Most people who sell their rental property want to make money. The goal of what to do with that money varies, but the first goal of making money (or at least not losing money) remains the same. Did you know that you can make more money on the sale of your rental property by following a few simple guidelines? We'll show you how to make the most money when selling your rental property in this guide.
Follow This Process to Maximize Your Profits
If you're still on the fence on whether or not you should sell your property, we've got you covered. In this guide, we'll discuss when selling a rental property makes sense, how to prepare your property to sell for a profit, how to save on sale costs, how to avoid taxes, and what to buy next.
Determine the Right Time to Sell
Deciding whether or not to sell a rental property is a gigantic task.
You waffle back and forth between selling and not selling, analyzing your goals over and over again. There are lots of reasons why people want to liquidate their rental property, but not all of them make the most sense. Here are a few instances when it makes sense to sell a rental property.
You Need Cash
Most of us have been in a bind with money. Maybe you just started a new job that doesn't pay you for a few weeks or you're going to school full-time and are living off of loans. There also might be unexpected medical bills or other personal disasters or finances you simply haven't planned for.
You could also need the cash for something you did plan-- like building your dream house, taking a luxury vacation, or funding a mission trip. Regardless of the reason, selling your rental property to have access to that cash makes sense.
Before you do it, however, you'll want to make sure it makes the most sense to sell the property, or use the proceeds to fund your personal expenses.
Think about it: Let's say you purchase a duplex for $200,000 and charge about $3,000 rent each month. After monthly expenses and saving some money, you make about $1000 per month.
Now let's say you want to sell it. You put about $40,000 down on the duplex initially, got a loan for $160,000 and paid it down to $145,000. The duplex is now worth about $250,000.
If you sell now you'll make back your initial investment of $40,000, and make a profit of about $65,000. Of course, out of that $65,000, you'll have to pay a real estate agent and other fees.
It'll take you about five and a half years of renting it out to make a profit of $65,000. Do your personal reasons for needing cash amount to more than $1000 per month? It may be worth waiting to take that trip or build that house if you can rent it out for that much and still make more money off of the property afterward.
Make sure you consider your options carefully.
You Want to Grow Your Portfolio
Another reason you might be looking into selling your rental is to grow your portfolio. You may have purchased a good little rental property in the beginning, but the equity in the house can now be used to buy a bigger property.
Growing your portfolio is a great way to see a compounding effect on your profits, as many have seen. There are several ways to grow your portfolio by selling your rental property.
You can sell the property, pay the taxes and fees, and then use the profits to purchase a larger property. This is a great way to build your portfolio with other investors. You can take the profit from the sale and pool it into one larger investment with several shareholders. Many investors use this strategy to purchase apartment buildings or other commercial entities.
Another way you can grow your investment portfolio by selling your rental is by exchanging that property for another one. This has many benefits as well as specific protocols to follow, and we'll discuss them below.
Still another way you can grow your portfolio by selling your rental is if you have used part of your rental as your primary residence for two or more years within the last five year period. You can then write off the taxes, get your profits out, and use that to buy into more investment properties.
Your Return on Equity is Dropping
If your Return on Equity starts dropping below that 15-20% mark, it may be a good idea to sell the property. It can drop by getting a lower monthly income from the property, or if you have to take out a bigger loan on the property to do repairs, etc.
Prepare Your Property For a Profitable Sale
There is a lot of work that goes into preparing your rental property for a profitable sale, especially if you've been holding onto it for a while. Consider these factors when making sure your house property sale is profitable.
Vacant or Not?
Whether or not to kick your tenants out (or get new ones!) when selling is a question often mulled over by many investors. The answer to this question largely resides on the type of rental you are selling.
Most people looking to buy a single-family home are people looking to live in it themselves. They don't want a house where they'll need to evict the previous tenant.
Beyond that, showing a single family rental with a family still renting it makes it less desirable for people who are planning on living in it as their primary residence. Tenants have a reputation for being harder on the house than an owner who uses it as their primary residence. Make the house more desirable by having the property vacant when you are going to sell it.
If you are selling a multi-family property such as an apartment complex or duplex, make sure you have tenants. Investors looking into multiple units like so see minimal vacancies because it speaks to what their future as owner of the property will look like.
