How Long Should You Keep an Investment Property?

Financial planning is a complicated task. If you are considering whether to purchase, hold, and/or sell an investment property, it is recommended that you discuss your plan with your financial advisor and accountant before moving forward.

Also, please note that for the purposes of this blog, we will focus on residential real estate. Commercial and mixed-use properties are also useful investment vehicles but can respond differently to market forces (i.e., they are a topic for another blog).

As you consider purchasing, holding, and eventually selling residential real estate, it may help to consider the following:

Growth Versus Income

An investment property usually favors one of the two primary investment objectives: growth or income. As such, researching an investment property is similar to researching a stock. Do you want an investment that will produce monthly income for your portfolio, or do you want a property that is likely to appreciate over a specific timeline? The beauty of real estate is that most income-producing properties also appreciate.

However, it still benefits you, the investor, to know why you are buying the property in the first place. What is your end goal? If your goal is to produce income, determine the market capitalization rate you need and also how much each prospective property can offer. That way, you’ll know if your investment objective is not being met. In this case, when your capitalization rate drops below the level that is profitable for your overall portfolio, you will know that it’s time to consider selling.

If your primary investment objective is growth, you may want to wait until the property’s value has appreciated to a certain level before selling. When timing your sale, consider your tax bracket for the current year and discuss this with your accountant or tax preparer. Also, have a plan for your net profit from the sale. If you can reinvest your profit and earn more in some other sector, it might be a good time to sell. However, if real estate currently offers a greater opportunity for growth than the stock market, bond funds, or some other investment, it might make sense to hold onto your real property until a future season.

How To Calculate Market Capitalization

The market capitalization rate for investment properties is calculated by dividing net operating income (NOI) by the property’s current market value. The market capitalization rate is also called the “market cap” or “cap rate.” A market cap equation also exists for stock investments, but for the purposes of this blog, assume that market cap applies to investment properties.

The numerator in your equation is the NOI. Start by adding all the rent you plan to collect each year. Next, reduce this number by the percentage of time the property is likely to be vacant each year. This figure should be at least 10% but could be higher depending on market forces and location. If you need help determining a vacancy rate in your area, The Department of Housing and Urban Development publishes figures that may be useful.

Next, take your vacancy-reduced revenue and subtract actual yearly expenses. These could include maintenance, taxes, utilities (if they are landlord-paid), any property management fees in your contract, and other costs associated with homeownership. Now you have the NOI figure.

Finally, divide yearly NOI by the property’s current value. The resulting percentage is the market cap for your property or prospective property. A high percentage usually means that conditions are good for income-producing properties and may also indicate that the property has room to appreciate in today’s market.

Real Estate as an Investment Hedge

Financial markets are cyclical and data from one sector can help investors predict and plan in other sectors. For example, when interest rates are low, bonds tend to become a less attractive investment while real estate becomes more attractive. This is because lower rates increase payment affordability, thereby increasing purchasing power in the market. In a low-rate market, it makes sense to purchase real estate because it is likely to appreciate at a time when other investments may not. Similarly, real estate can also be a useful hedge against inflation. When consumer purchasing power decreases, cash becomes less valuable. Some investors buy real estate as a sort of “safe haven” for their cash, since real estate has historically appreciated at a pace competitive with or above yearly inflation.

Selling In Response to Market Timing

The real estate market is like any financial market: it’s somewhat predictable, but not always. Interest rates, inflation, supply, demand, population drift, and human emotion are just a handful of the factors that could affect the return on a real estate investment. As prices and rents trend up or down, so does value. Sometimes the real estate market indicates that it’s time to sell regardless of an investor’s initial plan. For example, if demand is high for properties like yours but the population in your area is not likely to increase, it may be time to speak with your financial advisor and accountant about selling one or more properties at a gain. You could then reinvest into real estate at another location or reinvest into another sector.

Selling Before Retirement

Timing the market is one thing, timing your life is another. Sometimes it makes sense to sell regardless of market forces. If your real estate investments were purchased as part of a growth objective, and if they have appreciated to a level that supports your retirement plan, consider selling. Although the cyclical real estate market may or may not be at the top of an appreciation curve, selling could still be in your best interest.

If the value of your property cannot be realized at the optimal time for your retirement, it may be a good time to repurpose your investment. Can you earn a return greater than what the stock market offers if you rent your property? Can you break even on your investment as you wait for values to appreciate?

Selling At a Loss

It sounds counter-intuitive, but sometimes it makes sense to sell an investment and take a loss. If housing and/or rent prices in your area have decreased and are likely to continue trending downward, it may not be wise to hang on. Depending on the timeline you intended for a particular investment, ongoing depreciation could be a signal that it's time to cut your losses and move on to a different investment.

If you need to reduce your tax burden, taking a loss on a real estate sale could be in your best interest. This situation is complex and should be thoroughly vetted with your accountant or tax preparer before you make a decision.

A Final Word on Investment Properties

Real estate has historically been, and will probably continue to be, a great investment. While a single investment channel should never be your only source of net worth, smart investors include real estate in their portfolios. Well-balanced, well-hedged investment strategies probably have room for real property. If the tangibility of real estate is overwhelming, consider investing in a Real Estate Investment Trust (REIT). REITs are traded like stocks but do not require property management effort on the part of the investor. Either way, consider that the median home price in America has increased by over 100% in the past 20 years. This outstanding return occurred despite the Great Recession of 2008 and a global virus pandemic that shut down the world’s major economies in 2020.