Sell Your Rental Portfolio and Invest in LandApril 20, 2018 / Blog / 0 Comments
Last year I made a radical decision. I decided to sell the rental portfolio that I have been building for the last 28 years and move the equity into land. In this post, I’m going to tell you why.
Rentals are good investments
It was not a decision made casually. My investment partner and I started acquiring rentals in 1989, and those rentals have been very good to us. Up until around 2001, I was earning the modest salary of a youth pastor and buying rental properties as a long-term investment. By 2001 I had built up enough cash and equity via those holdings to leave my salaried position and start my career as an investment-property wholesaler. I was soon earning a good living finding below-market houses for myself and a handful of clients.
But the vast majority of the wealth I have today didn’t come from commissions, profits from “flips”, or a salary. It came from assets that I held for years at a time. The appreciation of those assets, some over a couple years, some over a much longer period, has simply dwarfed my other earnings. During that period I enjoyed a handful of (quite successful) raw land holdings, but most of my holdings have been single family home and 4 plex rentals.
I can understand someone being perplexed by my decision to sell the portfolio. Rental homes can be a great way to build wealth, especially for a small investor. You can obtain fantastic financing at low rates with a modest down payment. The cash flow can (mostly) offset the carrying costs and mortgage payment. You can add or sell them one at a time as the market or your personal circumstances change. That’s a lot of good reasons to own rentals.
Why Invest in Land?
I’m not selling my rental portfolio because I’m tired of it. I’m not selling because I don’t think rentals will provide a good return going forward. I’m selling because I think land is an even better investment for my equity.
When I was starting my investment career I was 28 years old and living on a school teacher’s salary. I had many decades ahead of me, a lot of energy, and not much cash. I didn’t see how I could tie up my limited capital in a land purchase, and come out ahead. So instead I used my hustle to build a significant rental portfolio, leveraging my down payment with a variety of financing mechanisms. In spite of the market crash in 2007 (ouch!), I came out on top with that strategy.
But what I want to put into an investment and what I want to get out of it has changed. I still want high annual returns (don’t we all?), but I now care far more about reducing risk than I do about capital outlay. I didn’t know as a young investor that I could pool my money with others to exploit the land market. Today I do. My beliefs about the comparative advantages and returns of single-family rentals versus land hasn’t changed much. My time budget and risk tolerance has.
I believe land investing offers me better returns, lower risk and fewer administrative headaches, all characteristics that make it more attractive than keeping my rentals. Let me explain:
a. Greater Appreciation. Strategically purchased raw land will out appreciate houses and small apartments over the long term. It will radically out appreciate them during growth phases.
It’s reasonable to expect single-family homes to appreciate on average 4-5% per year over a 10 year period. That means a home worth $100,000 the day you bought it would likely be worth $148,000-163,000 ten years later. Twenty years later that house is worth $219,000-265,000. But here’s a suprising fact: It’s not the house that’s appreciating. Old houses are worth less than new houses, not more. Once you adjust for inflation, the house itself is depreciating.
But the lot that house is sitting on is going up in value considerably more than the rate of inflation, so much so the value of the house plus its lot has a net increase of 4-5% a year. And even though that lot is only 20% of the value of the home when you buy it, every decade that goes by the percentage of that home’s total value contributed by the lot increases. In many older neighborhoods, the lot is contributing half or more of the value. After a long enough period, the home becomes too old and is considered a “tear-down.” But by then the lot alone is usually worth more than the original price paid for the entire home. It’s the lot that is appreciating.
Because of that increased appreciation, my free-and-clear raw land holdings have offered returns that have exceeded my indebted rentals.
b. Not dependent on debt. The dirty secret in residential rentals is that without the appropriate use of leverage (debt), the returns are simply not very exciting. In the very best years, we all get to brag about double-digit appreciation. But that never lasts. In order for the return on rental holdings to be compelling, they need a strategic amount of debt in order to amplify the effect that appreciation has on the investment. That effect works well while house values rise. The problem is that values don’t always rise. I’ve now lived through two radical drops in the value of housing (1989-1993 and 2007-2010). They catch us by surprise and rental portfolios holding appropriate and strategic debt get pummeled.
Because land investments in growth corridors appreciate so much more during normal market phases, you don’t need leverage to get those exciting returns. A full cash position can offer better returns than leveraged rentals. Plus, if the market takes a left turn, the cash investor doesn’t have a gun to his head to sell at an inopportune time. He simply waits.
c. Fewer moving parts. Rentals are a management-intensive real estate investment. I used to warn clients that the most frequent mistake new rental investors make is grossly underestimating the time and capital demands entailed by owning and operating a rental portfolio. People who end up dumping their houses most often do so because they are overwhelmed by one of those two demands. Rentals are not armchair investments.
On the other hand, land is an armchair investment. Most of what a land investor does is wait, especially when buying in the path of growth beyond the city limit. Active investors will sometimes, though not always, pursue entitlement activity to add value (working with cities and engineers to prepare the land for future development). But otherwise, there are typically no operational activities related to the investment.
Why am I selling my rental portfolio? Because I believe I have a better alternative. I expect the annualized return on equity in my land investments to be better than it is in my rentals. I’m getting rid of debt and the risks that come with it. The time demands from my new portfolio are a fraction of what they have been, and I believe my exposure to a downturn in the market will be substantially reduced. I’m trading up!
Investing with Arizona Land Partners
We are actively investing in land assets, and I’d love to have you join us. Whether you are just getting started with smaller amounts of capital, or you have a sizeable account you need to productively place, we can help you maximize your returns. I’m putting my money into the same shares that we are offering to others. Come join us!