Happy Friday, happy people!
About 6 months ago, I wrote a blog post about plans to downsize my real estate assets. Specifically, the plan was to sell some physical rental properties and move that cash into more passive investments.
Well, the mission is now half complete! We’ve sold 2 rental properties so far and have 2 left to go. Woohoo! 🎉🥳🎊🍾
Sale #1 proceeds –> about $35k
Sale #2 proceeds –> about $50k
These properties were joint partnerships with other investors, so the $$ proceeds represent me and my wife’s cut of the deal.
I’ve been getting a bunch of questions about the sales and learning stuff along the way, so figured I’d share some of these in an update post. Here you go!
Recap: Why we’re selling rentals…
First, here’s why we want to sell (or you can check out the original post here for full info: Why we’re transitioning away from rental properties). Main reasons are:
- I don’t find it fun anymore. I know, I sound like a complain-y spoilt brat. But my new goal in life is to slowly shed the activities I don’t enjoy → to make more room for the stuff I DO enjoy.
- My asset allocation is out of whack. We’re trying to downsize the real estate portion of our portfolio and increase our exposure to stocks.
- It’s not “passive” enough. In hindsight, this is probably my fault… I bought run-down shit box rentals that need constant maintenance. Some real estate is passive, but the physical properties I’m selling are not.
- Some of my properties are sub-performers. I think we can make a better return on our money elsewhere in the long run.
- Owning 20+ doors is emotionally draining. You’d think that the more properties you own, the thicker your skin grows… I’m somehow doing the opposite. My skin is getting thinner, probably because I am a wimp.
- I don’t like holding so much cash reserves. My thoughts on holding cash are changing.
- We can always buy more (or other types of) real estate later. We are not anti real estate! We just want to downsize our *physical* RE assets. We can still invest in other types of RE later, for example, syndication deals.
OK, now let’s get to some questions I’m receiving, and some of the stuff I’ve learnt through the sale process…
Where I’m investing the sale proceeds —> VTI
So far, we’ve just been dumping all the money into stock market index funds. In March we bought $35k of VTI, then again in June we bought another $50k of VTI after the second property sale. Our plan is to continue this with the next 2 properties.
I must admit it’s kind of scary putting money in the stock market while it’s at an “all time high” and so volatile! But, I’m practicing what I preach: You can’t time the market! And investing at all time highs usually has a better outcome than waiting for a big dip to buy.
Investing in the stock market solves a few problems for us… First, it helps shift our asset allocation out of real estate and into more equities. Next, it fits in with our long term goal to have more passive investments. The money that we invest we never have to touch or really even think about, ever again!
Selling during a “hot real estate market”…
I’ve been hearing this a lot lately… “Now is a great time to sell real estate! People are making ridiculous offers to buy property, way over asking price!”.
While yes this is probably true — it’s a sellers market right now — it’s important to understand the difference between residential home sales (the buyer wants to live in the place, driven by needs and emotion) vs. income rental properties (the buyer is an investor, motivated by ROI calculations).
Since the properties I’m selling are fourplexes (4 units all under 1 roof), the buyers interested in my props are mostly other real estate investors. They value the property based on the rental income it can generate from the 4 units (or 3 units if they want to move into 1 of them). While inexperienced or impatient investors might be willing to overpay a little for rental properties, most well-studied real estate investors won’t pay ridiculous prices.
So the best way I can boost my property sale values is to raise the rents for all the tenants within the units. This is much easier said than done! My property manager was able to do a little bit of this over the years, but not as much as what we hoped or initially projected.
Anyway, I just wanted to explain why we’re not making as much profit as people think we’re making. Not all real estate is equal! This current “hot market” gave us more interested potential buyers and a slightly shorter sales cycle, but not necessarily a huge increase in sale prices.
Selling the properties as a “bundle”…
A couple of people asked why we didn’t just package all 4 properties into a bundle and sell them as a group. This would’ve been the quickest way to get rid of them all.
But there were a couple challenges with bundle selling…
First, we didn’t know how many properties (or which ones) we even wanted to sell first. When there are multiple investors involved, making decisions takes a long time because every person has a different opinion. So at the beginning of the year, we really only agreed on selling 1 property to start with. Then the plan evolved from there.
Also, we realized that bundling our properties for sale isn’t really in our best interest financially. The type of people who buy packages of investment properties are more experienced investors (we prefer beginners that don’t negotiate as hard) and also they are looking for a bundle discount.
Since we’re not in a rush to sell, there’s no reason to give buyers a bundle price discount when we can sell the properties one by one for the best price we can get individually.
Boring Tax Stuff…
Here are some questions I got about taxes and how that might look this year for me.
“Have you thought about doing a 1031 Tax Exchange to defer capital gains?” —–> No, not really. Our goal is to get away from physical properties, not get into new ones. I have heard of some groups that allow 1031 exchanges into syndications, but since I’m transferring from joint ownership, I’m not sure how this would work.
