Hello everybody, it's Sam from Financial Samurai and in this episode I want to talk about whether we should rent out or sell an investment property when inflation is high. So we all know inflation is high right now, 8.5% was the latest print, maybe it'll go up but hopefully it's going to start fading into the second half of 2022 and 2023.

However, whenever there's turnover with a rental property, you're always going to be faced with this dilemma of whether to sell or just keep on renting it out. And the older and wealthier I've gotten, the more I prefer to sell rather than rent out. Being a landlord can sometimes create some very unpleasant experiences.

Whether it's getting paid late, experiencing damage, having to fix something, or resolving some type of misunderstanding, being a landlord is not for everyone. As you get older, it's definitely not something you want to do. It takes discipline and you need a lot of good patience and people skills frankly.

After I reached my limit of managing three rental properties, I stopped buying. I just couldn't take the amount of turnover and management and maintenance issues any longer. So instead I started investing my cash flow in private real estate funds that invested across the sunbelt. This way I could diversify my real estate holdings and more importantly earn more 100% passive income.

I'm really thankful that I've been able to invest in private real estate because it just helps me diversify. I just don't want all of my real estate assets to be in San Francisco. It's expensive, cap rates are low, what if there's a natural disaster. So I want to diversify and I want to earn more passive income.

And I'm assuming that it's the same with you. So right now I'm faced with the dilemma of whether to rent out my investment property or sell it. But this time we are in an unusually high inflationary environment. I'm hopeful inflation will start fading in the second half of 2022 and in 2023, but you just never really know.

So in this episode I'm going to walk through the pros and cons like I do with other dilemmas in my upcoming book, Buy This, Not That, How to Spend Your Way to Wealth and Freedom. Every dilemma I face is viewed with a 70/30 decision making framework. After analyzing the situation, my goal is to make the right decision at least 70% of the time with 70% confidence or greater.

And at the same time, I recognize that about 30% of the time I will make a suboptimal choice and need to learn from it. This is something I hope all of you guys do. Start thinking in probabilities, not absolutes. Don't wait for 100% certainty to make that choice. I think 70% or greater is when you can start making that move.

And how do you get to the confidence of 70% plus? Well, it takes practice. It takes constantly predicting outcomes and analyzing your predictions with the outcome and analyzing where you went wrong or where you went right. You can make predictions from NBA championships to whether your friend's new relationship love interest will last.

The idea is to narrow that confidence percentage to as close to 70% as possible. Because a lot of times people are like, well, I have no idea. I have a 40 to 80% confidence. The idea is to narrow it down to 70 to 75%. And you'll get better with practice over time.

So in this dilemma, rent out a home or sell in a high inflationary environment. I think the 70% move is to rent out your rental property in a high inflationary environment to capture higher rents. Real estate is not only a great hedge against inflation, it is a great beneficiary of inflation.

The best thing we can do in a high inflation environment is to own important real assets that inflate with inflation. So real estate, our housing living situation is the most important asset because if you can get your living situation under control in an affordable manner, you can do many, many other things, right?

Food is not that expensive. You don't have to buy all these clothes, transportation. Hopefully you have public transportation, but if not, then a car, unfortunately, would be a necessity and you're going to be faced with rising car prices and rising gas prices. So let's go into detail on why renting out and investing property in a high inflation environment is the right move.

So first, you want to ride the inflation wave as long as possible. If you are faced with the dilemma to rent or sell, you should rent out when inflation is high. Take full advantage by capturing market rents. This is especially true if high inflation is transitory. Since the mid 1990s, the average US inflation rate has hovered between two to two and a half percent.

And 2% is the official Fed funds or the Federal Reserve inflation rate target. US inflation is now at eight and a half percent, right? However, it's unlikely an inflation rate that's four times the 30 year average will remain for longer than a couple of years. I would bet heavily that inflation is going to fade by 2023.

Now, two, you want to buffer against downturns. Given the economy is cyclical, landlords may one day face tough times when they must cut rents to attract tenants. Landlords may also face times when they will have higher vacancies than normal. And vacancy is what tends to kill profitability the fastest.

Therefore, the savvy landlord will take advantage of high rents when times are good and save the extra profits to cover for when times are bad. It's the same situation similar to tax cuts. You know, you might feel good about having a tax cut and having more disposable income. However, if you're savvy and you realize the tax cuts aren't going to last because the next administration is going to raise taxes, then you're going to save when times are good.

