Real
Estate Investor Question: Rehab and Sell, or Rehab and
Keep?
by: Bruce W. Ford
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 land lording 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, spend able 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?
