Real Estate Investor Question: Rehab and Sell, or Rehab and
Keep?
Here's another awesome question I received from my discussion
board. The question; Why bother keeping property after it's
rehabbed? Why not sell it after the rehab and GET PAID!
Of course, the first questions that you must answer is how
emergent is your need for quick cash? You can likely generate
the most SHORT TERM cash by selling a freshly rehabbed house.
But, you will give much of it away in taxes come next April.
If you keep it, you stand to make more! You will also enjoy some
great benefits while you own it such as cash flow, a tax break,
and MORE cash with the future appreciation. You can still pull
some nice cash a few months after buying it when you refinance
(post rehab) the property from your hard money (at 70% loan to
value) to long term financing (at 85% or 90% loan to value).
The short answer is an investor is going to make considerably
more money by hanging onto a property after it's rehabbed. There
is a downside to it. You have to be a landlord, and you have to
decide if you want to do that. I don't think it's too bad as
long the landlording is done correctly.
Let me illustrate the difference in overall money between rehab
and sell, and rehab and rent investing with this example;
Let's say appreciation rates are 5% in your town and the average
price of a freshly rehabbed property in the neighborhoods
investors buy in is $100,000. Let's also say there is Bill and
Fred.
Bill sells his properties after rehabbing and makes $15-18,000
per house. Good boy Bill!
Fred keeps his rehab projects and cash-out refinances, pulling
out around $10,000 per house within 3-6 months of ownership.
(Fred trades his 70% loan-to-value (LTV) ratio hard money for
long term, 30-year mortgages at a lower interest rate with an
85-90% loan to value ratio. He pockets the difference between
what it costs to pay off the hard money and the new mortgage
less closing costs. This works out to about $10,000 per
property.)
Bill (rehab and sell) makes a great living. Ten houses per year
is $150,000-$180,000 per year...nice jingle! The downside is
that Bill has to keep rehabbing to keep making that living
year-after-year and pays taxes on all that money as regular
income (ouch!). So his $150,000 per year is in reality somewhat
less.
Fred (the rehabber) also makes a great living. Ten houses per
year makes him $100,000 or so in tax free, spendable cash. But,
Fred controls a million dollars in real estate and it's going up
in value year after year. Also, Fred pays no taxes on that money
he gets from the cash-out refinances. It's part of a mortgage,
so must be paid back, therefore is not income! I love that part!
Let's look at what Fred's doing more closely.
Let's say Fred bought 10 houses valued at $100,000 each, owes
$90,000 on each one (after the 90% cash out refinance), so he
controls $1,000,000 in property. If he keeps them 5 years
(assuming a low appreciation rate...which is pretty
conservative):
Purchase year - 10 houses x $100,000 = $1,000,000 Year 1 - Same
10 houses X $105,000 = $1,050,000 Year 2 - Same 10 houses X
$110,250 = $1,102,500 Year 3 - Same 10 houses X $115,762 =
$1,157,620 Year 4 - Same 10 houses X $121,550 = $1,215,500 Year
5 - Same 10 houses X $127,627 = $1,276,270
Essentially, Fred makes an extra $50,000 per year for keeping 10
properties. After owning them 5 years, if he sells, he puts
$276,000 in his pocket.
Remember
- Some parts of the country will appreciate much faster than 5%.
Heck some places properties will double in value in 5 years. -
No tax benefits of keeping the property is included here. That
equates to thousands of dollars in real income. - This is ONE
ten-house year. Let's say you want to "top out" at owning 30
houses. Well, in just a couple of years your buying will slow
down to a trickle and you'll start selling and cashing out of
properties. I mean, how many ten-house years to you need to
string together before you are set for life? - What if you hold
these houses 10 years? The numbers get pretty exciting.
If you're like me and you don't want to do this for too many
years, then holding properties for a few years makes a lot of
sense, especially if you don't have much personal money invested
in them.
So what of poor old Bill? Chances are, Bill will satisfy his
need for short term cash, then start holding property. What do
you think?