Three, to cover higher costs, right? Good times create high inflation. People feel richer, they spend more. And unfortunately, that means your costs may inflate as well. Let's say your gardener cost or the plumbing cost or electric nutrition cost, whatever it is. So when you're taking advantage of high inflation by charging higher rents, hopefully, those rents will more than offset the rise in costs.

Four, to generate more valuable passive income. We're still in a very interesting scenario right now. Inflation is high. However, mortgage rates, you know, are higher than they were in 2020 and 2021. But they're still negative, negative real mortgage rates, meaning that your debt is getting inflated away. So when rates are low, or relatively low, they're still relatively low right now, folks, don't don't think 5% on the average 30 year fixed mortgage is high.

It's not it's low, you can still get lower arm rates as well. So when rates are low, the value of passive income goes up because it requires more capital to generate that same amount of passive income. So overall, your passive income is still quite valuable, because rates are still historically low.

Now five, I talked about this already negative real mortgage interest rate, you want to hold on to your low interest rate debt for as long as possible in a high inflationary environment. Because inflation is basically inflating away the true cost of that debt. More than 90% of mortgage debt out there is trading at under a 5% interest rate.

My seven one arm that I got in 2020 is that a 2.125% interest rate, I'd be foolish to start paying that off. When inflation is at 8.5%. I have a negative six plus percent interest rate. That's crazy. And I'm going to hold on to that for as long as possible.

And the other thing is, I know some people are like, Oh, well, you got an arm and inflation went up. Well, I still believe that the long term trend for inflation and interest rates is down. So yeah, rates are up right now, folks. And you know, I might be looking foolish.

However, I think rates are going to go back down in 2023 and 2024. And my arm doesn't reset until 2027. And so we can revisit where interest rates and inflation will be in 2027. I'm pretty sure certain it's going to be lower than where it is right now. Okay, six, six reason why you should continue to rent out your rental property, you want to minimize tax liability.

If you sell your rental property, you may have to pay capital gains tax due to depreciation recapture and price appreciation. You know, property prices have done very well since 2020. And very well since 20 2011 and 2020 12. So in general, the best holding period for real estate is forever, you want to be like the billionaires out there that own a lot of assets, they never sell and they just borrow from their assets.

So you can tap your equity, and then reinvest in somewhere else. But in general, I don't think it's great to tap equity to leverage up to buy more real estate. But that's something you've got to decide based on your risk parameters. Seven, minimize reinvestment headaches. I tell you, if you sell something and you have this huge windfall, it might feel good, but chances are high that you're going to be at a loss for what to do with your money.

When I sold my rental property in 2017, I had $1.8 million in windfall after commissions after taxes. And basically, that was way more than I've ever had, you know, to invest at one time, usually I'm investing like 10,000 20,000 50,000, you know, at the most at one time. So it took me about six months to try to redeploy that capital in a positive way in a safe way.

Because, you know, for 13 years, the rental property was just chugging along just appreciating I never really thought about it. But as soon as you realize those gains, you will see its real time performance. So six months, it took me to re invest that money. And I did 33% in the S&P 500 and some stocks, about 30% in municipal bonds, and then the remainder in real estate crowdfunding and private real estate to diversify.

It's not easy to reinvest a big windfall. Alright, so I've given you seven reasons why you should hold on to your rental property and keep renting it out to capture higher market rents in a high inflationary environment. Now let's go through some of the reasons why you should sell.

Inflation might only be temporary. Right? Like if you look at the history, we're, we're inflation is at two to two and a half percent, we're at eight and a half percent, the chances are high, it's going to be temporary, and inflation starts coming down, perhaps rental start coming down, and then you won't be able to get that high price that you want.

So you've kind of got to figure out where we are in the real estate cycle. To me, it feels like we're in phase three, not two and a half to three. So phase two is expansion, phase three is hyper supply phase four is recession, right? Some cities, you know, in the heartland, where you can just build an endless amount, because land is infinite supply, it seems, I would be a little bit skeptical about buying property there.

And you know, if you had a good run owning Austin, Texas real estate, over the past two, three years, maybe you want to offload some because supply is coming. Another reason why you might want to sell is when your depreciation benefit runs out. So depreciation is a non cash expense, it's just the IRS decided you can depreciate straight line depreciation of your buildings value over a 27.5 year period.

And that helps lower your rental income. So which means it lowers your taxable rental income. So when that expense is gone, you know, maybe it depends on how your income is structured, you might want to sell the rental property because you might have to be paying more ongoing taxes.

