Rental trends in Birmingham, Alabama have flattened out in recent years. Prices have also appeared to hit a peak, according to Realtor.com.
Therefore, you might have thought about selling your rental property before prices and rents fall too much.
If so, you’ll want to read this guide ASAP. We’ll show you:
The steps involved in preparing your property for sale
How to price your property appropriately
A few ways to determine if now is the time to sell
Several “special situations” that could impact the sales process and your profits
Keep reading for all you need to know about selling your Birmingham rental property.
What Should You Do Before Selling Your Property?
Before selling your Birmingham rental property, there’s some prep work to do:
Compiling a buyer package
Making required repairs
Calculating your potential capital gains for tax purposes.
Let’s take a look at how to do each one:
Compile a Buyer Package
Your buyer package contains documents buyers need to determine if buying your property is right for them.
Here are some documents to include:
Copy of the lease and resident rent roll
Financial reports, such as profit and loss (P&L) statements
List of vendors and maintenance history
List of significant repairs/improvements done in the last several years
This buyer package attracts more interest and accelerates the closing process because it makes the purchase decision far easier for the buyer. This means more potential money for you in less time.
Make Required Repairs
With the buyer package in hand, it’s time to fix up the property. This will increase the property’s value, boosting your negotiating power and streamlining the closing process.
Begin with mechanical and structural repairs, like:
Electrical
HVAC
Pipes
Plumbing
Roofing
Water heater
These fixes tend to be expensive but critical to safety, making them the best repair-related investments. It’s hard to sell a property with these issues, after all.
After these critical fixes come cosmetic repairs. Start with the exterior to boost the property’s curb appeal and pull in buyers. This might involve:
Checking the sump pump
Cleaning and clearing out gutters
Fixing cracks and dents in walls
Fixing or adding caulk to doors and windows
Taking care of wood rot
Touching up paint
Also, do some landscaping and wash the exterior to make your property pop.
As for the interior, you might need to:
Fix cracks and dents
Fix plumbing
Repaint walls
Repair and replace window and door frames
And more.
Remember: Cosmetic repairs are not necessarily critical to safety. So you’ll have to weigh the cost of the repairs against the potential gains in your sale price and what you can negotiate during the closing process.
For example, if the repair is quite minor, the buyer may be willing to do the repair themselves for a slightly lower sale price. In that case, you would save on the repair without extending the closing process.
Calculate Your Potential Capital Gains
Selling your property for more than you bought it might cause you to incur capital gains. To calculate these, you must determine:
The cost basis: Purchase price + escrow-related fees + improvements
Any adjustments to your basis, such as depreciation
Sale price
Here is how to calculate capital gains with this information:
Capital Gain = Sale Price – (Initial Cost Basis +/- Adjustments)
Adjustments that increase your basis could include things like repairs and improvements, since these boost the property value. Adjustments that decrease the cost basis might include items like depreciation or property damage.
After calculating the gain, you’ll need to know which tax rate to use:
Short-term capital gain: You incur these if you sell a year or less after buying. Short-term capital gains are taxed at your ordinary income tax rate — the same rates you’re taxed at for rental income or job income.
Long-term capital gain: You incur these if you sell longer than a year after buying. Long-term capital gains are taxed at favorable long-term capital gains rates. You could pay 0%, 15%, or 20% taxes on these gains, depending on your overall income.
How to Price Your Rental Property for Sale in Birmingham
Once you’ve performed the physical preparations, it’s time to calculate a good selling price.
This process is a bit complex, but some financial formulas can help you zero in on a good number.
Below, we’ll explore three formulas useful for pricing your property:
Capitalization rate
Cash-on-cash return
After repair value (ARV)
Calculate Cap Rate
The capitalization rate — or cap rate — tells an investor the return rate they can expect when owning an investment property. It will be the same for every investor on a given property, making properties more comparable.
Here is the cap rate formula from the seller’s perspective:
Cap Rate = Net Operating Income / Current Market Value
Where:
Net Operating Income = Gross Rental Revenue – Property Management Expenses
Current Market Value = Property Value when calculating the cap rate
Calculate Cash-on-Cash Return
Cash-on-cash return measures the cash returns compared to the cash invested.
This helps investors see how much cash they will receive — which is different from revenues. It includes financing costs, allowing investors to see what kind of returns they could earn on this specific property at different amounts of leverage.
Here is the cash-on-cash return formula:
Cash-on-Cash Return = Annual Pre-Tax Cash Flows / Total Cash Invested
Here is the formula for Annual Pre-Tax Cash Flows:
(GSR + OI) – (V + OE + AMP)
Where:
GSR = Gross scheduled rent
OI = Other income
V = Vacancy
OE = Operating expenses
AMP = Annual mortgage payments
Total cash invested is the amount of cash the buyer invests into the property. This can differ from the purchase price. It’s usually the down payment.
For example, if an investor buys a $200,000 property with a $40,000 down payment and $160,000 mortgage, the cash invested is $40,000.
