I used to like the idea of holding on to properties forever to collect rent, but my view has changed recently. The main reason is that while collecting rent every month and seeing my bank account inflate is lots of fun, it’s also taxable at my income tax rate. In contrast, capital gains in this country is tax-free, and who’s to say seeing a lump sum in the bank is any less fun?
Some may protest that they may not be able to find a replacement investment to put their money in, and with inflation numbers running up and interest rates so low, they’re losing money by the day. I would argue that there are ALWAYS under-valued properties for sale, but you have to find them and they must fit your profile. Some are hard to find, while others may not fit your criteria or budget. You just have to do your homework, or get a good agent to do it for you.
A lot of people spend a lot of time researching when they are buying an investment property, but neglect to think as hard about selling it. Perhaps they wanted to keep it forever for rental income like I did, or they think that they would just think about it when the time comes. However, when the time comes, owners tend to over-estimate the value of their property, which leads to the situation where they are always asking for above-market prices which don’t get done. Owners are left holding on to property which may be growing in value but the value is not easily realisable.
Therefore, I argue that there is a need to think about your exit strategy. As an example, when I am deciding whether to sell a property, I make my judgement based on certain criteria:
1. Seller’s Stamp Duty: For residential properties, sellers have to pay additional tax if they sell within the first 4 years of purchasing the property. The amounts are 16% on selling price in the first year, 12% on selling price in the second year, 8% on selling price in the third year and 4% on selling price in the fourth year. This measure was put in to extend the holding period of properties and to discourage “flipping” activity which is seen to be one of the main causes of a property bubble. As such, I look to keep investment properties for at least 4 years because I don’t like to pay more taxes than I have to.
2. Age of property: I estimate that for most properties will need to be overhauled at the 15-year mark, given normal wear and tear. That’s when the “original condition” property will show signs of catastrophic failure. Appliances will probably fail earlier, around 10 years old, but those are relatively cheap to replace. What I’m talking about are the electricals, waterproofing, plumbing, and other pipings, that require major hacking of the walls and floor. As such, the closer I get to that milestone, the more likely I am to sell the property.
3. Softening rental yield: It could be that price is catching up with earlier rental increases, but this raises a red flag for me. Price rises with stagnating rents mean lower yield, and in my book, once it hits a lower limit of yield, it’s time to sell, simply because someone who buys from me will not be able to cover his mortgage payments with rent. It may also be a leading indicator that the market is about to weaken. However, there is an exception to the rule, which is if it rises due to en bloc potential. There are other investors who are willing to pay more for the chance of high profits afforded by en bloc cases. In this case, it bears waiting for a while, but I’d still prefer to sell to lock in my gains once prices exceed my threshold. Sometimes $500k in my pocket is worth more than $800k of en bloc potential.
4. Target growth rate: I set for myself a target annual growth rate for the value of the property. For example, if I set it at 4%, then at the end of 5 years, when I’m ready to sell the property, I want to sell it for at least 20% more than what I paid for it. Having a target like this helps me to define where my bottom line is when I receive offers. Note that this growth rate is on the value of the property and not on capital outlay. With an 80% loan, your return on cash is actually 100%!
5. Appearance of a great deal: In the serendipitous event that an irresistible deal comes along, and I have no additional funds to take advantage of it, then I may consider selling an existing property to finance it. However, I will have to do thorough evaluations to make sure that it is well worth it after all the costs involved.
I’m definitely not saying that you should follow my criteria. After all, everyone has their own investment goals. What I’m trying to impress upon you is that if you intend to sell your investment property eventually, you should put some thought into your exit criteria or strategy. By having such a thought process going on, you will be able to make more objective decisions about your investment property.