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Why it’s OK to Sell Your Property at a Loss

It’s hard to admit that you messed up. It’s even harder to admit the mistake, have it cost you month after month, and then just walk away from it (in my case, by selling the property at a loss). It’s almost like fighting a gamblers impulse – if I just put in a few more dollars this machine will pay out.

I did it for years with one of my Niagara Falls Crackhouses (If you’re new to Rev N You – you might want to read about my two “no money down deals” that have done nothing but cost me!). After initially getting the properties for next to nothing, I shelled out a lot of money year after year for repairs, court fines and more repairs. I took out a line of credit to cover the extra expenses.

The area in Niagara Falls where the real estate investments are located has been improving. A very nice Motel 6 went up across the street. Land has been bought all around the area for new development. I kept thinking if I could just hold on to the property for a few more years I would hit the jackpot and be holding very valuable land. I thought if I just fixed it up, I would attract better tenants and would have an easier time with it. Bottom line is that I just kept thinking if I put a few more dollars in that slot machine I would eventually win big.

Here’s just a sample of the problems/issues I had with this real estate investment, and why I chose to sell at a loss rather than feeding the nasty slot machine:

  • It was costing me a lot of cash every month to service all the expenses;
  • It caused me and my wife considerable stress with all the problems it always seemed to have;
  • After my new property manager helped to evict the bad tenants, he couldn’t get good ones to replace them;
  • No matter how much work and refurbishing we did, there always seemed to be another problem;
  • Although the neighbourhood was getting better, it was improving at a snail’s pace.

Hopefully by reading Rev N You, you’ve learned enough real estate investing lessons that you don’t end up with your own crackhouses or troublesome properties, but if you do and you find yourself unhappily evaluating the situation regularly, know that it’s ok to sell your property at a loss, especially because:

  1. Assuming you make money on the sale of another property within the next seven years, the capital losses from the sale of the money-loser will make a nice good offset for capital gains you realize in the future.
  2. Continually throwing money at a problem waiting for it to magically become a winning investment is foolish. Yes, some people get lucky but hoping you are going to be a lucky one is not really a good strategy.
  3. Stress is bad for your health and for your relationships. If selling the property, even at a loss, will rid you of a lot of stress then it’s worth it. What good is building a big real estate portfolio to be rich from, if you’re not healthy enough to enjoy your wealth?
  4. Owning a negative cashflow property not only costs you money out of your pocket, but can hurt your chances of financing other investment properties because you may not be able to service the debt on the new property.

So, when the deal closed this month, we went out and celebrated it’s sale. We couldn’t toast with the finest wines or the best foods because that deal didn’t make us rich, but we could smile that our Niagara Falls Nightmare is over.

Don’t miss next month’s newsletter – sign up today! We will not sell or give away your name, so don’t worry about SPAM. And if you aren’t entertained, educated and enlightened by our newsletter, you can unsubscribe easily at the bottom of every email.

 

May 21, 2008

As we wandered through some open houses this past weekend we found a big house on a nice corner lot a few blocks from us. It’s a bargain when you consider what townhouses are selling for in our area. And, as we calculated the potential rent revenue versus expenses for it’s main suite and finished basement, it’s almost tempting to make an offer. BUT, the house is not lovely at all and is a real handyman’s project. And the sellers, like those of most of the houses we’ve looked at recently, are still asking prices that are too high in hopes that the buyers haven’t noticed the slowing market.

The unreasonable price tag and the daunting nature of the work it needs will keep us from making a move on it. Besides, May has not been a profitable month for us. As of May 15th, we have one less property in our portfolio. That is six less rental units that we have to rent out and make money from. And, all we have to show for the sale of that property are scars and line of credit debt. But we are glad to be rid of it.

And, alas, a routine replacement of the shingles on our Toronto tri-plex brought about the discovery that there were actually three layers of shingles on our roof already. Those had to go and they didn’t go away for free! The roof repair cost us almost two thousand dollars more than we expected! The good news is that we have some nice tax write offs from all of the above to offset the income from our good properties and our other income.

It’s almost summer time – the real estate market typically slows a bit during this season. Will you be buying, selling, or sitting by the lake and not worrying about either? Let us know, and let us know if you have questions for us. Contact one of us directly at: dave@revnyou.com or julie@revnyou.com.