Help paint the picture of the success new owners could have by getting quality tenants in your units. If you can show them on a longer-term lease (at least a year), that's even better. New owners like to know that they'll have a minimal amount of work to do coming into their new investment.
Increase the Rents in Multi-Family Properties
Beyond having the property as rented out as possible, you'll want to make sure you're charging your tenants at least fair market value.
Higher rental income = a higher cap rate. Since the cap rate is listed on the property listing on the MLS, investors will seek you out if yours is high.
To determine the fair market value of rents in your area, complete a CMA. Look at rental properties similar in property type and location to yours, and see what they're renting out for. The demand for rental properties will also factor into the price of rent.
What Renovations Add Value
If you've been hanging onto your investment property for quite a while, chances are some updates are in order. While it seems a bit counterproductive to put more money into an investment you want to sell, there are a few renovations that you'll want to consider.
Update the kitchens and add significant value back into your pocket.
The kitchen is the room many buyers pay the most attention to when looking at a space. The trick is renovating what will add true value back into your investment.
Many people go overboard when renovating for a sale. When determining an amount to spend on the kitchen renovation, try to keep it between 6 and 10 percent of the property value. This will ensure that you make back about a 70% return on investment.
What updates do you make? Stick to the basics, then appeal to your audience.
Paint the cabinets and replace the countertops. Update the appliances and flooring as well, if needed.
If you are trying to appeal to a higher income market, make sure your updates match. Granite countertops, wood flooring, and stainless steel appliances will go a long way in helping you recoup your costs.
Updating the bathroom should be fairly easy and nets a good return. A little paint goes a long way, but a new vanity or water spigots couldn't hurt, either. If you are living in a tougher market or have space, you may consider adding a bathroom to one of your units to make it more appealing to buyers.
Odds and Ends
Adding a fresh coat of paint and updating the flooring adds value back into your pocket as well. Make sure the walls are a neutral color, and the carpet is one that will hold up after many tenants.
Make sure you make any repairs that need to be done as well. Things, like patching holes in the wall, replacing broken glass, and fixing the squeaky door, will help the house feel taken care of.
Stay Away From...
There are a few renovations that will not add value to the home.
Specialty furniture and storage spaces are one of them. Dropping three dollar figures on fully extendable drawers in the kitchen, for example, may get you a few impressed noises, but it won't add significant value to the home.
You'll also want to stay away from trends-- such as an accent wall or themed rooms. Everyone has their own tastes, and if buyers see a lot of renovations that they've got to make right off the bat, they're not going to want to buy it.
View Your Investment As A Product
After owning a piece of property for so long, you may have an emotional attachment to it. In the end, though, remember that this is a product designed to help you meet your financial goals. Remembering that will help you treat it like a product when negotiating a sale and brokering a deal.
You'll need to remember this as you increase rental rates, complete unbiased renovations designed to get your money and pick a buyer.
Save on Costs When You Sell Your Rental Property
There are multiple costs to expect when you sell your rental.
Whenever you close on a property, you can expect some form of closing costs. Here is an example of the closing costs you can expect:
As you can see, many of the line items are pro-rated taxes and bills. Depending on which time of the month you close, you may be credited a portion of your monthly bills back, if you prepay them. There are also fees associated with the title exchange.
The total closing costs are deducted from the equity made on the house. In this case, the closing costs (after the loan was paid back) came out to $15,582.24 or roughly 5% of the sale price.
Investment properties typically see a higher sale price when you list with a realtor. It's another expense you have to factor in, but the services more than make up for it.
Choose a realtor who works with investment properties like yours specifically for the best results. Those realtors will often have connections investors who are looking for properties similar to yours. They'll also be able to give you pointers on renovations to make and things you can do to get the best price.
Real estate agents provide services such as:
- Completing a Competitive Marketing Analysis (CMA)
- Pricing your home effectively
- Marketing your home-- both on the internet and using other tactics such as signs, newspaper listings, open houses, etc.
- Negotiating price and conditions
- Being present throughout inspections and appraisal
Realtor fees typically range 2.5-3% per agent. The seller usually pays these fees and pays not only for their agent but also the buyer's agent. This brings the total commission rate to 6% of your sale price.
