Sell_Or_Keep_Renting_Out
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about whether
00:00:04.160 | we should rent out or sell an investment property when inflation is high. So we all know inflation
00:00:10.160 | is high right now, 8.5% was the latest print, maybe it'll go up but hopefully it's going to
00:00:15.680 | start fading into the second half of 2022 and 2023. However, whenever there's turnover with a
00:00:22.800 | rental property, you're always going to be faced with this dilemma of whether to sell
00:00:27.040 | or just keep on renting it out. And the older and wealthier I've gotten, the more I prefer to sell
00:00:32.640 | rather than rent out. Being a landlord can sometimes create some very unpleasant experiences.
00:00:39.280 | Whether it's getting paid late, experiencing damage, having to fix something, or resolving
00:00:44.400 | some type of misunderstanding, being a landlord is not for everyone. As you get older, it's definitely
00:00:51.200 | not something you want to do. It takes discipline and you need a lot of good patience and people
00:00:57.120 | skills frankly. After I reached my limit of managing three rental properties, I stopped
00:01:02.240 | buying. I just couldn't take the amount of turnover and management and maintenance issues
00:01:07.280 | any longer. So instead I started investing my cash flow in private real estate funds that
00:01:12.240 | invested across the sunbelt. This way I could diversify my real estate holdings and more
00:01:18.000 | importantly earn more 100% passive income. I'm really thankful that I've been able to invest
00:01:25.120 | in private real estate because it just helps me diversify. I just don't want all of my real estate
00:01:30.400 | assets to be in San Francisco. It's expensive, cap rates are low, what if there's a natural
00:01:34.800 | disaster. So I want to diversify and I want to earn more passive income. And I'm assuming that
00:01:41.280 | it's the same with you. So right now I'm faced with the dilemma of whether to rent out my
00:01:45.600 | investment property or sell it. But this time we are in an unusually high inflationary environment.
00:01:51.520 | I'm hopeful inflation will start fading in the second half of 2022 and in 2023, but you just
00:01:58.800 | never really know. So in this episode I'm going to walk through the pros and cons like I do with
00:02:04.400 | other dilemmas in my upcoming book, Buy This, Not That, How to Spend Your Way to Wealth and Freedom.
00:02:10.640 | Every dilemma I face is viewed with a 70/30 decision making framework. After analyzing the
00:02:15.920 | situation, my goal is to make the right decision at least 70% of the time with 70% confidence or
00:02:22.960 | greater. And at the same time, I recognize that about 30% of the time I will make a suboptimal
00:02:28.400 | choice and need to learn from it. This is something I hope all of you guys do. Start
00:02:34.160 | thinking in probabilities, not absolutes. Don't wait for 100% certainty to make that choice.
00:02:40.480 | I think 70% or greater is when you can start making that move. And how do you get to the
00:02:46.560 | confidence of 70% plus? Well, it takes practice. It takes constantly predicting outcomes and
00:02:53.680 | analyzing your predictions with the outcome and analyzing where you went wrong or where you went
00:02:58.800 | right. You can make predictions from NBA championships to whether your friend's new
00:03:05.440 | relationship love interest will last. The idea is to narrow that confidence percentage to as close
00:03:12.640 | to 70% as possible. Because a lot of times people are like, well, I have no idea. I have a 40 to 80%
00:03:18.960 | confidence. The idea is to narrow it down to 70 to 75%. And you'll get better with practice over
00:03:24.240 | time. So in this dilemma, rent out a home or sell in a high inflationary environment. I think the
00:03:30.240 | 70% move is to rent out your rental property in a high inflationary environment to capture higher
00:03:36.000 | rents. Real estate is not only a great hedge against inflation, it is a great beneficiary
00:03:41.840 | of inflation. The best thing we can do in a high inflation environment is to own important real
00:03:47.120 | assets that inflate with inflation. So real estate, our housing living situation is the most
00:03:53.360 | important asset because if you can get your living situation under control in an affordable manner,
00:03:58.880 | you can do many, many other things, right? Food is not that expensive. You don't have to buy all
00:04:04.480 | these clothes, transportation. Hopefully you have public transportation, but if not, then a car,
00:04:10.000 | unfortunately, would be a necessity and you're going to be faced with rising car prices and
00:04:13.840 | rising gas prices. So let's go into detail on why renting out and investing property in a high
00:04:19.120 | inflation environment is the right move. So first, you want to ride the inflation wave as long as
00:04:25.680 | possible. If you are faced with the dilemma to rent or sell, you should rent out when inflation
00:04:30.400 | is high. Take full advantage by capturing market rents. This is especially true if high inflation
00:04:36.400 | is transitory. Since the mid 1990s, the average US inflation rate has hovered between two to two
00:04:42.720 | and a half percent. And 2% is the official Fed funds or the Federal Reserve inflation rate target.
