Are you selling a rental?

[elliot]

Like the post, Are you buying a rental, maybe it is the time to sell my rentals.
I have 2 rentals in an excellent area in Rotorua and have seen excellent capital gain in the last 18 months.
However, I think the top of the market is very close and any further capital gain is unlikely to be around for a long time.
My net yield (rates, insurance and small allocation to maintenance subtracted from rent) is now around 3.5% for both properties. There is no further value that can be added. So, I am getting long term bank deposit rates with now no compensation for extra risk.
So, would you sell?

[Bobsyouruncle]

You don't sound like a property investor so maybe sell. Your bank deposit rate is pretax and has no deductibility and is eroded by inflation. Your properties will at the bare minimum keep up with inflation so why you would even be comparing them in this way is not apples with apples. Your likelihood of a better outcome long term with property is about 10,000% better than having 5 or 600K in the bank instead.

[Perry]

So, would you sell?

No, I wouldn't.

[mrsym0r]

3.5%? In Rotorua?

[Anthonyacat]

This really depends on your goals. In most cases having cash in a term deposit isn't a good move for the long term, but a good share portfolio with a low-fee provider might give you a bunch more income than your current properties, and still keep up with inflation. Or you could sell the ones you have, and buy 'better' rentals elsewhere - the definition of better depends on your perspective, could be similar yield with less complications, in a less desirable area with a higher yield, or somewhere you can add some value.

[elliot]

Anthonyacat, yes I was thinking of that, I could get a better yield as you outlined. The properties are worth around $500000 each in a top area.

[andyp2010]

elliot, I'm thinking along the same lines, very similar situation. I'm looking at mixing Anthony's suggestion of index funds with p2p lending. I'd also like a 3rd arm to my investments but haven't found one that suits me yet.

Property values double, therefore better yields elsewhere, therefore put your money in a more productive place. It's too easy to get fixated on one asset class, do what's best at the time.

[Anthonyacat]

Got to remember that jumping in and out of markets is a surefire way to miss the gains and catch the losses!

I'm a big fan of P2P lending, my Harmoney portfolio has provided very healthy returns over the last three years. But it's been all good times, and we don't know how they'll perform when there's a significant downturn.

[elliot]

I also invest in shares and have a large portfolio in this area. Shares are more volatile but I see past that. So what I am saying is that where I live, which has low population growth, if future capital gains are now likely to be very low I can get a better yield and capital gain else where.

[Anthonyacat]

Certainly arguable, and if your predictions are correct it's a good move. Why would you stay in a low-yielding asset that has no capital growth, and comes with management problems (even when professionally managed) that use up some mental capacity. There's no reason to do so.

But will you kick yourself if you look back in 5 years and see the market has gone up another 90%? Your guess at the future is probably no better than mine or anyone else's.

[Wayne]

I also invest in shares and have a large portfolio in this area. Shares are more volatile but I see past that. So what I am saying is that where I live, which has low population growth, if future capital gains are now likely to be very low I can get a better yield and capital gain else where.

Depending on your stage in life you could release the capital and use it for property that does have more potential.
Or sell and buy shares - plenty of return to be had there.

[orion]

Like the post, Are you buying a rental, maybe it is the time to sell my rentals.
I have 2 rentals in an excellent area in Rotorua and have seen excellent capital gain in the last 18 months.
However, I think the top of the market is very close and any further capital gain is unlikely to be around for a long time.
My net yield (rates, insurance and small allocation to maintenance subtracted from rent) is now around 3.5% for both properties. There is no further value that can be added. So, I am getting long term bank deposit rates with now no compensation for extra risk.
So, would you sell?

No I wouldn't sell. Your reasons for selling are not logical, nor sensible.
Would you also sell if they went down in value like many investors do?
You've missed the whole point of investing if you're wanting to or even tempted to sell because the prices have gone up!
The yield is valid when you buy, not what you think it is now based on value.

Here is an excerpt from my book 20 Rental Properties In One Year which will hopefully make sense ...


Before getting into the purchase of this property, I want to talk a bit about yields and the way to look at these, long term. You may have heard before that it’s best to constantly review the yields on your properties and if they get too low, then you should sell these properties and buy higher yielding ones. Accountants often recommend this to property investors and a very well known Australian investor and author was also a big promoter of this, he used to be an accountant before becoming a full time investor.

