What should i do with the money when i sell my rental property

Your rental property was once a great source of passive income. Now it’s a maintenance headache with minimal profit. What should you do? Just because most real estate investors opt for the “buy and hold” strategy doesn’t make it right for you —  especially if you believe your money could be better invested elsewhere. 

Most homeowners look at housing market trends to determine the right time to sell, but there are additional factors at play for rental property owners. Before you decide to sell your rental home, you’ll need to consider economic factors, your personal financial situation, maintenance needs, taxes and more. In this article, we’ll answer common questions rental property owners ask themselves before deciding to sell. 

Should I sell my investment property in a sellers market?

Yes, you should sell an investment property in a sellers market if the profit you earn will outweigh the future property value growth and the passive rental income you’ll miss out on by selling. In a sellers market, conditions favor sellers with faster sales, fewer price cuts, and offers very close to or even sometimes above asking listing prices. While it’s impossible to forecast future market conditions precisely, here are a few factors that might make it the right time to sell. 

I have substantial equity

If you bought your property years ago for an affordable price without much renovation, and if you’ve seen significant appreciation since then, it might be time to cash out and access your equity. 

There’s no telling how long prices will stay high, so if you can profit today more than you ever expected, that’s a strong sign that it’s a good idea to list. 

Buyer demand is high right now

If your local area is seeing a large influx of buyers, perhaps because of significant job growth, you might consider selling now while demand is high, in case it fizzles in the future. 

I plan to sell soon anyway

A few more months of passive income is beneficial, but if you’ve been thinking about selling in the near future anyway, it can be smart to sell when you know you can fetch a high sale price. After all, if you wait and have to sell at a lower price down the road, those monthly rent checks may not have been worth it. 

Should I sell my rental property when rent prices drop?

Yes, it’s best to get ahead of price drops. Instead of waiting until it’s too late, pay attention to your local market trends to predict when rental prices will drop too low to cover your mortgage, tax and maintenance costs. An oversupply of rentals in your area is one reason rent growth stalls. A flood of rental housing on the market doesn’t necessarily mean rents will drop, but if supply outpaces demand, your rental growth could diminish as the rest of your costs rise. 

Fortunately, rent growth is up in most major markets. According to Zillow research, rents are increasing 2.7% annually in the U.S. as a whole. But trends can vary regionally. Watch for the following market conditions that could lead to less rent growth over time. 

Influx of new construction

Pay attention to residential construction in your area. If developers are focused on building rental housing, that means demand is high. But once those thousands of units flood the market, there may be more supply than demand, causing rent growth to stagnate or drop. 

Low interest rates

Low interest rates can help make home ownership more affordable for some people who are currently renting, potentially driving down rental demand.

Should I sell my investment property because of a low cap rate?

Yes, a low cap rate is a persuasive reason to sell. Most, if not all, property investors use cap rates as an indicator of how strong their investments are and to calculate their cash flow. You probably did a cap rate calculation when you first purchased the property, but you should calculate it again to see where you stand now. And make sure you compare against other investment opportunities, in case you can make a better return elsewhere. 

What is cap rate?

Cap rate is a calculation used to determine an investment property’s profitability. A high cap rate would happen if you purchased a property for a small amount of money but you rent it for a high price. High cap rate is usually indicative of a good deal. What is considered a good cap rate depends on where you live. In a large city with high rental costs, 4% can be considered cap rate. In rural areas or regions with lower rental costs, a cap rate can go as high as 10%. 

Rental income should increase faster than your operating expenses, which would raise your cap rate over time. But sometimes cap rates fall, and investors consider selling. 

How to calculate cap rate

Cap rate is your net operating income (gross rental income minus expenses) divided by your purchase price. 

Your cap rate should be calculated based on annual figures. Your gross income is all income you get from your renters. Operating expenses include things like insurance, taxes, maintenance and property management fees. Here’s an example:

• Purchase price: $100,000
• Gross annual rental income: $12,000
• Minus annual expenses: $5,000
• Gives you a net operating income of $7,000
• $7,000 net operating income divided by your purchase price gives you a cap rate of 7%. 

The higher the cap rate, the higher the reward. You might be tempted to sell one rental property to buy another one with a higher cap rate. But keep in mind that cap rates fluctuate based on market conditions. A hot deal today with a 10% cap rate may be reduced if the rental market slows.  