00:04:48.560 | US inflation is now at eight and a half percent, right? However, it's unlikely an inflation rate
00:04:55.040 | that's four times the 30 year average will remain for longer than a couple of years. I would bet
00:05:00.640 | heavily that inflation is going to fade by 2023. Now, two, you want to buffer against downturns.
00:05:07.120 | Given the economy is cyclical, landlords may one day face tough times when they must cut rents to
00:05:12.880 | attract tenants. Landlords may also face times when they will have higher vacancies than normal.
00:05:19.440 | And vacancy is what tends to kill profitability the fastest. Therefore, the savvy landlord will
00:05:25.680 | take advantage of high rents when times are good and save the extra profits to cover for when times
00:05:30.800 | are bad. It's the same situation similar to tax cuts. You know, you might feel good about having
00:05:36.880 | a tax cut and having more disposable income. However, if you're savvy and you realize the
00:05:42.800 | tax cuts aren't going to last because the next administration is going to raise taxes, then
00:05:47.600 | you're going to save when times are good. Three, to cover higher costs, right? Good times create
00:05:54.400 | high inflation. People feel richer, they spend more. And unfortunately, that means your costs
00:05:59.680 | may inflate as well. Let's say your gardener cost or the plumbing cost or electric nutrition cost,
00:06:05.360 | whatever it is. So when you're taking advantage of high inflation by charging higher rents,
00:06:11.120 | hopefully, those rents will more than offset the rise in costs. Four, to generate more valuable
00:06:17.520 | passive income. We're still in a very interesting scenario right now. Inflation is high. However,
00:06:24.960 | mortgage rates, you know, are higher than they were in 2020 and 2021. But they're still negative,
00:06:30.240 | negative real mortgage rates, meaning that your debt is getting inflated away. So when rates are
00:06:37.760 | low, or relatively low, they're still relatively low right now, folks, don't don't think 5% on the
00:06:43.200 | average 30 year fixed mortgage is high. It's not it's low, you can still get lower arm rates as
00:06:47.920 | well. So when rates are low, the value of passive income goes up because it requires more capital
00:06:55.760 | to generate that same amount of passive income. So overall, your passive income is still quite
00:07:02.400 | valuable, because rates are still historically low. Now five, I talked about this already
00:07:07.920 | negative real mortgage interest rate, you want to hold on to your low interest rate debt for as long
00:07:13.360 | as possible in a high inflationary environment. Because inflation is basically inflating away
00:07:18.400 | the true cost of that debt. More than 90% of mortgage debt out there is trading at under a 5%
00:07:25.600 | interest rate. My seven one arm that I got in 2020 is that a 2.125% interest rate, I'd be foolish to
00:07:33.360 | start paying that off. When inflation is at 8.5%. I have a negative six plus percent interest rate.
00:07:39.920 | That's crazy. And I'm going to hold on to that for as long as possible. And the other thing is,
00:07:44.560 | I know some people are like, Oh, well, you got an arm and inflation went up. Well, I still believe
00:07:49.440 | that the long term trend for inflation and interest rates is down. So yeah, rates are up right now,
00:07:56.880 | folks. And you know, I might be looking foolish. However, I think rates are going to go back down
00:08:01.200 | in 2023 and 2024. And my arm doesn't reset until 2027. And so we can revisit where interest rates
00:08:09.760 | and inflation will be in 2027. I'm pretty sure certain it's going to be lower than where it is
00:08:14.240 | right now. Okay, six, six reason why you should continue to rent out your rental property,
00:08:19.680 | you want to minimize tax liability. If you sell your rental property, you may have to pay capital
00:08:24.240 | gains tax due to depreciation recapture and price appreciation. You know, property prices have done
00:08:29.920 | very well since 2020. And very well since 20 2011 and 2020 12. So in general, the best holding period
00:08:37.200 | for real estate is forever, you want to be like the billionaires out there that own a lot of assets,
00:08:42.560 | they never sell and they just borrow from their assets. So you can tap your equity,
00:08:47.120 | and then reinvest in somewhere else. But in general, I don't think it's great to tap equity
00:08:51.200 | to leverage up to buy more real estate. But that's something you've got to decide based
00:08:55.840 | on your risk parameters. Seven, minimize reinvestment headaches. I tell you, if you
00:09:02.320 | sell something and you have this huge windfall, it might feel good, but chances are high that
00:09:08.160 | you're going to be at a loss for what to do with your money. When I sold my rental property in 2017,
00:09:13.840 | I had $1.8 million in windfall after commissions after taxes. And basically, that was way more
00:09:21.600 | than I've ever had, you know, to invest at one time, usually I'm investing like 10,000 20,000
00:09:27.680 | 50,000, you know, at the most at one time. So it took me about six months to try to redeploy that
00:09:33.200 | capital in a positive way in a safe way. Because, you know, for 13 years, the rental property was
00:09:40.080 | just chugging along just appreciating I never really thought about it. But as soon as you
00:09:44.560 | realize those gains, you will see its real time performance. So six months, it took me to re
00:09:51.040 | invest that money. And I did 33% in the S&P 500 and some stocks, about 30% in municipal bonds,
00:10:01.280 | and then the remainder in real estate crowdfunding and private real estate to diversify.
