes up, the rents go up a little bit, but not as fast as the equity.
Let’s go back to the $400,000 house example that is now worth $480,000.
You had $80,000 equity before, now you have $160,000.
That’s a 100% increase in the equity!
But the rents have only gone up 10%.
We’re gonna make up a number and say the rents were $1,000 and now they’re $1,100.
So they’ve come up a little bit, but not that much.
What does $1,000/month look like?
Typically around 50% of the rents will be used for expenses in the property.
If that’s the case, you’ll have $6,000 at the end of the year (after expenses)
You started with $80,000 inequity, which basically gives you a 7.5% return on your equity per year.
You might be thinking that, okay, you can deal with that 7.5%.
What happens if your equity has risen?
Now you have $1,100/month in rent.
You’ll then have $6,600 at the end of the year after expenses.
But this is the big difference:
You have $160,000 in equity now.
That’s a lot more!
Your returns substantially go down on the equity you have.
Now you’re only making 4.1% per year.
Not as good, right?
Again, as this number grows, your equity grows in a property.
Your return on that equity goes down.
This is almost half of what it was before.
That’s why it’s really important to consider the return on your invested capital.
In this particular scenario, I would likely choose to refinance, pull money out, or go find another way to deploy that capital.
Some people have found that it’s difficult to scale.
When I was doing single family years ago I had four houses and it was very difficult to manage, even though I wasn’t the one actually managing them.
It was hard because the equity was out there.
I have found doing multifamily investing was actually less work.
My returns were better and higher.
The return invested capital was better.
Somebody could take this $80,000 and invest it in one of those deals.
There’s a lot of great operators out there that do multifamily.
It allowed us to scale and do bigger things without taking up more time.
The more houses you have, the more work, even if you’re not managing them.
That’s always something to consider.
Now I want to hear from you!
What are you going to do with your property?
Will you refinance?
Will you do HELOC?
Are you gonna sell or 1031?
Let us know in the comments and let’s have a conversation!
Before you leave, make sure to check out our special report about investing. It compares the stock market to real estate, and it also includes how the pandemic affects your investment future.
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.