Author Topic: Hypothetical Situation - Equity Rich but Cash flow Poor  (Read 3135 times)


  • 5 O'Clock Shadow
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Hypothetical Situation - Equity Rich but Cash flow Poor
« on: June 13, 2015, 11:32:45 PM »
Lets say you are 60 years old and have 8 townhomes (originally purchased for 1.6 million) now worth 2.3 million, with a mortgage of $500k remaining. Property is in a great location with relatively fast appreciation and rent increases, easy tenants.

Rental income: Net cash-on-cash return is 3% per year ($60,000/yr). Total ROI = 4.5% when accounting for equity accrual from mortgage paydown.

Would you just retire on the rental income or liquidate the properties, paying capital gains tax, and then invest elsewhere?

Here is another situation.
Instead of owning this property at 60, lets say you inherit these properties at 35. Would you do something differently than if you were 60 years old? 3% cash-on-cash return is low.

Additionally, you can sell the property without paying capital gains tax.

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  • Walrus Stache
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #1 on: June 14, 2015, 05:31:14 AM »
The 35 year-old's situation is fairly easy.  No capital gains and no depreciation recapture reduces the problem to finding replacement investments that yield a better after tax return after the costs of selling and buying.  If you can find better investment opportunities, you probably want to sell and buy the better investments.

The 60 year-old's situation has a lot more moving parts.  There are capital gains and depreciation recapture to consider.  If you can 1031 into better after tax yields after the costs of buying and selling, then it might make sense.  However, in 10 years the 60 year-old will be 70, and managing rental properties may not be what they want to do at that point.  Extrication in as tax efficient manner as possible and shifting to more passive investments might be the way to go. 

The market needs to be considered as well.  If the cycle is at a high point, selling makes more sense than it does in a weak market.  In a market like 2009-2012, holding on until the cyclical recovery is in most cases the better choice.


  • 5 O'Clock Shadow
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #2 on: June 14, 2015, 09:13:31 AM »
I don't know if this is the "correct" way to think about it, but in a buy-and-hold situation, I think of the cash return as similar to the dividends on another investment, with the appreciation and rent increases as similar to market movements with other investments. So, thinking about the likely total return-- including appreciation, rent increase, equity accrual, tax benefits from depreciation and mortgage interest, etc - is the main number I would look at in this situation.  With a mortgaged purchase, this is especially important, because only a portion of the worth is tied up in the equity, but you get to keep 100% of the equity gains over the purchase price.  Tough to beat that outside Real Estate as a private, passive investor (although I would be glad to hear other strategies). Meanwhile, inflation is reducing your real costs (with the mortgage payments) while rents will keep up or exceed inflation.

Then, I would also consider how actively you want to be involved at any age, as the previous commenter mentioned in the 60-yo scenario.  If you are personally managing it, you may want to invest in something more passive; if not, the management fees are eating into your returns. 

Either way, this sounds like a great situation to be in.  If this is your real situation, congratulations on your financial success and freedom!


  • 5 O'Clock Shadow
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #3 on: June 14, 2015, 10:17:03 AM »
Agreed that it's a great situation to be in, and that when you net out all of various adjustments (equity accrual, cap gains taxes, selling costs, etc.) that you may do better with the townhouses than having that money in the market.

The hesitation I'd have is lack of diversification.  You've got everything in real estate.  If we have a 2008-9-10 repeat, and you find that your equity is down, rent needs to go down, and particularly if you can't liquidate the properties (because the real estate market comes to a near stand-still)'re in a tight spot..I would probably sell 2 of the 8 townhomes and put that money into a good index fund and some bonds, simply because you will have more flex in your cash flow system, particularly given your age and not having the luxury of 10-20 years to recover, or to pick back up a job quite as easily as a 35 year old.

Just my two cents.


  • Pencil Stache
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #4 on: June 14, 2015, 11:55:41 AM »
Whether to hold, 1031, or sell would depend on market conditions, tax effeciency and personal preferences.
The 60yr old needs to start anticipating how age plays into the cards well before age 70, get a plan in place and start moving now.  RE is not a passive investment unless you've got excellent management in place.

Factor in expected declines in energy and ability so that the 70yr old isn't staring at a mountain that they have to climb.

Anecdotally, almost all of the older people I know in RE (or knew) waited far too late in their game and had their hands forced. They kept saying, "yes, I will sell (or get a pm)..." 

Several of them watched their properties deteriorate and admitted that action was needed yet still failed to act; resulting in rotting properties, huge tax hits - massive issues for them and/or heirs.

Some realized it had become too much for them but had to sell in poor markets or as "fixer uppers".

Only two (out of dozens that I remember) actually moved in time.  One sold and redeployed into investments.   The other turned over management to his son.


  • 5 O'Clock Shadow
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #5 on: June 14, 2015, 09:12:38 PM »
Thank you everyone for the input.

As I had anticipated, the decision on what to do is very situational. This is the situation that my mother and I are in. She is nearing retirement and I have taken over management.

I ran the numbers and realized that her total cash-on-cash return is very low. However, this is due to the fact that there is so much equity locked into the building. This is essentially my mother's retirement vehicle (all eggs in one basket). I started contributing to a Roth IRA to help diversify. The plan currently is to collect net income from rent, which will fund my mother's retirement. I will help manage the property and continue to raise rent (tenants paying slightly below market rent currently).

However, when my mother passes away and my brothers and I inherit these properties, we will need to evaluate if it is worth keeping this investment. It is a decent amount of work during tenant turnovers. If the Cap rate is low, I will likely sell the property. Right now, the property values in Southern California is so high, whereas the rent hasn't kept pace.


  • Bristles
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Re: Hypothetical Situation - Equity Rich but Cash flow Poor
« Reply #6 on: June 15, 2015, 06:35:33 AM »
If I were you, I would just continue to manage the properties and pay your mother what it takes to live on - Assuming you will inherit the properties at some point.  Even if you have to manage them for free...

I am in a similar boat, but no kids.  I may start to liquidate at some point, even if taxes are there,  By the time I am ~70, they would all be sold.  I have about the same equity, but a bit more investable assets.

Get better tenants, and your turnovers will be a lot easier.