00:10:05.200 | It's not easy to reinvest a big windfall. Alright, so I've given you seven reasons why you should
00:10:12.080 | hold on to your rental property and keep renting it out to capture higher market rents in a high
00:10:17.440 | inflationary environment. Now let's go through some of the reasons why you should sell. Inflation
00:10:22.720 | might only be temporary. Right? Like if you look at the history, we're, we're inflation is at two
00:10:28.160 | to two and a half percent, we're at eight and a half percent, the chances are high, it's going to
00:10:31.520 | be temporary, and inflation starts coming down, perhaps rental start coming down, and then you
00:10:37.200 | won't be able to get that high price that you want. So you've kind of got to figure out where
00:10:41.920 | we are in the real estate cycle. To me, it feels like we're in phase three, not two and a half
00:10:48.400 | to three. So phase two is expansion, phase three is hyper supply phase four is recession,
00:10:54.400 | right? Some cities, you know, in the heartland, where you can just build an endless amount,
00:10:59.680 | because land is infinite supply, it seems, I would be a little bit skeptical about buying
00:11:05.120 | property there. And you know, if you had a good run owning Austin, Texas real estate,
00:11:09.920 | over the past two, three years, maybe you want to offload some because supply is coming. Another
00:11:15.200 | reason why you might want to sell is when your depreciation benefit runs out. So depreciation
00:11:21.280 | is a non cash expense, it's just the IRS decided you can depreciate straight line depreciation of
00:11:27.600 | your buildings value over a 27.5 year period. And that helps lower your rental income. So which
00:11:33.760 | means it lowers your taxable rental income. So when that expense is gone, you know, maybe it
00:11:39.920 | depends on how your income is structured, you might want to sell the rental property because
00:11:44.400 | you might have to be paying more ongoing taxes. Our next reason, when there's an easier way to
00:11:50.480 | own rental property, the older and wealthier you get, I highly doubt you'll want to spend more time
00:11:56.160 | managing rental properties. Yeah, you can hire a property manager, but then you have to manage
00:12:00.720 | the property manager while paying, you know, one or two months worth of rent as a fee. Now,
00:12:06.880 | there are many ways to reinvest in real estate, right? You can buy public REITs private funds.
00:12:13.840 | I like fundraisers because they buy single family homes, rental properties and the Sunbelt.
00:12:18.560 | To me, that is a demographic that I think is going to do well long term. And it helps me diversify my
00:12:23.680 | expensive coastal city real estate for when cap rates are no longer attractive. Think about cap
00:12:29.280 | rate as a net rental yield. So compare the cap rate to the risk free rate of return. So 10 year
00:12:36.960 | bond yield, let's say it's at 3% and your cap rate is at 3.1%. So you have a point 1% premium,
00:12:42.640 | is that really worth it to have to manage property and you know, fix things and stuff?
00:12:47.440 | Some would say no, I think many would say no, if you could earn a risk free 3% rate of return.