To give you a couple of examples of what I mean, let’s say you purchased a property 10 years ago for $150,000 and at the time the property was rented for $280p.w. This would give you a yield of 9.71% p.a. ($280 x 52 weeks/$150,000). Now 10 years later the property is worth $280,000 and is rented for $320p.w.
The accountant and many investors would now say that your yield is less than it was when you purchased it; and if you work out it, is now only 5.94% p.a. This compares to a yield of 9.71% p.a. when you purchased it ($320 x 52 weeks/$280,000).
And let’s say another property was purchased 15 years ago for $240,000 and was at that time rented for $340p.w. giving a yield of 7.37% p.a. ($340 x 52 weeks / $240,000). Today the property has risen in value and is now worth $600,000 but the rent has only gone up to $420p.w. Many accountants would say your yield is now only 3.64% p.a. ($420 x 52 weeks/$600,000). They may say to you that your yield has halved compared to when you bought it; and is now only returning you the same interest as you would be getting if your money was in the bank, and is less than the interest rate you are paying on your mortgage. They may also suggest to you to sell these properties and buy some higher yielding ones which will make more sense. While I can see some logic to this, there is a problem with it. In order to find higher yielding properties to match what you had at the time of purchasing these two properties, you will most likely have to buy in a far less desirable location. You would be extremely unlikely to be able to purchase two properties in a similar location to these two properties that you purchased many years ago that would now give you 9.7% p.a. as in the first example and 7.37% p.a. in the second example. This is of course because not only did your properties go up in value, but so did everybody else’s! The only way now to get a better yield is to buy in a not so good area where you will get a higher yield, but also a less desirable neighbourhood.

In Hawkes Bay where I live, house prices now range from around $160,000 for a standard 3brm home up to around $350,000. The only difference is the location of these properties. The properties could be identical, but because of the location they’re in, one property is worth more than twice as much as the other one. That would be the same for almost any city in NZ with a population of 100,000 + people. You have great locations and very safe, secure neighbourhoods and some streets where you wouldn’t want to walk down alone after 10p.m.

So for me, the yield is only important when you buy the property, not in several years time when prices may have gone up a lot, and rents have only increased slightly. There are times when you buy a property to hold as a rental and either it’s under rented, or the property may need some renovation work to be carried out before being able to get market rent. In these cases you want to work out what the yield is going to be after the rent is brought back up to the current market rate, or the renovation work is completed, so you can now achieve a higher rent. The renovation work of course is added to your purchase price and then you work out the yield by determining what the new rent will be. As an example, let’s say you purchase a property for $140,000 that needs work and because of this, is rented at only $240p.w. The current yield is therefore 8.91%p.a. You now spend $15,000 on some much needed repairs and maintenance and are now able to rent the property out for $310p.w. Your total spend is therefore $155,000 and with the property now rented at $310p.w. the yield works out to be 10.4%p.a. ($310 x 52 weeks/$155,000). So work out the yield at the time you buy if the rent is already at market rate, or the all up costs after any maintenance and repair costs are completed, and what the new rent will be.

This now brings me to Property Number 18. In 2006, eight years before I bought this property, it was purchased for $195,000. From 2005 to 2014 rents changed very little in Hawkes Bay, so I imagine it would have rented at a similar amount in 2006. The rent was $285p.w. when I purchased the property in late 2014. If the rent was say $285p.w. in 2006 when the previous owner bought the property, the yield at that time would have been 7.6%p.a. which was an okay yield. At that time, I was looking for properties with yields of over 8%p.a. so it wasn’t too far off that. With the GFC (global financial crisis) affecting property prices in Hawkes Bay from 2007 for a number of years, prices in the region here dropped slowly over that time, in some cases dropping by 20 – 30% from their highs.

The vendor of this property had listed it for sale with an agent in February 2014 for $180,000 and it had sat on the market for nine months and still hadn’t sold. I bought the property in November 2014 for $144,000 which I think was good value for what it was. It was a very tidy 3brm home with garage on a section size of over 800m2, and I estimated the market value to have been around $160,000 - $165,000. I had got a very good deal buying it because the vendor now ‘just wanted it sold’. It sat on the market for a very long time, and maybe the vendor’s expectations were too high when it was first listed. Some of the sales people may have believed the price was unrealistic and their buyers may also have been put off by the high asking price. It’s hard to say, but often when a property is listed at too high a price to begin with, it ends up selling for a lot less than it would have, had it been priced correctly to begin with.