Investment properties (specifically multi-family) can generate quite a profit, and 6% is often a huge chunk of that profit. While it's worth paying for a local expert to market your home, you don't have to pay full price to get the services you are looking for.
Flat-Fee Real Estate Agents
Flat-fee real estate agents like those at Clever complete all of the services a traditional real estate agent would, but without the traditional price. Clever agents are experts in your local market-- meaning they know the pricing trends and how to get the right people interested in your property. They also come highly rated from people in your area who have used them.
Clever agents charge the flat rate of $3,000 or 1% for properties selling for $350,000 or more. That means you could save 2% of your sale price without cutting back on service.
As we lightly brushed over earlier-- there are taxes attached when you sell your property.
Long-term Capital Gains
Long-term Capital Gains Tax is a tax on the capital gain you make from selling your property. The capital gain is anything you make off of the top of your initial investment.
If you purchase a home for $200,000 and sell it a few years later for $220,000-- the gain would be $20,000. With capital gains tax, you could end up owing up to 20% of the profit you made.
The exception to long-term capital gains tax is if you used your rental property as your primary residence. If you've lived in your rental property for at least two out of the last five years, you can write it off of your taxes up to a certain profit amount. Those filing taxes as single can write off as much as $250,000 profits on capital gains. Those who are married, filing jointly can write off up to $500,000 of capital gains.
Short-term Capital Gains
If you buy your property and sell it all within the same year, you will pay short-term capital gains tax. The profit you make from that property is taxed as income based on whichever income bracket you fall under.
If you make quite a bit of profit off the property, the short-term capital gains tax shouldn't phase you too much-- although it could be quite a bit of money. The smaller the profit, though, the larger the pinch on your wallet.
Avoiding Capital Gains Tax
There is a way to not pay capital gains tax. It's perfectly legal and truly is as good as it sounds. It's called a 1031 exchange.
1031 Exchange refers to tax code 1031 which allows you to defer taxes when you exchange the property for like/kind properties.
In plain English, this means you can take the profits you make from selling your investment property and put them toward buying up to three similar investment properties without paying taxes on it. Pretty cool, right?!
You can use the 1031 exchange as often as you'd like, too. Exchanging your lower performing properties for up to three larger properties with each exchange.
Many investors use the 1031 exchange to build their portfolio and avoid paying taxes on the sale. In fact, you can really just keep exchanging until you die and pass down the portfolio to your loved ones. Often, in a scenario like that, they won't have to pay the tax accumulated if they choose to liquidate the entire portfolio.
Rules of 1031
There are rules to follow when completing a 1031 exchange, and you'll want to talk to a real estate agent experienced in 1031 exchanges before you try to complete one.
1. Like/Kind Property
The properties you are exchanging must fall under the like/kind classification meaning they are the same type of asset. For example, you cannot exchange stocks for a commercial real estate property. They are two separate assets.
Here are some examples of what you can exchange:
- A duplex for a cafe
- An office building for a series of vacation rentals
- A single-family rental property for a multi-family rental property
2. Greater or Equal to Value
When completing the exchange, you can only exchange your property with one or more properties that are greater than or equal to the value of the property you are selling.
Let's say you want to complete a 1031 exchange for your duplex worth $300,000. You can only exchange it for a property or properties whose combined value is greater than or equal to the $300,000.
3. Investment/Business Properties Only
You can only use a 1031 exchange on investment or business properties-- not your residential property. While there are ways around this, for a single-family home that you use as your primary residence, using the 1031 exchange is a no-go.
4. No "Boot" Allowed
It would be such a dream to be able to exchange your property tax-free and have money left over to do whatever you'd like to. Unfortunately, that's not allowed.
When you complete a 1031 exchange, all of the money from the sale goes into a third-party escrow, then gets transferred into the properties. All of this is backed up with paperwork, leaving no room for even the teensiest bit to make it back to you.
5. Same Buyer
The exchange can only be completed by the one who owns the original property. Meaning if Tom Jones bought a duplex and wanted to exchange it for a quadplex, he could only purchase the new property in his name.
This rule can seem a bit confusing. Many people who start out investing don't open an LLC at the beginning, but will later in their investing period. To complete the 1031 exchange, however, the name on the deed to the original property must match the name being signed on the new property's deed.
