Part 1: Deciding to Sell
Posted on April 1, 2008 - Filed Under My Strategy |
Last week, some of you indicating that seeing numbers would help understand more why I decided to sell Project #2.
In order to clearly understand, a review of some history is in order. Along with a snapshot of my current financial picture. Upon finishing the article, the decision will be made clear as to why the decision was made.
Why Selling
It’s no secret that neither property has positive cash-flow. Property #1 is fully rented however it still has a negative cash-flow. This is due to the large HELOC. That money was used for two purposes.
- Pay off credit card debt
- Purchase Property #2
Using the HELOC to pay off credit card debt was still a smart move. Instead of paying nearly $700/month, the payment was reduced to almost $125/month with the added bonus of being tax deductible.
The rest of the HELOC went directly into Property #2. Both for the purchase and for the renovations. The purchase went smooth enough. The renovations did not. Large overruns and serious delays turned a three month project into a six month odyssey. To finish, a small HELOC was taken out on Property #2 and the rest was financed via credit cards.
The burden on my finances: Carrying one large and one small HELOC on both properties. Paying water, trash, etc for two properties each month. Credit card debt. On top of all that, add my personal expenses just to live. Car, cable, Internet, food . . .
This has stretched my finances. Purchasing another property, even in these market conditions, has become impossible. Unless the next property has stupendous positive cash-flow, all my negatives would wipe out any serious gains.
With all that being said: the finances forced me to ask some seriously hard questions. The biggest question: Do I remain in a situation with having two negative cash-flow properties OR do I jettison one property in preparation for the next property which will have positive cash-flow? If selling a property resulted in a loss of cash, would it still be worth it?
What do you think?
Tomorrow I’ll discuss the logic behind picking Property #2.
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6 Responses to “Part 1: Deciding to Sell”
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Selling a money-losing property, even if it results in a cash loss, is often a good idea. The value of this property is more likely to go down than up over the short term, reducing your ability to sell in the future. You are strapped for cash, and from your comments on your savings, you have virtually none. If you were to lose yeur job, you could easily end up in foreclosure or even bankruptcy.
Not every investment you make will make you money. No matter how carefully you analyze the investment, something you do not anticipate will affect the outcome. It doesn’t matter if the investment is a stock, a bond, a business, or a piece of real estate. Cash flow and yield numbers in a spreadsheet are based on assumptions about the future, not facts.
Real estate has a lot of risk as an investment. In a “normal” real estate market, investors demand a higher rate of return to compensate for having an illiquid investment dependent on leverage. The market over the last few years has been dominated by new investors that did not understand the risk. Now those people are being squeezed out.
Selling this property, even at a loss, reduces your risk. Deleveraging and reducing risk are key to surviving to invest another day. Just ask those investment bankers on Wall Street!
I agree.
I do have savings. My entry about the Bread Crumb Savings plan was my attempt at increasing my savings, not creating one. Add to that my investments in stocks and a few mutual funds and I’m doing alright.
Even if I lost every tenant in every property (all whopping 3 of them) I could get by for two months. If I can’t rent at least 2 properties within 2 months in a rental market with a 98% occupancy rate then I should just cash out now.
The thought that I could slip into bankruptcy has never crossed my mind. I refuse to dwell on it. This is about preserving the capital I have left and aligning myself into a better position for the next deal. A better one.
I don’t know your financial situation, but it sounds like you might be undercapitalized by my standards. Relying on long term stock and mutual fund investments as contingency funds is not something I would do. You might find the market down 25 or even 50 percent just when you need the money.
The rental market was at 98 percent occupancy the last time it was measured, probably two to three months ago. With accelerating job losses in a declining economy, it could drop under 90 percent in six to eight months. It’s happened before.
A more likely scenario than having to rent three units in two months is having one (or worse two) tenants lose their jobs or businesses and be unable to find new employment/income. The tenant quits paying the rent. When you go to evict, they file bankruptcy. Nine months after they file and a year after you stopped receiving rent, you finally get the tenant out. They leave you with $15,000 in repairs to make the unit rent ready and a big legal bill. I have seen this happen too.
I agree you should not dwell on bankruptcy. What I would do in your position is to prepare for a down market with lower rents and much higher vacancy and collection losses. I’m sure you have heard you need three to six months expenses in an emergency fund. A landlord with no net income from the rental property and a job that pays his living expenses needs that and a lot more.
Undercapitalized? You betcha, I am undercapitalized. I’m a beginning investor!
The mention of stocks and mutual funds was a “break glass in case of extreme emergency” statement. Along with my two months living expenses, I have the means to go a bit further if I decided to liquidate. But that would have to be an extreme emergency. By emergencies I’m talking about earthquakes, invasion by hostile poop-throwing monkeys, Twinkie shortages . . .
I honestly don’t have the time to concentrate on worst case scenarios. It’s a bit late in the game for me to prepare for my tenants all going “default” on their rent. The possibility that the occupancy rate may or may not drop to 90% is not something I will face today.
This is about mitigating risk, which is what I am doing. I won’t address a hypothetical problem until it becomes a real problem. Once a real problem exists, then it will be addressed.
Hi, Clifford! I agree that selling Property#2 would be in your best interest. There’s really no good time to be cashflow negative. I know lots of investors (actually speculators) purchased properties in the past specifically to cash in on the appreciation (they hoped) meanwhile paying into them every month. I’m pretty sure you didn’t set out to put yourself in this position, however. There’s absolutely no shame in taking your money back from Property#2. I’d say don’t delay in getting the property on the market!
Hello Trisha! This is definitely not the type of market to speculate in. I had sincerest hopes that Property #2 would be at least break even after the expenses. But that didn’t happen, due to multiple reasons, and now it’s in a negative cashflow situation.