The other day I was doing some wealth training with our ProVision employees. We were talking about Internal Controls. One of our employees mentioned that it seemed like Internal Controls were not just about preventing embezzlement and theft, but about all negative actions, including mistakes with a portfolio. I totally agreed with this comment and we started to discuss what an investor needs to do to prevent simple mistakes in their real estate portfolio.
I suggested that values need to be monitored on a regular basis so that real estate that has gone up in value beyond its “true” value can be sold. What is a property's “true” value? Under my definition, a propertie's true value is any value at which we would buy the property ourselves. So, if the property has appreciated to such an extent that we would not purchase it ourselves, then we should sell it. Let me give you an example.
Suppose you have a single-family home that you purchased for $200,000. The property has appreciated over the years to $400,000. Let's say also that your investment criteria include a requirement that any property you purchase must produce positive cash flow. When you purchased the property for $200,000, the property had strong positive cash flow. But if you paid $400,000 for this property, it would now have significantly negative cash flow. In other words, rents have not kept pace with appreciation.
But, you might say, you paid $200,000 for this property so it still has strong positive cash flow. Wrong! If you own property that is worth $400,000, it's cost to you is about $370,000 ($400,000 less selling commissions and other closing costs). This is because you could have $370,000 to use on other, positively cash flowing properties, if you sold the house. Another way to look at this is to determine whether this house would positively cash flow if you borrowed out the appreciation. If it does, then you should keep it under your criteria. If not, you should sell it.
Most people make the mistake of believing that if they have positive cash flow from their property, then they should hold onto it forever. This is a mistake and ignores the enormous benefits of Velocity of Money.
So don't forget to monitor the value of the properties in your portfolio so you can maximize your investment returns.