For the last five years, we’ve rented out a two bedroom condo we own in the Vancouver area. We’ve owned it for 10 years, the first five of which we lived in it as our primary residence. It has been a fantastic investment with one tenant for five years and it has been slightly cash flow positive the entire time.
Unfortunately that picture changed unexpectedly this year. The strata had the mandatory depreciation report completed, and it uncovered significant concrete repairs needed throughout the complex. Some repairs are needed immediately, while the rest will need to happen within the next 10 years. The estimated cost is approximately $20,000 per unit. Ouch! The strata’s approach has been to assess a special levy of $2,000 now and almost double the monthly maintenance fees from approximately $200 to $400 per month.
Our nice little self contained investment no longer looks so great as we’re suddenly cash flow negative to the tune of about $300 per month. We will still see a positive return on equity of 3.6% this year and 4.9% next year assuming no additional special levies (down from a return on equity of 7%+ in prior years). It’s not terrible; however, considering the risks associated with real estate investments, it’s not exactly a great risk premium considering we could put that equity into a GIC paying 2.45% right now and have a guaranteed return with none of the headaches, risks, and uncertainties that come with a rental.
If selling real estate was as simple as selling stocks, I’d probably go ahead and sell. Of course the decision is much more complex than that.
I have a buy and hold investment philosophy so I was expecting to hold this property for the long term. Given the dramatic drop in returns and the fact we now have to shovel $300 a month into it, it’s time to re-evaluate. But how do I decide whether it’s better to sell now or continue to hold on?
The case for selling the rental property now
- The Vancouver real estate market is hot right now. I expect it to crash at some point, so now could be a good time to lock in gains.
- The risk premium we receive if we hold on is not great (only about 2% above what we could achieve risk free in GICs).
- We would avoid having to shovel $300 into it every month
- Our net worth is weighted a bit heavily to real estate (~60%). Selling would reduce it to a more reasonable 48%.
The case for holding on
- I like real estate as an investment class. This is our only real estate investment (other than our primary residence).
- We have excellent tenants that I expect will stay for a while yet. Listing the property for sale will certainly get our tenants looking for a new place and in the event we didn’t sell for the price we needed, our costs in the short term would go up.
- I don’t expect the stock market to do well in the next year or two, so I don’t see us doing much better (if it all) compared to the returns we’re seeing on the property.
- I like having the ability to leverage our equity in real estate. I’m too risk averse to leverage equity in stocks.
There are certainly pros and cons to each option and no clear cut winner in my mind. I decided to build out a decision tree to determine whether to sell or hold on to our rental property. This tipped the scale in favour of holding on rather than listing it for sale.
I’ve posted the details on using the decision tree approach and an Excel template for determining if you should sell or hold on to a rental property. In that post, I walk through all the details of using the template. Here, I’ll simply summarize the results:
To summarize the results of the decision tree, at current sales prices it doesn’t make sense to sell. I based this on a ten year time horizon, essentially comparing selling now, and earning a 5% return on the proceeds for 10 years, with holding on and selling in 10 years instead. The expected value difference between the two options is not huge, but in playing around with the assumptions and probabilities, the option to hold on consistently comes out on top.
I’ve also calculated the standard deviation and it shows the two options are for the most part within a standard deviation from each other. The option to list and sell has notably higher variability due to the range of possible sales prices.
Based on this analysis, I’ve decided we’ll hold on and not list the condo for sale at this time. I’ll revisit this decision if anything materially changes in the assumptions. In particular, if there was a high degree of likelihood of selling it quickly for $270k or higher (17% over current market value) then it starts to make sense to sell rather than hold. In the meantime, I’ll be:
- Monitoring listings and sales in the complex to keep an eye on price movement
- Keeping our current tenants happy
- Raising rents once per year to start reducing the negative cash flow
- Next time we refinance the mortgage, extend the amortization length to improve cash flow
Be sure to read my post on using an Excel decision tree to decide whether to sell or keep a rental property if you’d like to see the calculations I used or download and use the Excel template I created.