Also, given our probable tax bracket this year, my wife and I might be able to avoid some capital gains altogether. (My partners might be in a different situation, but my wife and I will have pretty low income this year, so locking in small cap gains is OK with us).
“Don’t forget to set some money aside for depreciation recapture” —–> Absolutely! My partners and I have a reserve account with money set aside for estimated taxes. Since our gains weren’t too big and we only owned the places for 3-4 years, we don’t have a too hefty bill.
(For those of you who don’t know what depreciation recapture is… When you sell a property that has provided you depreciation benefits or tax offsets in the past, the IRS will recapture that benefit by charging you for gains made when you sell. The only way to avoid/defer depreciation recapture tax is to a) do a 1031 exchange or b) sell the property at a lower value than you bought it minus depreciation – neither of which make sense to us.)
“Who pays the taxes for joint partnerships?” —–> For the properties that are in LLC’s, the LLC entity itself files it’s own tax return and “passes through” the tax liability to the members of the LLC through a K1 statement. All the LLC members file this K1 statement with their personal return. This splits the tax responsibilities fairly between the LLC members in proportion to their ownership percentage.
For properties that are in joint personal names, each person just claims their split percentage of the property on their personal return.
For example (in either scenario) If you own 50% of a property, you report 50% of the income, claim 50% of the deductions, get 50% of the tax benefits, etc.
Setbacks, mistakes, and dirty dealings…
One setback we had on the first sale was a small water heater leak we noticed 1 week before closing. A repair man was at our property fixing an unrelated issue when he noticed a little bit of water in the drip-pan of a water heater. Being a good repair man, he reported this issue to my property manager and said we might want to get it checked out.
Since there was no real problem (yet), we could have just proceeded with the sale and turned the keys over to the new owner and made him fix the issue when he took ownership. But, that would be unethical (and probably illegal) because as a seller we are bound to disclose any known issue with the property to the buyer prior to taking ownership.
So we fully diagnosed and fixed the issue, which cost us ~$1000 out of pocket for a new water heater. It sucks to buy brand new appliances for another investor, but I couldn’t in good conscience hand over known potential faults. I never want to compromise my values for money – it’s not worth it!
Speaking of unethical dealings, we had a strange transaction with a realtor that I didn’t feel was 100% above board. Long story short, we were in negotiations with a potential buyer that fell through… and somewhere within our negotiations we exposed our “rock bottom” price that we would sell for. After the deal fell apart, we immediately received a different offer from that buyer’s own broker! (not their specific agent, another realtor in their office). It was for the exact same ending negotiation price we were settled on with their client just days earlier.
The reason I felt this was unethical is because I don’t think agents are allowed to share confidential negotiation details with other agents and use it for personal offers. It really put a bad taste in my mouth. After I raised a red flag, the broker denied doing anything unethical, and that offer fell apart shortly afterwards.
Anyway, this event (and a few other small things in the selling process) reminded me that real estate has many grey areas, and there’s a lot of room for greedy individuals to take advantage during the buying/selling process. It’s sad that this happens, but all I can do at the end of the day is to continue doing business the most ethical and responsible way I know how.
Oh, one last shitty thing that happened (and this was my mistake) was that I promised one of the buyers some repairs as part of our contract negotiations… And I grossly underestimated the repairs costs. This ended up costing my partnership about $2700 extra, which I feel horrible about. Thankfully, we still made some great profits on the deal and all was forgiven in the end. My main lesson here is to never promise paying for repairs based on someone’s word – always get written quotes and second opinions for everything before agreeing to pay.
Windfalls and bullets dodged…
One cool thing that happened during the first sale process was an unexpected insurance claim. The buyer asked us to get a new roof as part of the sale contract, and we agreed, building that into part of our planned costs (It was about $6000).
But just before we got the roof replaced, someone suggested I file an insurance claim because there was a hail storm recently that might have done some damage to the roof. If there was evidence of any hail damage, we might be able to get insurance to pay some of the replacement cost.
We didn’t know if the claim would get approved, but there was no harm filing one anyway since the property was being sold. It took less than 1 week to file the claim and get an adjuster out there, and lo and behold they found some damage that was covered under our policy. So all in all we only paid about $3k for the roof replacement instead of $6k. A nice unexpected profit!
One other dodged bullet was some tenant issues that happened *after* the sale of a property…
My property manager caught wind of some tenant problems (missing rent, bad behavior, etc) a few weeks after the sale of a property. Since the new owner inherited our existing tenants (willingly!), this was now their problem to deal with. If we had never sold the place we’d be dealing with that mess now, which sounds like a real headache.
All in all, our long term plan is working out…
So far, we’ve gotten rid of 2 properties, and I can’t tell you the weight that’s been lifted off of my shoulders. My partners and property manager feel the same!
Since moving the sale proceeds to index funds, we’ve had zero headaches, and even some great gains so far!
Next step is to sell 2 more buildings we’ve mostly agreed to list. I’ll keep y’all updated as we go along!
Got any questions I didn’t address? (sorry, can’t disclose specific sale/profit numbers due to partner reasons – but happy to tackle all other questions!)
Have a great day!