Determine the After Repair Value (ARV)
ARV is a property’s estimated potential value when all repairs and renovations are completed.
The ARV formula is as follows:
ARV = Current Property Value + Value of Repairs/Renovations
Home flippers and rental investors both weigh ARV for different reasons.
Home flippers use ARV to see how much profit they could earn after fixing and flipping the home. In other words, they try to determine whether they’ll earn a return that justifies the repair costs.
Rental investors use ARV to prioritize repairs on potential incremental rental revenue increases. They will first go after repairs that offer the maximum revenues per dollar invested.
You can use ARV in the same way when prepping your property for sale. After the structural and mechanical repairs, you can prioritize cosmetic fixes by the ARV increase per dollar you invest.
Selling Your Rental Property at the Right Time
Timing your property sale can make a big difference in your profits, tax implications, and even ease of closing future deals.
So once you’ve prepared the property for sale, consider selling when one of the following matches your circumstances:
Your Property Has Appreciated
Did your Birmingham property rise in value during your ownership tenure? Locking in your profits is a perfectly valid reason to sell.
If taking profits is the primary goal, make sure to plan for taxes accordingly. As we’ll discuss later, there are potential tax consequences to watch out for and tax breaks you might qualify for.
No More Depreciation Deductions
Depreciation lets you deduct your taxable income to represent wear and tear on your property. This is the largest tax deduction many investors can take, but in the US, it generally runs out after 27.5 years.
When you run out of depreciation, it might be a good time to sell. Keep in mind that you might owe more in taxes since depreciation will have lowered the cost basis.
You Aren’t Earning Sufficient Returns
Even the best due diligence on the safest real estate investments can’t guarantee any returns, let alone sufficient returns for your goals. If your property isn’t earning you enough, selling could help you cut your losses.
However, find out why the returns aren’t as much as you had hoped for. For example, the property may have some underlying issue that, when fixed, raises your returns to acceptable levels.
You Want to Exit Real Estate
Maybe you’ve had a long and illustrious real estate career. Or perhaps you’re tired of hunting for and managing properties.
In any case, wanting to exit real estate simply to retire or pursue other things is totally fine. However, if you want to leave over frustrations with the field, don’t jump ship right away.
Instead, consider working with a Birmingham property management firm. The right property manager will handle all the stuff you don’t like or don’t have time for while helping you maximize your returns.
Special Situations
Here are a few special situations that could occur when selling a Birmingham rental property:
Selling With a Resident
Selling your property to a resident is an excellent idea if you’re on good terms, they’re financially stable, and they’re looking to own the property or use it as an investment property. This virtually eliminates time and money spent marketing your property.
If your resident doesn’t qualify for traditional financing and you own the property outright, you can offer them seller financing. This means you essentially become the lender, crafting financing terms that fit your needs and your resident’s ability to pay.
Keep in mind that seller financing has risks. You’re on the hook if the resident defaults. On the other hand, traditional financing lets you sell the property, take your proceeds, and leave without worrying about the resident’s financial situation.
Weigh the convenience of selling to your resident with the risks before making a decision.
Selling at a Loss
Selling for less than your basis could cause you to incur a capital loss. Losses offer potential tax deductions up to certain limits.
If your losses exceed these limits for a particular year, you may be able to carry them forward to future years to deduct against income in those years. You might also be able to carry them backwards, reducing taxable income in previous years and potentially getting more refund if you amend your return.
Keep in mind that you may need to add back depreciation deductions, which can make what looks like a loss into a gain.
IRS Topic No. 409 Capital Gains and Losses offers more information about capital losses. Given the complexity of the topic, working closely with a tax specialist is strongly recommended.
1031 Exchange
Investors can defer capital gains taxes by investing property sale proceeds into another property of equal or higher value and meet other requirements. This is called a 1031 Exchange, named after US Internal Revenue Code Section 1031.
The 1031 Exchange can help investors grow their real estate portfolio faster by cutting their tax bill, offering them more capital to acquire larger or more numerous properties.
For example, you have more capital for a larger down payment on a more valuable property that commands higher rents. Alternatively, you could use that capital to put down payments on two properties — Section 1031 lets you get multiple properties at once if you meet all the rules.
Final Thoughts on Selling Your Rental Property in Birmingham
Selling your rental property in Birmingham could be a good move if you’re looking to take profits as the market cools or exiting the market entirely. You can use the proceeds to get another property or keep for yourself.
However, remember that selling successfully requires some work. You have to fix up the property — both the critical and cosmetic — then run a few formulas to price the property. Look over the tax implications as well.
All of that comes before marketing your property, vetting buyers, and closing the deal.
If that sounds a bit overwhelming, you’re not alone. Evernest can take on the hard work for you. We’ll help prepare the property for sale and get it in front of hungry property buyers.
For more, subscribe to our podcast, the Evernest Real Estate Investor Podcast, for all things real estate investing, being a landlord, growing your portfolio, and more.
Source: This content was originally written for Evernest and published at Evernest.co
