I have met many property investors who steadfastly hold the principle that one should always buy and never sell investment property. A discussion of whether to sell can be fairly controversial and depends on many factors which can differ from one investor to another. Before getting into the pros and cons of selling, it may be useful to look at how an investment property might perform over time.
Over time, investment properties experience different phases where, when new, they tend to generate higher returns. As capital growth generally increases faster than rent, the property will go through a cycle of growth and maturity where returns will start to slow and eventually decline. Newer properties in the market with modern facilities will generally command higher returns than properties where fixtures and fittings are older and dated.
Just as there is a right time to buy, there is also a right time to sell. And I have learnt from Steve McKnight that your chances of achieving financial independence are almost non-existent if you dismiss selling as a possible option over your investment lifetime. The right time to sell is when you can earn a higher return from your investment elsewhere.
Cons of selling
Investors who believe that selling is a ‘bad’ idea will invariably have the following arguments against selling:
- Paying Capital Gains Tax, selling costs etc – Selling an investment property requires effort, let alone time and money. Costs involved may include hefty CGT, agent’s fees, legal costs let alone stamp duty and other acquisition costs during purchase. The emotional factor may also loom large when sentiments are attached to the property and when it has made decent returns over many years.
- Refinance the capital gains – This is a convenient option to access equity without having to incur CGT and other costs.
- Forgo future capital growth – Selling will involve “missing out” on any future capital gains the property may yield.
- Cost of buying back in – Buying another property upon selling may seem futile as there will be additional costs such as stamp duty, legal fees notwithstanding the costs of selling. There can also be no guarantee the next investment property will perform better than the existing one.
Pros of selling
There are obvious drawbacks about selling as discussed above. However, there are also key advantages:
- Crystallising your profits – A capital gain is only worth its paper value unless it is realised and converted into cash through a sale. Many investors, especially those in the US would have seen their capital gains vanished overnight when property values nose-dived in the wake of the global financial crisis.
- Investment focus as a key criteria – The aim of sustainable property investments should be to constantly achieve the highest possible returns rather than to save tax.
- Refinancing and its setbacks – Refinancing is a popular way to access the equity or capital gains achieved. However, the most important thing is to ensure the refinanced funds will be utilised in such a way as to achieve a higher return than the additional interest charges from the refinance.
a) Finding a suitable lender – Refinancing involves borrowing from the same lender and if that is not possible, refinancing the entire loan can be costly.
b) Increased credit risk – A larger loan exposure means higher risk from adverse movements in interest rates and exchange rates for investors who own off-shore investment properties.
c) Valuation and LVR – Refinancing is subject to the bank’s valuation and limits on amounts that can be borrowed.
- Paying down debt – The proceeds from the sale can be used to reduce debt and interest charges and hence, improve cashflow or be used as a equity for a property with better returns. It can also demonstrate to your financiers that you are in control understand how and when to realise a gain on your investment.
- Tax deferral – By deciding not to sell, you are deferring tax liability to a later date when and if you do eventually decide to sell. You will need to take into account inflation although this may (or may not) be compensated by higher capital growth.
- Fund your path towards financial independence – you need to be able to fund financial independence from positive cash flow properties. By not selling and refinancing equity to take on more debt, your interest bill will be increased and it should be remembered that in funds used for lifestyle expenses is not tax deductible.