Our next reason, when there's an easier way to own rental property, the older and wealthier you get, I highly doubt you'll want to spend more time managing rental properties. Yeah, you can hire a property manager, but then you have to manage the property manager while paying, you know, one or two months worth of rent as a fee.

Now, there are many ways to reinvest in real estate, right? You can buy public REITs private funds. I like fundraisers because they buy single family homes, rental properties and the Sunbelt. To me, that is a demographic that I think is going to do well long term. And it helps me diversify my expensive coastal city real estate for when cap rates are no longer attractive.

Think about cap rate as a net rental yield. So compare the cap rate to the risk free rate of return. So 10 year bond yield, let's say it's at 3% and your cap rate is at 3.1%. So you have a point 1% premium, is that really worth it to have to manage property and you know, fix things and stuff?

Some would say no, I think many would say no, if you could earn a risk free 3% rate of return. However, you would only hold on if you think the property is going to continue to appreciate or you can raise rents, right? Fifth reason to sell major life event.

Now, there are some key life events that warrant the re-evaluation of owning investment properties. Maybe it's a birth of your son or daughter, a death in the family, a terrible accident that requires extra care, an unwanted layoff, or a job relocation to name a few events. Managing rental properties takes time, even if you hire a manager.

When my son was born, I was just a first time father who had read like five books and I wanted to be hands on and I just didn't have any bandwidth to deal with this particular rental property with four or five guys as tenants always throwing parties and all that stuff.

Another great time to sell is if you expect a huge recession, a really bad recession, not, you know, not the March, April recession of 2020, you know, the lasted relatively short period of time as a quick rebound, but something that drags on for years, you know, one, two, three years, like the global financial crisis, right?

It was bad from 2007 to 2010. That's three years of kind of misery. And then only in 2011 and 2012, did people start feeling better about themselves. The problem with this is you just never know how bad the recession will be, how long it'll be, and when it'll come.

Just think about all the people who sold real estate in February, 2020, right before the lockdowns began. Some probably most felt good, like, ah, I sold out. Great, awesome. But of course, real estate prices went up 20 to 50% over the next two years. And if you didn't get back in, well, then you missed out.

All right, seven, when real estate commands greater than 70% of your net worth. I would say really more than 50%. But I said 70% because some of you, you know, might be younger, you just bought real estate, and it's just accounts for a big portion of your net worth.

But my recommendation is to try to get your primary residence equal to 30% of your net worth or less the value, the total value. And for real estate to be no more than about 50% of your net worth, because you want to have diversified assets that zig when others zag.

Eight, you want to sell because you way exceed the 250 to 500,000 tax free profit. It's actually not way exceed. When you're right at that limit, and you can sell tax free, that might be an optimal time depending on your current income and marginal tax rate. Obviously, the higher the marginal tax rate you face, maybe the better actually it is to sell before you surpass that limit by too far.

Nine, when commission rates decline here in 2022, it's pretty amazing that it still costs 5% commission to sell your home, two and a half percent to each, you know, the buying agent and the selling agent. And then you've got like, one to 2%, based on the taxes you pay, and so forth.

So when commission rates come down, you know, it creates a more liquid market. And that's the irony of having high, stubbornly high commission rates is, you know, people just don't want to bother why bother paying that commission, paying a higher home price, or, you know, paying a higher rent to find a new home, just stay where you are.

It's just much easier, because commissions and taxes creates economic waste. All right, finally, when there are major upcoming repairs, you might want to just sell because you just don't want to deal with installing a new water heater, replacing the windows, replacing the roof, painting the house, and so forth.

Right? Just sell it as is, make the disclosures and just let the new buyer spend their time and money to fix those things. Now, if you just painted the house, well, it's actually could be a good time to sell too, because it's as good as it's gonna look. And then it just fades over time.

At the same time, you might want to enjoy the fixing for a while because it hopefully won't give you problems for many, many years. All right, now that we've gone through the pros and cons, I think the bottom line is it is better to keep holding on to your rental property in a high inflationary environment, and capture market rents.

That is the 70% plus move. When it comes to owning investment property, real estate in general, the ideal holding period is forever. It's almost like a war of attrition. Whoever can hold on to their real estate, the longest generally becomes the wealthiest. All right, I hope you enjoyed this episode.

This is the exact type of analysis I do for some of life's biggest dilemmas in my book, Buy This, Not That, how to spend your way to wealth and freedom. I appreciate all your support, pre-ordering hard copies. They really mean a lot to me. And the book is out July 19, 2022.

Because of supply chain issues, it's been delayed by three weeks, but it's It's still coming and it's going to be better than ever. Thanks so much, everyone.