When To Unload That Investment Property

Wondering when to flip that house, especially in a cooling housing market? As many markets are softening here in Florida and throughout the U.S., the speculators that helped fuel the boom are finding that they can’t quickly turn around and flip their properties for quick investment gains. Should they hang on and rent or should they bail out, possibly at a loss?

Selling your investment property is likely the best strategy, according to columnist Jonathan Clements of the Kansas City Star.

If you have no choice but to sell, then you ought to sell quickly. Take the rental income on your investment property and subtract costs, including the home loan, insurance, maintenance and property taxes. If the house or condo is a sizable cash drain and there’s no way you can cover the shortfall, you clearly have a problem.

If you have a cash flow problem now, it could get worse really quickly. If you have trouble finding tenants or your tenants stiff you on the rent, you are out a lot of money and time. If the property is a drain now, imagine how grim things could get without any rental income.

To make matters worse, Florida’s many speculators could be hit with rising borrowing costs as the rate goes up on their Florida home loans, or, worse yet, the principal becomes due on an interest-only loan. Of course, the Florida housing market could perk up again, allowing you to unload at a profit. But that doesn’t look likely, at least not in the near future.

“I still don’t believe that we are at the beginning of a crash,” said Chris Mayer, a real estate professor at the Columbia University Graduate School of Business, “But people shouldn’t count on big appreciation in the future.”

Mayer noted that sales are slowing, which usually foretells a period of stagnant or falling house prices. Even if prices simply stay put, many speculators will be reluctant to sell homes and condominiums, because they will be taking a loss after the 5-6 percent commission.

This reluctance to sell at a loss helps explain why a slowdown in home sales typically precedes a price decline. As we are seeing in the Broward County housing market, sales are way down, yet prices are still climbing. In nearby Palm Beach County, they have dropped but very slightly. Homeowners have a target price and initially refuse to accept anything less.

But waiting to “get even, then get out,” as many investors strive to, could be a huge mistake. Not only will you cope with the property’s monthly cash drain, you also could be hit with leveraged losses. If you bought that Florida condo with a 5 percent down payment, all it takes is a 5 percent price decline to wipe out your home equity.

“When prices start to fall, they usually continue to fall for a while. You want to be aggressive in setting a price that allows the property to sell, rather than slowly lowering your asking price and following the market down,” Mayer said.

On the other hand, if you’re collecting a healthy amount of rent or you have a small home loan, the property’s income is covering your costs. But you may want to sell even then. The key question is if you could you earn higher returns by through other investment vehicles?

Over the past 30 years, real estate prices have outpaced inflation by two percentage points a year. But over the past five years, that margin has jumped to seven percentage points a year. The implication of this is that recent returns are unsustainable —- and modest gains may lie ahead.

Indeed, for today’s property investors, rental income is likely to be the biggest source of profit. Suppose you’re collecting rent equal to 5 percent of your property’s likely selling price. Meanwhile, assume your investment property’s price merely matches the 3 percent inflation rate.

Put it together and you have a respectable 8 percent annual return. The problem is that the 8 percent is before costs. Take the 8 percent total return and knock off the annual amount you spend on homeowners insurance, property tax and maintenance. Those expenses might amount to 2 percent a year or more.

“That gets your return down to 6 percent or below. Remember, you can get 5 percent on bonds. If you’re south of 6 percent on a risky, idiosyncratic investment, I don’t think that’s a smart investment,” Mayer said.