6. 45-day Identification Period
This is where pre-sale homework comes into play. From the time your property comes under contract, you have 45 days to identify the property you are going to exchange.
It's a good idea to have several properties in mind before you list your property, just in case the sale happens fast.
7. 180-day Close Period
After you close on the sale of your original property, you have 180 days to close on your new property or properties. This process can go quick so you want to be on your A-game.
Increase Cash Flow
A great way to increase your cash flow is to buy a bigger property. Bigger doesn't have to be in size, though.
A bigger property can be any property that allows you to make more money. You may want to consider exchanging your...
- Duplex for a higher performing duplex in a nicer part of town
- Single-family rental for a quadplex
- Quadplex for a 12-15 unit building
- Multi-family house for a multi-purpose commercial building
To understand if it's a good exchange, you'll want to analyze a few things first.
Calculate the ROE
As you begin the process of selling your rental, keep an eye out for your next venture. The great thing about a 1031 is that it helps you get bigger, better-performing investment properties for a better price.
When looking to increase your cash flow by buying a bigger property, analyze the Return on Equity.
If you are an investor already, you probably already have calculated your return on equity. Here's a refresher for those who need it.
Return on Equity is where you take the net income and divide that by the total equity of the investor, and multiply that number by 100. Here's an example.
In the example above, you bought a duplex for $200,000 after putting $40,000 down on it. That $40,000 is your equity stake. If you make $1000 per month, you'll net $12,000 in one year. So we'll take your net income ($12,000) and divide that by the total equity you own ($40,000), and multiply it by 100. ($12,000/$40,000)100= 30%.
This means, that for every dollar you put into your duplex, you receive 30 cents. A good ROE is usually between 15-20%.
Purchase a Larger Property
We don't have to tell you that more units= higher rental potential. There are many benefits to purchasing a larger investment property.
When you own your first few properties, you get your first taste at what your passive income potential is. You're able to pay off properties faster, maybe even have some help with your monthly mortgage payment.
If you use the profits from your rental to put a down payment on a bigger, higher performing property, that ROI and ROE that you saw in your first investment can be compounded. You could be bringing in five times the income your first rental was generating.
More Sway With the Property Manager
Property management companies are often more attentive with larger properties. It's worth more of their time to respond to tenant complaints, property issues, and repairs.
While you can have a property management team with smaller rentals, property managers typically treat your tenants in your larger properties the way you would treat them.
If you have a vacancy in a smaller property, it can affect your cash flow quite a bit.
With larger properties, however, a vacancy here and there isn't something to panic over.
In fact, with a larger property like a commercial office space, you can get your tenants in longer leases and worry even less about vacancy.
Home Buyer Rebate
Clever can save you money while you sell your rental property, but we can also save you money when you go to buy a new one. Many buyers who choose to go with a Clever agent can receive up to a 1% rebate. That 1% can be used to spruce up your new rental or it can simply go back into your pocket.
Getting a bigger bang for your buck on the sale of your rental doesn't have to be difficult.
Determining the right time to sell is the first step. Some reasons to sell might be because you need the money, you are wanting to increase your portfolio, or your ROE is dropping.
Preparing your property for a profitable sale is the second step.
Remember: vacant single-family homes sell well, but having tenants in multi-family homes increases your chances of selling for a good price. Increase the rents on your multi-family properties to fair market value to show the best cap rate. Renovate to add value to your properties, but stay away from updates that do nothing for your sale price. Don't forget that your property is a product-- treat it like one when selling it to help you make the best business decisions.
The third step is to save on costs. When selling your house, costs can add up fast. Save by using a Clever agent who charges a great flat rate for high-quality service.
The fourth step is to avoid taxes. You can avoid paying taxes on the property by 1) living in it for two out of the last five years, or 2) completing a 1031 exchange. There are rules to the 1031 exchange, so make sure your property follows those rules.
The fifth step is to increase your cash flow by calculating the ROE, buying a larger investment property, and using a Clever agent to get a buyer's rebate when you purchase your new property.
This process can be a lot to remember, and sometimes difficult to figure out. Having the right agent helping you along the way to ease the stress and walk you through it makes all the difference. Using a top agent doesn't have to be pricey, though.
Make the most from the sale of your rental by using a Clever Partner Agent. Our top, local agents are already experts in selling in your area, so you don't have to be.