Is Your Real Estate Equity Working Hard For You? Or, is it Dead Equity?

Michael QuanFI / FIRE, Investment, Real Estate6 Comments

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1031 Exchange My Rental

Sometimes we make poor choices and end up with less than optimal results.

Sometimes we know we made a bad choice, and we don’t do anything about it.

I see this all the time with my coaching clients, and yes, I’ve been there myself… very recently in fact!

It could be purchasing a bad stock and then holding onto it because you don’t want to take the loss. Or, it could be buying something with financing that you regret later. For me, it was holding onto a property for way too long.

Never say “never”

Finally, if you’re a real estate investor, have you ever bought a “bad” deal and then stuck around too long?

Today, I want to share some mistakes by holding onto a property for too long.

You see, I held a naive belief that real estate should never be sold. You simply buy it and hold it indefinitely.

It’s not a terrible belief because it can serve you at times, but it can also stifle your growth as you’ll see.

Purchasing Real Estate for a Home is NOT the Same as for an Investment

When I was in my upper twenties my wife and I were just starting out. We purchased a townhome close to the top of the market back in 2005. I was convinced it was an “investment” because I “knew” that real estate goes up over time AND since we’d be living in it, it would save us on rent.

The first lesson that I’ve come to understand is this. Never believe absolutes when it comes to your money beliefs. In hindsight, we were buying with emotion first, and then logic second.

It was a beautiful townhome. It overlooked an urban valley and was in central San Diego. How could the property not rise in price over time? It was a “sure thing”, plus we got to live in it.

We lived in this townhome for over a decade. However, when my son was born, we realized that we wanted a larger space vs. the tri-level we currently had. I had just retired from a traditional 9-5, so I was free to move anywhere. My wife taught at a school further south, so we checked out some homes near her school realizing we’d save costs with her being close to her work. We found a beautiful new development and purchased a home less than a mile away from her work.

Hanging Onto a Bad Real Estate Investment

We were blessed to have enough cash to purchase this next home with 50% down, and not have to sell the townhome. In fact, as we were going through the process, we always assumed that we’d just keep the townhome as a rental indefinitely. There were so many great memories there and we were attached to it emotionally.

After running the numbers, I realized we could make $300-$400 of passive income from renting out the property. So, I asked my friend to manage it for us and we set it and forgot it.

Here’s the problem though that I didn’t face upfront. I didn’t ask the right question. Is $300-$400 of passive income a good return on my money? If I had asked that earlier I would have realized “no”. The opportunity cost was too high. You see, we had nearly 65% equity already into the property. Shoot, with that much equity pretty much anything will cash flow!

Equity that is NOT serving you at the level is should is called DEAD EQUITY. I would soon find this out.

Lost Capital Gains Exclusion & Dead Equity

By holding onto the townhome, I was simply kicking the can down the road for later. And this also caused me to make another critical mistake. We missed out on the capital gains exclusion tax benefit. If we had sold the property within the first 3 years of turning it into a rental, we could have taken a capital gains exclusion of up to $250,000 for both my wife and I. At that point, we probably had $125,000 of gains, which would have saved us over $30,000 in capital gains taxes… ouch.

This was an expensive mistake!  As a real estate investor, I should have known better. Again, I let emotion cloud my judgment.

Finally, the property never did grow in value as we anticipated. We literally just came out of the best bull market ever and the return on our equity has been a paltry 1.8% annually. In contrast, where I have done well is investing in my Vegas properties. Each of those properties has returned ~30% annually so far! I just wished I had bought 10 more.

Moving Forward

So, I’m finally taking action and am in the process of selling the property. I freeing up hundreds of thousands in equity and I will be strategically deploying it to better use over the next few years.

I’m also preparing for the next real estate downturn. It’s just a matter of time, and I believe we’ll see significantly depressed prices over the next few years. Those with cash will be in prime position to benefit, and I intend on re-couping some of my lost opportunity costs.

As a cash flow real estate investor, I’m going to be seeking out cash flow aggressively now. I’m excited though and if you’re eager to participate too, consider getting educated NOW.

Final Thoughts

Look, this wasn’t the first time I made a mistake in real estate investing. And, it likely won’t be the last. But, it’s okay because I’m in this for the long game. Are you?

One thing I didn’t touch on was how I came to the decision to finally sell. I knew what the right decision was for a while, but I still didn’t do it. So, I sought counsel from other people I respect. I shared my dilemma with them around my dead equity problem, and they gave it to me straight. That’s a true value of masterminds and coaching. Sometimes you’re too close to the action emotionally and it’s helpful to get some additional perspective.

I really hope that you can learn from my dead equity mistakes and accelerate your path to wealth with a clearer head than I did. Again, don’t get stuck in a property or investment too long. If it wasn’t a good decision, that’s okay. Learn from it and move on. It takes courage to admit a mistake, but the learning you get from it is invaluable.

Readers, what investment mistakes have you made? What was the valuable lesson that you learned from it? 

Michael Quan
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6 Comments on “Is Your Real Estate Equity Working Hard For You? Or, is it Dead Equity?”

  1. I have the same situation. I ended up renting out my prior home instead of selling it when I moved into my current home. I would have freed up a tremendous amount of equity. That equity could have been deployed elsewhere with higher returns.

    At the time of when we moved, we had money that we needed to put to work. Therefore, we were not in a rush to release the equity in our prior home and held onto it. I thought why get more cash if I still have cash I need to invest.

    I do plan to sell the property within 2 years from now.

    1. When you’re ready to sell, definitely get an accurate estimate if your proceeds that calculate all of the depreciation recapture tax. Then you can see if a 1031 makes sense… I’m still considering this option, although the window is closing quickly.

  2. I had a similar story with our first townhouse. The problem was that when we moved, the market had already dropped. We were 30% underwater. It hasn’t been a good property and we didn’t keep it out of any emotion. We simply kept it because it was the best of some bad options.

    It’s taken about 13 years, but we’ve turned it from a $100K loss to a $166K in equity. It’s just getting back to what we paid for it – the equity is coming from paying off the mortgage. It’s about 20 miles out of Boston, so with the prices exploding there along with most of the suburbs within 10-15 miles, I think it’s just a matter of time before it spreads to this property.

  3. That is a bummer property prices did not increase. I like San Diego but I guess it depends on the location. SF Bay area has been on fire so I assumed all of CA cities were similar. Would the result be different if it was a SFH and not a town home?

    I did a cash out refinance from my primary for similar reasons. Given that we are back to all time highs I don’t think I would get an opportunity to invest that money.

    1. Yeah, it was a bit strange that prices didn’t rise more recently. But, sometimes you take a gamble and it doesn’t pay off. At least it didn’t lose money, right? 😉 And yes, to answer your question, SFHs definitely did better on average than our condo… many times over. Ah well. There should be more time to pick up excellent deals within my lifetime. Can’t wait!

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