00:12:53.040 | However, you would only hold on if you think the property is going to continue to appreciate
00:12:58.160 | or you can raise rents, right? Fifth reason to sell major life event. Now, there are some key
00:13:05.440 | life events that warrant the re-evaluation of owning investment properties. Maybe it's a birth
00:13:10.160 | of your son or daughter, a death in the family, a terrible accident that requires extra care,
00:13:15.600 | an unwanted layoff, or a job relocation to name a few events. Managing rental properties takes time,
00:13:22.960 | even if you hire a manager. When my son was born, I was just a first time father who had read like
00:13:29.040 | five books and I wanted to be hands on and I just didn't have any bandwidth to deal with this
00:13:34.720 | particular rental property with four or five guys as tenants always throwing parties and all that
00:13:40.080 | stuff. Another great time to sell is if you expect a huge recession, a really bad recession,
00:13:46.400 | not, you know, not the March, April recession of 2020, you know, the lasted relatively short
00:13:52.560 | period of time as a quick rebound, but something that drags on for years, you know, one, two,
00:13:58.160 | three years, like the global financial crisis, right? It was bad from 2007 to 2010. That's three
00:14:06.560 | years of kind of misery. And then only in 2011 and 2012, did people start feeling better about
00:14:12.000 | themselves. The problem with this is you just never know how bad the recession will be, how long it'll
00:14:18.640 | be, and when it'll come. Just think about all the people who sold real estate in February, 2020,
00:14:24.320 | right before the lockdowns began. Some probably most felt good, like, ah, I sold out. Great,
00:14:30.160 | awesome. But of course, real estate prices went up 20 to 50% over the next two years. And if you
00:14:36.320 | didn't get back in, well, then you missed out. All right, seven, when real estate commands greater
00:14:41.520 | than 70% of your net worth. I would say really more than 50%. But I said 70% because some of you,
00:14:48.400 | you know, might be younger, you just bought real estate, and it's just accounts for a big portion
00:14:52.880 | of your net worth. But my recommendation is to try to get your primary residence equal to 30%
00:14:59.600 | of your net worth or less the value, the total value. And for real estate to be no more than
00:15:04.880 | about 50% of your net worth, because you want to have diversified assets that zig when others zag.
00:15:10.640 | Eight, you want to sell because you way exceed the 250 to 500,000 tax free profit. It's actually
00:15:18.800 | not way exceed. When you're right at that limit, and you can sell tax free, that might be an
00:15:24.000 | optimal time depending on your current income and marginal tax rate. Obviously, the higher
00:15:30.640 | the marginal tax rate you face, maybe the better actually it is to sell before you surpass that
00:15:37.360 | limit by too far. Nine, when commission rates decline here in 2022, it's pretty amazing that
00:15:45.040 | it still costs 5% commission to sell your home, two and a half percent to each, you know, the
00:15:50.480 | buying agent and the selling agent. And then you've got like, one to 2%, based on the taxes you pay,
00:15:57.120 | and so forth. So when commission rates come down, you know, it creates a more liquid market. And
00:16:03.600 | that's the irony of having high, stubbornly high commission rates is, you know, people just don't
00:16:07.520 | want to bother why bother paying that commission, paying a higher home price, or, you know, paying
00:16:13.920 | a higher rent to find a new home, just stay where you are. It's just much easier, because commissions
00:16:19.040 | and taxes creates economic waste. All right, finally, when there are major upcoming repairs,
00:16:26.400 | you might want to just sell because you just don't want to deal with installing a new water heater,
00:16:32.000 | replacing the windows, replacing the roof, painting the house, and so forth. Right? Just sell it as
00:16:37.440 | is, make the disclosures and just let the new buyer spend their time and money to fix those
00:16:42.480 | things. Now, if you just painted the house, well, it's actually could be a good time to sell too,
00:16:48.400 | because it's as good as it's gonna look. And then it just fades over time. At the same time,
00:16:54.320 | you might want to enjoy the fixing for a while because it hopefully won't give you problems for
00:16:59.120 | many, many years. All right, now that we've gone through the pros and cons, I think the bottom line
00:17:04.160 | is it is better to keep holding on to your rental property in a high inflationary environment,
00:17:10.080 | and capture market rents. That is the 70% plus move. When it comes to owning investment property,
00:17:17.360 | real estate in general, the ideal holding period is forever. It's almost like a war of attrition.
00:17:23.520 | Whoever can hold on to their real estate, the longest generally becomes the wealthiest. All
00:17:28.960 | right, I hope you enjoyed this episode. This is the exact type of analysis I do for some of life's
00:17:34.480 | biggest dilemmas in my book, Buy This, Not That, how to spend your way to wealth and freedom.
00:17:39.360 | I appreciate all your support, pre-ordering hard copies. They really mean a lot to me. And the
00:17:44.800 | book is out July 19, 2022. Because of supply chain issues, it's been delayed by three weeks, but it's
00:17:51.120 | It's still coming and it's going to be better than ever.
00:17:53.720 | Thanks so much, everyone.