A lot of the properties that I purchased in 2012 – 2015 were bought from investors who now had little or no equity in their properties because of the market values dropping so much. As mentioned earlier, a lot of investors only buy a property because they think it will always go up in value. They generally use interest only loans as they think ‘why pay off the debt if the price is going to double in 10 years time?’ Many say ‘I will just buy 10 properties and in 10 years time they will have all doubled in value, so I’ll sell five of them then and pay off the debt on the other five properties. That will give me five good properties with no debt and a good income’. That is how a lot of investors still think today. There are a couple of problems with that; firstly prices don’t always do what you hope or think they will do, and secondly if they do double in value - they don’t sell half of them to pay off the debt on the others. What generally happens is they think they are smart and because they were right about prices doubling, they think it will happen again and again, continuously. So now they want to borrow more money and buy more properties with all the extra equity they have. They go out and buy another 5 – 10 properties and expect prices to double again. This may go on for some time and all the while they are highly leveraged because of all the extra debt they have created by buying so many more properties (anything over a 70% LVR I think is high when you have over $2 million borrowed). When the properties these people buy don’t behave in a way they think they should, they blame the location where they bought, or simply think property investing isn’t all it’s made out to be, or is too risky and decide to sell their properties. It’s not that property investing is necessarily risky, it’s that the investor themselves is the risk. They start investing with certain assumptions and when these assumptions don’t happen, they lay the blame on something other than themselves.

To show you how this works; with Property Number 18 here that I purchased, let’s assume the previous owner put in a 20% deposit of $39,000 on their $195,000 purchase price. The mortgage would therefore have been $156,000 in 2006 and most likely was an interest only loan. At the time interest rates for mortgages were around 8 – 9%p.a. An interest only loan of $156,000 at 8.0% p.a. is $240p.w. If you add on the rates and insurance of around $45p.w, it would have been fairly much break even if the rent was $285p.w. at the time.
Now eight years later, the debt is still $156,000 and the property is worth considerably less than what they paid for it. This may have been the reason why the property was first listed at such a high price compared to what it was now worth. As mentioned, the list price in early 2014 was $180,000 and from memory it had come down to an asking price of $159,000 when I looked at it. If the mortgage was still $156,000, they would lose all of their $39,000 deposit plus have to put in more money just to sell it when you take off the agent’s sales commission. At this point many investors will seriously just want to sell and wish the problem would go away. They may be thinking ‘I paid $195,000 for this property eight years ago and now it’s only worth $150,000 and I still owe $156,000 on the mortgage! What will it be worth in another eight years time, maybe even less again?’
It wouldn’t be a nice situation to be in, and if they had bought the property with less assumptions and more thought to begin with, it could have all worked out well for them. Today the property is worth around $190,000 again, very close to what they originally paid for it. But with me eventually buying the property for $144,000 nine months after it was originally listed; my yield was a very reasonable 10.29%p.a.

I wonder if the same accountants mentioned earlier that recommend investors to sell their investment properties when it appears their yields have gone down over time, would now have recommended this owner to have kept this property, as his yield was now a lot higher than when he purchased the property! Somehow I don’t think so, and you can hopefully now see the logic why I’m only interested in the yields of investment properties when buying them, not what they may appear to be years later.

[Nick G]

Good point Graeme.

There are two ways to look at returns. I might not have the names right but here are the concepts.

One is Return on Invested Capital. This keeps getting better because you invest your deposit and (probably) put in principal payments over the year but the rent and gains growth (usually) far outstrip that capital, due to leverage and all the other reasons property prices and rents go up.

The other is Return on Equity. This you measure year on year and its your net worth increase (including net CF) at the end of the year as a % of what it was at the start of the year. It's how fund managers are measured, i.e. XYZ showed a 14% return in 2015 and a 7% return in 2016. You don't see a report saying "those who bought in 2008 are 127% up, from 2009 you are 115% up" or "your dividend this year is 32% based on the share price at which you bought".

RoE is probably the more accurate way to assess your results year on year, especially when comparing asset classes.

BUT remember property is not the same as shares. You've got very high transactional costs that you would pay 2x if you decided later to buy back in. Every house is different, you might not be able to buy back in later because the banks might not be lending or there might not be anything you want to buy for sale. You also have the massive benefit of leverage.

What should you do? I tend to only sell a property if I was moving on from a mistake, consolidating in an area or I wanted to roll my equity into another opportunity. I sold a block of 4 flats in Edgecumbe (12 months before the flood, luckily) that I had held for years because I wanted to buy a property and convert it into flats. In that conversion I unlocked more equity that I rolled in and got the same yield % on a higher value property. If I value that property now, the GY is 6% on value, but 9%+ on what I paid.

[Wayne]

When it comes to investment I find it pays to think wider than property.
Some people think property is the only valid investment so, with this in mind, you probably wouldn't sell.
But that ignores other investment options, maybe with better returns short and long term.
It all comes down to what the goals are - and they change as time goes on.
Early on it might be about growth in equity, later it might be about cash flow.
Risk comes in here also.

I can't see how anyone can give a hard answer to the Ops question without knowing more about the circumstances surrounding it.

[Nick G]

^^ very true