“Can you help me out here?” “Is this a new thing?” “Isn’t there anything we can do here to move things forward?”
Sometimes real estate investors react to market corrections in a very human way. They remember how easy it was when they were kids. Life was as easy as drawing a question mark in the sand. Answers to real estate investors’ questions are sometimes much simpler than imagined.
Questions my son and I hear too often, from investors who’ve owned rental property, but kept waiting for their investment to continue reaching record highs.
The correction hit, and they slowly but surely began to realize — time isn’t always their friend.
Where is this happening?
Did your property go up at a rate exceeding 20% for at least one year? Are listings, for the most part, just not selling?
Just about any location in California will fit the definition. Several years of cartoonish appreciation. Markets currently sluggish, if not moribund. Sellers living in their own world — one in which their properties are immune to the free market.
Attention — mini-rant is coming.
If you wish to sell your property during a correction, here are some things you’ll need to know.
Buyers would have to go up two levels to be apathetic about how much you have invested in your property. They literally couldn’t care less. Properties in as close to perfect condition, which relatively speaking, are almost sexy, — sell.
The faster your capital is freed from its current prison, the faster you can make up for lost time. Remember, time isn’t your friend now. Giving it a new address(es) will turn time into your friend again. If your property isn’t priced to sell in 30 days, you’re playing games with yourself. Stop it. Either get serious, or learn to enjoy moribund. 
Assuming your agent is an experienced pro — ignore the urge to argue with his/her suggestions. This is how they make their living. The idea is to sell the property, right? Then sell it. The competition is, in most areas, fierce. The most objective, realistic seller — wins.
End of mini-rant.
If your market is face down in the water, and there’s enough equity to make it worth your while, bite the bullet, and get outa Dodge. By moving your equity/capital to a dynamic, growing region, you’ll have resuscitated your retirement plan.
There is simply no benefit, in most markets, of waiting out the correction. Are there exceptions? You betcha. But property owners in those areas know who they are.
You’re probably not one of them, sorry.
Here’s a thought to guide you in your thinking.
You bought your rental property in (fill in location) before the spring of ’02. It’s worth a lot more than you paid for it. The problem is, most listings just aren’t selling.
What to do, what to do?
First, we need to think clearly, and with a sharp focus. The current market correction is not founded upon chaos.
Your ultimate goal is either growth or cash flow. Neither is happening now, or will happen in the near future, (or never again in some areas) so you’re stalled.
Let’s take your property. You think it’s worth at least $XXX, right? Let’s stipulate, for the sake of this discussion, your price is high by 10%. If you thought it was worth $280,000 — what happens if you sold it in 25 days for say, $255,000?
You bought the dang thing back in ’00 for $115,000. Your present loan balance is around $80,000 or so. Sold now at $255,000 you’d net around $155,000 give or take.
You put that net equity (via a tax deferred (1031) exchange) into a far more investor friendly market. Here’s an option for your consideration.
Your exchange lands you in another region, the proud owner of six separate properties — all of which pay for themselves — many providing a little cash flow.
Your tax shelter goes off the chart. The sold property was sheltering some positive cash flow, leaving you a couple grand a year to offset some of your job income. The new investments now shelter any positive cash flow. They also allow you to lop off $25,000 of your job income before you even begin doing your tax return.
For most folks, that’s a tax savings of $5-9,000 a year. That’s cash you get to keep in your Levi’s. Cash you’d be sending to Uncle Sam if you’d stayed put, holding out for your fantasy $280,000 price.
Let’s say each new property cash flows a whole grand a year. That’s $6,000 a year. If we say you’re in the middle on the tax savings — $7,000 — you’re now doing $13,000 in positive cash flow — after tax.
We’re not done yet, but tell me again why getting a buyer to pay that extra $25,000 was so freakin’ important?
Let’s say the first year, your new properties appreciate a very impressive 3%. What does that mean to you in real dollars?
Well, you traded into six properties. I didn’t say how, but you did it using some prudent leverage, fixed rate loans, and they’re worth a total of around $1.3 Million.
Geez, I wonder what 3% of that much value comes to? Turns out it’s $39,000 on the button.
Let’s review.
You decided to be rational, and lowered the price from Dreamland to Real World, and, at least in your mind, lost $25,000 in the process. The first year of owning your new stuff has resulted in a $39,000 gain in value. You’ve benefitted by way of what I’ve called, “Dollars In Levi’s” amounting to $13,000 in after tax cash flow.
That adds up to around $52,000 in a year of executing a solid Purposeful Plan. The Plan comes first — before any action is ever even contemplated.
Call me silly — but that looks a lot like more than double what you thought you lost by lowering the sales price of your old property.
What a co-inky dink.
Back to your property, in your dead-in-the-water area.
What’s the value in today’s market? If you executed a tax deferred (1031) exchange, would the resulting improvement make the decision a no-brainer?
Yes?
Then what the (fill in the blank) are you waiting for?
If you’re not sure, contact me, and I’ll tell you in no time flat. I love doing that kinda stuff.
Don’t allow your dead market to derail your Purposeful Plan.
It’s your retirement in the balance.
Related posts:
- How To Get Your San Diego Real Estate Equity Growing Again — Get Outa Dodge Now
- Loan Terms — Appreciaton — Capital Growth Is What Matters Most
- Time May Not Be Your Friend — What’s The Return On Your Equity?
- Getting Out Of A Dead Market — The Case For Taking What’s There And Movin’ On
- Picking Up Pennies — Needless Cash Flow — And Million Dollar Pizza & Beer
About BawldGuy
Jeff, Great advice. We have done this and it is a good stategy.