Published May 21st, 2008


Featured Article:

We’re very pleased to share that recently a Rev N You article entitled Real Estate 101: Making Money When You Buy was featured in Early To Rise (Internet’s most popular Health, Wealth and Success E-Zine). We love Early to Rise and have been reading their publications for nearly four years. It was a real honour to be published in their great newsletter. Thanks ETR!

Money Pit Properties

Money Pit Properties Niagara

 

I was so excited to get out there and build up my positive cashflow from rental properties. Fresh from a real estate investing course from one of those late night gurus, I was motivated, armed and very dangerous. I bought a triplex (Money Pit!) in Niagara Falls, ON for $113,000. I got it cheap and I put down only 10% because the vendor was willing to give me a promissory note for a small loan (there weren’t 90% loan-to-value mortgages from lenders like there are now). They teach you at these courses to find the motivated sellers that will “hold paper” on the property, and I found one!

It was an older building with tenants on disability or other forms of government support. It looked a little rough, but it seemed to only need cosmetic touch ups. When I bought it, the numbers indicated that I would earn about $400/month after expenses and financing so I figured that I would be able to afford the odd repair.

As I set out painting, replacing carpets and putting in things like new doors, I uncovered some serious problems such as:

  • a leaky roof
  • electrical wiring was not safe
  • plumbing was old and falling apart
  • mould in the bathrooms
  • rotten wood.

On top of all of that, I received complaints regularly from a tenant that thought everything should be fixed overnight. Inside his unit I discovered a complete mess. He’d destroyed the walls, had cats that had urinated throughout his unit and destroyed all the window ledges. This tenant eventually called the city of Niagara Falls who then inspected the unit and ordered me to make a variety of repairs to his suite – most of which were directly caused by the tenant or his cats! Because the laws in Ontario do not allow landlords to collect a damage deposit, the only recourse is to use last month’s rent or take the tenant to Small Claims Court to recoup your costs. It’s just not worth the effort to take a tenant with no money to court.

After weighing my options (and my costs and time), I decided rather than spending several thousand dollars repairing the money pit, I would try to sell it “as is”. If you have ever seen “as is” in a sales listing, be careful. This often means there are conditions of the building that are less than stellar and require a thorough inspection and/or repair.

Because I had the orders from the city to repair the problems with the unit, and because I was stressed out dealing with the tenants, I sold the property for $104,000. Yes, that’s $9,000 less than I what I had paid 2 years earlier in an appreciating market and after spending about $10,000 in repairs. To throw even more money away, I had to pay legal fees and the sales commission to my realtor. All in all, I lost about $25,000 in 2 years! That’s why I called it the Anti Investment.

The good news?

* A good portion of the loss was a tax write-off;
* I will NEVER purchase a property like that again;
* Hopefully you will learn from my mistake and be very careful in your future purchases.

Although I lost a considerable amount of money, getting rid of the property at a loss (and as fast as possible) was the best thing to do because I got my life back. The stress of dealing with money pit properties (and problematic tenants) is so draining. l was ecstatic once it sold. I could breathe again – even if my wallet was a LOT lighter!

Evaluating Your Real Estate Investment

How many properties can you afford if each one costs you $400/month?

To buy, or not to buy that real estate investment?

You have found your perfectly located property and are convinced it meets your goals. How do you know whether you should buy it? What if the rent is not enough to cover all of the expenses?

Many of the get rich quick books like Robert Allen’s Multiple Streams of Income or Russ Whitney’s no money down real estate courses are quick to focus on monthly cashflow. They preach that you must buy properties where the rent is high enough to cover mortgage, expenses and profit. We don’t disagree, but just as we have in the last three editions, we want to take you back to your goals before you rule out the ones that don’t have good cash flow.

When we moved to Toronto almost five years ago we bought a small condo in North York. Rents were higher than a mortgage, and we thought we would live there for awhile and rent it out. That is exactly what we did, but it costs us almost $400/month because the rent doesn’t cover the maintenance fees. Why haven’t we sold it? Right now, it still works for our goals.

