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?
About the author:
Bruce W. Ford is the editor of Rehab-Real-Estate.com Get
his important Special Report entitled "12 Things Real
Estate Investment Gurus Won't Tell You" at
http://www.Rehab-Real-Estate.com
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