Should I sell if my investment property needs repairs?

Yes, you should sell your investment property if the cost of necessary repairs is too much of a financial burden. When estimating maintenance costs, consider both expected and unexpected expenses. 

Calculate age of appliances

Even if none of the appliances require immediate replacement, some of them might be due for serious repair or replacement over the next few years. If you can’t afford the cost of several upgrades, especially if they’re big-ticket updates like a furnace or a new roof, then you might want to sell while they’re still in decent shape. 

Factor in special assessments

If your rental property is under a homeowners association (HOA), consider any upcoming special assessments that could severely impact your net profits. For example, if your HOA is considering a new roof in the next few years, it could cost $20,000-$30,000, depending on your share of ownership in the building. 

Consider buyer needs

While selling now could help you avoid longer-term repair costs, there may be things a buyer wants repaired as a condition of buying the home. If you can’t afford to do the repairs and updates that will make your home appeal to a traditional buyer, consider offering a buyer concession. This essentially gives the buyer some money out of your sale proceeds to do the repairs on their own, but you won’t have to pay out of pocket or manage the repairs yourself while there are renters in the home.   

Do property taxes determine when to sell a rental property?

Yes, property taxes are part of your monthly expenses and ultimately your cap rate, which is a strong indicator of profitability and timing to sell. High taxes could minimize your profit and make selling worthwhile. If you do decide to sell, you could consider investing in a different market with lower property taxes. 

States with the highest effective property tax rates are New Jersey (2.25%), Illinois (2.22%) and Texas (2.18%). In 2018, property taxes on single-family homes jumped 4% nationwide. Dallas saw an 8% increase, LA increased 5%, and Washington, D.C., was up 4%. 

Will I owe capital gains tax on a real estate investment property?

Yes, depending on your income, you may owe capital gains tax on the sale of an investment property. Unlike a primary residence where you are exempt from capital gains up to a certain threshold, investment properties are not exempt from capital gains at any amount. If you turn a profit on the sale of your investment property after owning it for a year or more, you’ll owe long-term capital gains taxes at a rate of 0%, 15% or 20%, depending on your income and filing status. 

If you’re filing under a different status, capital gains tax rates can be found here.

There are a few strategies you may try to minimize your capital gains on an investment property. If you choose to explore one of these options, always consult your tax professional. 

Subtract losses

Losses from other investments should be included on your annual tax return to offset capital gains from the sale of the property. 

Do a 1031 exchange

A 1031 exchange allows you to defer taxes by swapping one investment property for another. This kind of transaction, while complicated to execute, can be worthwhile if you’re planning on purchasing a different investment property within 180 days or before your income tax return is due. 

Turn the investment property into your primary residence

If you convert your rental home into your primary residence, you can avoid capital gains taxes, but it’s not a quick fix. You’ll need to live in the home as your primary residence for at least two years of the past five before you can qualify for an exclusion of $250,000 in profit for single filers and $500,000 for married filers. 

When is selling a rental property a good financial move?

Selling an investment property makes the most financial sense when you plan on using the profits to invest in a stronger opportunity or to diversify your portfolio. 

Here are some instances where it may make financial sense to sell your rental property. 

I found a better passive income opportunity

Better investment options could be the stock market, a real estate investment trust (REIT), bonds or a different property with a better cap rate. 

My net worth is strongly tied to one property or portfolio

If the majority of your net worth is tied up in one single property (like one rental home) or one portfolio (like rental property investments in general), you’re not sufficiently diversified. If the housing market bottoms out, your entire financial health could be in jeopardy. If you have too much of your money in real estate, it may be worth selling to make way for a more diversified financial portfolio. 

Am I still satisfied with my investment?

Whether an investment makes sense for you isn’t just about the finances. You need to consider the non-financial impacts as well. Owners in these circumstances may be wise to sell.

I’ve undergone a major life event

You may need to access the equity in your rental home because of a health issue, a new member of the family or some kind of financial emergency. Or you may just be too busy to properly manage the investment, perhaps because you have a new job or are being relocated far away from the property. 

I can’t handle the maintenance and hassle

Simply put, if being a landlord, dealing with tenants and managing maintenance is too much of a headache, the money isn’t worth it — it might be time to sell.