In an ideal world you would find a real estate investment in a location that is right for you (as discussed last month) that will give you:

  1. Positive cash flow each month (you are taking in more money from rent than you are paying out in mortgage and expenses)
  2. High potential for appreciation over a five to ten year term (or sooner!)
  3. High level of liquidity (in other words, everything about the property is desirable and it wouldn’t be hard to sell in a hot or cold market).

Unfortunately, we don’t live in an ideal world and you will likely have to prioritize which ones you want based on what your short and long term goals are.*

Cash Flow

One of the most common methods of evaluating a purchase in commercial and residential real estate investment is cash flow. In commercial real estate you will often here everyone talk about the cap rates. In residential real estate a common one is the gross rent multiplier (GRM). To calculate GRM:

* Estimated (or known) rent x 12 months = Annual Rent
* Asking price (or what you plan to pay for it)
* GRM = Asking Price / Annual Rent.

For example, if your monthly rent is $1,000, and the asking price is $100,000 your GRM is:

$100,000 / $12,000 = 8.33.

The basic rule of thumb is that you need a GRM of 10 or less to have decent cashflow. This is based on the assumption that your operating expenses are less than 40% of your monthly rent. Operating expenses include your property manager, taxes, insurance, and maintenance and repairs. It also assumes that your financing costs do not exceed 60% of your monthly rental income.

Just to give you an idea of expenses, our properties average about 37% of our rental income each month for operating expenses.

Once you narrow down your list of potential investment properties, contact the listing realtor and obtain an income and expense sheet for the property or ask for actual receipts to determine the true expenses and possible rent of each property. Now, you will be more informed whether to continue looking at this property on a cashflow basis or you should move on.

If your goal is to find properties that will provide you monthly income, then you will need to focus on this method of evaluation. The two other considerations (appreciation and liquidity) should be less of a concern. If you are holding properties for the long term, and looking for ones that are less likely to cause you problems with tenants or repairs, then you are likely also going to be factoring in the other two evaluation criteria.

Potential Appreciation

It is difficult to evaluate appreciation potential as it is based on what happens in the future. There are ways to feel more confident in the potential of your property increasing in value though. For example, consider:

* Are more people moving into the area than out of the area?
* Are there new developments around? What about schools, stores and other services?
* Is there a shortage of land to build new homes?
* Are new roads being constructed? Is the economy in the area diverse and growing?
* Is it a Starbucks area? (from last month’s edition)
* Are people renovating and spending money on nice landscaping?

None of the above guarantees appreciation of a property, but if appreciation is a primary concern, you need to be mindful of these elements.

Liquidity of a Property

Many of the same factors that may help to identify properties that will appreciate are the same ones that will help you evaluate it’s potential liquidity. The objective here is to determine whether you could sell the property in a hot or cold market at a good price.

For us, liquidity is important, but comes in third because we make all our purchases with the intent of holding them for 5 – 10 years or more. In a long term hold situation, liquidity is less of an issue because you do not need to sell it in the short term, and can hold on to it in bad market conditions and wait for the cycle to return to one of strength.

How do you evaluate liquidity? Current market conditions will help you in the short term (how many listings there are on MLS relative to sales is one), but when trying to figure out liquidity in the future, you can consider:

  • Single family, detached homes are always more in demand than any other product, especially ones that are well taken care of,
  • Safe locations near parks, schools and shopping are in demand no matter what the market is doing,
  • Properties that are without extras that people do not need and will not pay for in hard times (pools, 3 car garages, large acreage).

Essentially, you want your property to appeal to the masses in order to ensure liquidity. If it is too unique or too specialized then your market is smaller, and therefore it will be much harder to sell in a market downturn.

Maybe you are tired of hearing it, but it all depends on your real estate investing goals what criteria are most important in your decision. If you only want one investment property and you want the most appreciation potential and least hassles, putting $400/month into it is not a bad thing. Especially if you are in a higher income tax bracket. You can write-off the mortgage interest as well as most of your investment property expenses (speak to your accountant). Furthermore, if your mortgage interest rate is reasonable (less than 6%), your tenant will be paying down a portion of the principal, helping you to build equity (which is our situation with the condo in North York). If you can’t afford to put a dime into the property each month, then you must find one that has good cashflow regardless of the other criteria.

July 16, 2006

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