We get a lot of owners who call us undecided whether they should sell or hold. My advice to them every time is simply this: If you have a very good reason for the use of the net proceeds from sale, then sell. But in every other case, HOLD!Owners see the market up and want to sell the real estate just like they might sell a stock. However, stock is much different than real estate so the same rules do not apply. Transaction costs associated with real estate are much higher first and foremost.
But the real reasons for holding on to real estate are several-fold. First, there is nothing more powerful than passive income. Sure, rentals cause headaches once in a while. But the amount of wealth they create is nothing compared to the amount of hassle of getting up and fighting traffic every morning to be around people you may not enjoy being around.
Second, there is nothing more powerful than compounding appreciation. Eight percent this year, on top of 10% last year, on top of 6% the year before and so on and so on. You get the idea. What is even better is OPM – Danny DeVito’s “Other People’s Money”! That 8 to 10% appreciation applies not only to the 25% you put down on the property, but also to the 75% the bank lent you!
Finally, and perhaps the biggest reason is that real estate is the biggest wealth building of all. Look at any Fortune Top 100 Wealthiest People list and it will be littered primarily with individuals with large real estate holdings. We are not talking income here. Wealth. This is long-term. So, while you are earning income to enjoy the lifestyle you have today, you are also building wealth for later in life when income may be more scarce.
When is Selling a Good Option?
Going back to the sale option, there are several reasons when selling is a good option. The best when you are to 1031 exchange it into another piece of real estate to upgrade your investment. Perhaps your property is in a bad location or has other deficiencies associated with it. Upgrading to a better property makes good, long-term sense. But you may also need it for other investments. A business less than two years old is not a good “investment” because a lot of businesses fail within the first two years and you stand to lose all of your gains. Lifestyle gains are a good reason if you are late in life or have accumulated a sizeable real estate portfolio.
The worst reason for selling is just because the market is near a top. Imagine if you had sold at the previous top in 2008. Those next three to four years would have been excruciatingly painful. And the next six to seven – a tremendous victory! A buy-and-hold strategy rewards patient, long-term investors because real estate only appreciates. When you die, the real estate gets ratcheted up to current market value for tax purposes. The difference between your purchase price and the adjusted value is all tax-free to your beneficiaries (in most cases), subject to inheritance limits. Consult an adviser for your particular situation.
So, if you bought that little shanty for $100,000 and it is worth $500,000, when you pass away, then $400,000 of it passes to your beneficiaries tax-free!
The problem with that one is that you are not around to relish in that wealth transfer. But there are ways to transfer your real estate to your beneficiaries while you are still alive. That is, for another discussion, another time. The bottom line is that real estate is a great wealth builder – for you, and for your family – if you don’t sell.
Peter Nelson is CEO of Full Service Property Management. Reprinted with permission of the Rental Housing Association of Washington.