You know the following details but I will tell them for others.
We have two properties left that I have decided are in your “exception” catagory.
We exchanged most of our properties in 2004 at your advice, for Phoenix.
Next, we stripped equity out of the last two and invested in Boise.
Our mistake, we didn’t sell the two properties that we equity stripped. Now a sale would be upside down in this market.
Would you please address this situation because I know that many are in this situation.
I’m not talking about the folks who stripped equity out to buy boats and cars, I’m talking about those who stripped out to INVEST in growth markets but still have the stripped property that is dragging down the portfolio..running a negative.
The current market correction is not founded upon chaos.
Not yet anyway. Even if “chaos” is only a small possibility why risk it? My point is about risk concentration. That single or few properties past peak appreciation potential and renting for a small a fraction of value are not diversified. A vacancy becomes a 100% (or more) hit to cash flow. Better 4-6 properties/units where turnover is a mathematical event factored into the equation.
Good post.
And…ducky advice for the guy who bought in ’00 and is annoyed because he’s up 120% instead of the 150% that he had his heart set on.
But…how are you dealing with the client who bought in ’06?
Christopher, I also have this question. It is worrysome when some property bought in ’06 is worth lessin ’07. The problem sometimes for an investor is that your net worth goes down. Emotionally, that is difficult…must think long term and hope that history will repeat itself.
Chris — The ’06 buyer will ride this out just like the ’87 stockholders did.
Obviously there will be exceptions. We’re seeing them now. There are some for whom no help is possible — just like real life.
That said, we’ll see, when the smoke has cleared — the huge majority of them emerged, bloody, but able to move forward.
The ‘loss’ of net worth, as Cher implies, is difficult. What she doesn’t add, is the ‘loss’ exists only on paper ’till you sell.
She’s also right about history repeating itself. The chart — she goes up, she goes down — but she never does one forever.
This too shall pass.
Ahh, so true, Jeff: “this too shall pass”.. the mantrum of a long term investor every 10 years or so.
Late to the party, as usual. I’m catching up from the weekend. I really liked the post. You’ve written similar posts in the past but just keep preaching the word. And your advice to the ’06ers is about all they can do short of bringing a boat load of money to the table.
I’m still trying to figure out just how you an keep up with four kids and do all you do at work. By the time you’re 50 you might look like Moses.
As far as the ’06ers are concerned — if it’s 4th and 2 you might try for the 1st down. For these folks, at least sometimes, it’s 4th and 18, and surely time to punt.
You’ll get the ball again, later.
Just to inject a slightly different read on things…
Maybe it’s the trader in me, but I can’t buy the “it’s only a loss on paper until you sell” line.
A loss is a loss. Case in point, I got into Countrywide at $20 ’cause I thought the market had overreacted; it’s been up and down since then, but now it’s at $15. My fundamental view hasn’t changed so I haven’t sold out of the position, but that $5 bucks per share is just as much a loss right now at this moment as it would be if I went into my E*Trade account and cashed out.
A house is no different. A loss is a loss, whether you’re holding your wealth in the form of cash, stocks, houses, or whatever.
So here’s a thought experiement. Say you buy a house for $400k and it goes down in value to $350k but you haven’t sold it. Have you lost $50k? What if you sell it for $350k. What if you sell it for $350k on Tuesday, then get cold feet and buy it right back on Wednesday for $350k…have you “undone” the loss (work with me on this one and ignore the transaction costs, lawsuits, mad Realtors, etc….it’s just a thought experiement.)
Hey Chris — I see where yer goin’ here, but I prefer the reality of what words mean. Grandma scolded me one day, saying, unless I learned that words have meaning, I’d be forever stuck in ‘what if’ land.
Back in ’87 when the stock market tanked so badly they closed it, many folks thought as you proposed.
If I had invested $10,000 back in ’85 and woke up that woeful October morning in ’87 to find out my stocks were now worth less than $7,000 — I would have had two choices.
Make the ‘potential’ or ‘paper’ loss real, by selling OR wait until everything settled down to see what happened.
If I’d sold a few years later, when my stock was then worth $15,000 it would have meant I never lost a dime in the ’87 crash. In fact it would have meant I didn’t lose anything.
Fantasy losses, and gains for that matter, are just that — fantasy. Until you have empirical real world evidence of that loss or gain — nothing has happened except in your mind.
You may have lost sleep, but you didn’t lose money until you sold for less than you paid.
Furthermore, if an investor believes so much in his loss — making it real by actually selling at a loss unnecessarily is irrational in the extreme.
Bottom line? Your example of the homeowner with the paper loss of $50,000. What’s more real? His paper loss, or when he ACTUALLY sells that house for a $50,000 profit — and gets a check at close of escrow?
I’ll take the check and bank the real world profit.
I bet you agree with me on that one.
Jeff,
Great article. As an investor my only question is how do you handle going from one local property to six properties in a variety of locations. The management headaches make this a tough proposition for a working investor. These properties do not seem to have the size for a property manager, so what do you suggest to your clients?
Michael – Thanks
Six properties — Remember, we’re going from a Nordstrom’s refund straight to the Dollar Store.
If a San Diego, or similarly priced region nets an investor, say $170,000 or so, they can easily trade into six Texas properties. And, he says in a brilliant segue….
We ensure property management is in place. For San Diegans they get newer or brand new properties, which is cool for them since their stuff was probably older than Moses’ last wife.
The only folks who don’t absolutely love having property managed for them are the control freaks — and most of them learn to love it pretty quickly.