In May 2014, I shared a template for reviewing your real estate. Let’s revisit that property – (prior values in parenthesis).
- Today’s Zillow value $1.2 million ($850,000, +26%)
- Recent Assessment value $1.05 million ($830,000, +27%)
Zillow and the county assessor have revised values up by more than 25%. You’re wondering if there is a bubble. You receive an offer of $1.1 million, should you sell?
In the article from May 2014, the “owner’s value” was $925,000. This offer is ~20% higher. Seems straightforward to sell, but pause to consider…
- How has the investment changed over time?
- What are you going to do with the money?
- What are the tax consequences of selling?
The big story in Denver/Boulder real estate has been increasing rents. The current rental income for the property is ~$60,000 per annum. Taxes, insurance and repairs cost $10,000, so the net cash flow is $50,000 per annum.
Previously, cash flow before interest and depreciation was closer to $25,000 per annum. So there has been a near doubling in the annual cash flow from this investment, but pause to consider…
Is the cash flow sustainable?
In this case, the cash flow is not sustainable. Houses wear out, roofs need replacing, plumbing needs repair and appliances break down. So let’s adjust the $50,000 per annum to $40,000 to reflect sustainable cash flow.
The offer is $1.1 million to buy $40,000 of sustainable cash flow. That is an implied yield of 3.6%.
How does that stack up?
Alternative Uses of Funds
- 5 year, 1.6%
- 10 year, 2.3%
- 30 year, 3.1%
- VTSAX (US Equity) – 2.0%
- VBTLX (US Bond) – 2.2%
If you are the seller then you should ask yourself “What am I going to do with the sales proceeds?”
If you sell real estate that yields 3.6% to buy bonds that yield 2-3% then the value of your investment is likely to be eroded over time. Most obviously, because rental income tends to increase over time, while interest payments are set for the duration of the bond.
High-quality assets with growing income streams are attractive.
If you sell at $1,100,000 (to a buyer without an agent) then what’s your net realizable value?
Using numbers consistent with the May 2014 article, you would net about $1,025,000 (before any mortgage pay off).
You’d also want to adjust the sustainable cash flow from the property to reflect taxes you pay on the income. To make things simple, let’s assume a sustainable cash flow after taxes of $32,500 (yielding ~3.2% after tax).
The above numbers would change, possibly significantly, based on the size of mortgage payoff and your personal tax position.
It’s worth having a professional walk you through the detail.
When I look at the above, I see a market that has increased 25% in value. Seems like a lot.
- Rental growth is in line with the increase in value.
- Alternative investments are yielding less than this asset.
- The asset is located in a zip code with real-economic growth that is higher than the US average.
So the market seems fairly priced – at least to me, today.
What should the buyer and seller do? In these market conditions, they are likely fine either way.
What’s going to happen to future rents and prices? I would be suspicious of anyone that claims to know.