We all like to fantasize about the best-case scenario in managing a rental property. We find perfect tenants, the house remains in good condition, and we make a ton of extra money every month while keeping our occupants happy.
But the sad reality is that many landlords are forced to deal with a nearly opposite scenario. Their tenants are unreliable and disrespectful. The house is falling apart. And there doesn’t appear to be any easy solution to set things right.
In this type of scenario, it may be best to cut your losses on a rental property, getting rid of it before it causes you any more financial losses.
But what’s the best way to approach this?
The Sunk Cost Fallacy
All of us have experienced the sunk cost fallacy in at least one scenario. This cognitive bias encourages us to continue investing time and/or money into an endeavor that has already taken significant time and/or money from us.
For example, stock investors sometimes continue putting money into a stock that keeps falling in price. Let’s say a share of stock originally went for $50, and you invested $1,000 in that company, purchasing 20 shares. The price of the stock falls to $40, decreasing the value of your investment by 20 percent. You convince yourself that the stock is still a good long-term play, so you see the price drop as an investment opportunity. You put another $1,000 in, but the stock price falls further.
There are situations where this strategy can play out, especially if you have reason to believe that the company is undervalued. But if your only basis of reasoning is that you have to continue investing to try and make up for your earlier losses, you’ll be proverbially “throwing good money after bad.”
People often fall prey to the sunk cost fallacy in the rental property management world. Property investors and landlords understand that there’s always a risk of loss, and many losses in this area are temporary. Your first year of operation may cost you thousands of dollars, but if things go well, you can become neutral in a year or two, and ultimately find yourself making a significant profit.
However, newcomers often underestimate or overlook the possibility that the losses could indefinitely continue. Dumping more money into the property isn’t going to magically reverse its momentum; in some cases, it’s better to simply sell the property, recoup whatever losses you can, and move on to your next investments.
The first step in cutting your losses on a rental property is understanding and avoiding the sunk cost fallacy.
Identify Your Losses
Next, objectively identify your losses so you have an understanding of how much this property has cost you since you’ve owned it.
- Money. Where do you stand financially? How much have you spent managing and maintaining this property, and how much have you received in income? Are you currently operating at a loss? And how much is that deficit?
- Time. How much time have you spent on this property? If you’re financially neutral, but you spend hours every month managing the property, you’re suffering a different kind of loss.
- Stress. Don’t neglect the mental and emotional toll that a difficult rental property can have on you. If the property has several structural issues, if you have a problematic tenant, or if you have difficulty staying on top of your responsibilities, it may not be worth continuing.
Revisit Your Exit Strategy
Hopefully, you have a business plan or a formal strategy document for your rental real estate management approach. If you don’t, spend some time thinking about your mentality at the beginning of this strategy.
Do you have an exit strategy for this property in place? In other words, when were you originally planning on selling the property and what was your plan for selling it? You’re certainly not bound to this plan, but you should take a moment to evaluate your current position as it compares to the forecast you initially made. Is this a good time to sell according to your original vision? And if not, what changes led you to this place?
Forecast the Prospective Future
It’s not always the right move to cut your losses by selling the property. Before you go this route, forecast the prospective future. Could this property become profitable and worth managing? If so, what would it take to get there? What would the potential upside be, and is it worth the risk? The answers to these questions are dependent on your goals and your mindset.
Consider Your Options
If you decide to cut your losses, think about the strengths and weaknesses of the options available to you.
- Sell traditionally. Most real estate sellers are interested in making as much money as possible from the sale, but this can be time-consuming and stressful.
- Sell as is. An alternative option is to sell your house as is to a cash buyer. This is very fast and easy, but you may not receive the highest possible offer.
- Hire a property manager. If you’re mostly concerned about the time requirements of a rental property, consider hiring a property manager to help you out.
- Evict/terminate the lease. If the tenant is the problem, you may be able to repair the situation by evicting them.
Whatever you choose, you’ll need to think about your next moves.
- Analyze and reflect. Take a moment to assess how you got here and how you can avoid this situation in the future.
- Invest your proceeds. If you sold the house, consider investing those proceeds in new assets.
- Take away key lessons. Even if you’re not in real estate, there’s something you can learn from this.
Are you interested in cutting the losses you’ve experienced with a rental property? Are you eager to sell your property as soon as possible? Light Street Residential can help. In just a few minutes, and with just a few pieces of information, we can make you a cash offer on your home. There’s no commitment necessary – so try it today!