Author Topic: Time to Sell the Rental?  (Read 1049 times)

mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Time to Sell the Rental?
« on: February 18, 2020, 02:38:48 PM »
Hey all,

So I have a rental property (my old primary residence). When I moved out 5ish years ago, rented out mainly b/c of the market at the time (new development, was going to have to undercut new construction to sell, could at least break even in the short term renting). Over the last 5 years, it has become distinctly cashflow positive (although nothing extraordinary). The market in general where I live is good for landlords. Lots of new jobs, both tech jobs and blue-collar. Vacancies for rentals are astronomically low in the area of the city I'm in. With that said, over the last year, the market for sellers has gone absolutely bananas. If I were to put my house on the market today, it would, with almost no doubt, have at least half a dozen offers at/over list price by tomorrow afternoon (in the words of a friend who is a realtor...."I could have your house sold before you went to bed tonight). For some reference of the market, the house is in a suburb of a mid-sized city (metro 450k). The suburb has a population of about 50k. In the city limits of the suburb, there are currently three houses for sale that is < 1750 sq ft. Anything that goes on the market is typically gone before it even shows up on the MLS. Ok, so that's the backstory of the general market. Here are the numbers

Home Value: ~$200k (mind you, this number is climbing pretty rapidly right now)
Purchase Price: $158k
Remaining Mortgage: $127k (8 years into a 30 on a house I put very little down on...the life of young and fresh out of school)

Current Rent: $1395/month
Management Fee: 10% of rent
Current Mortgage Payment (including taxes and insurance): $1030
Occupancy over the last 4 years in my unit is ~95%. That's probably in line with the area of the city that it's in.
Current Lease: Ends in September
Major repairs? Brand new HVAC last summer (10 year warranty on parts), roof has 30-yr architectural shingles. So not expecting any massive repairs anytime soon.

So, as you can see, assuming 90% occupancy, after management fees, I net about $1200/yr. Not a ton. But, given the above 90% occupancy historically and the new HVAC, I expect to end up cashflow positive most years. But yeah, not like I'm pocketing any money month-to-month. I basically keep my $5k "repairs and vacancy fund" filled up. If you assume all of the above about vacancies, assume repairs run ~1% of the value of the house per year, and project out rental rates that outpace inflation by 1%, my calculations show that at the end of my mortgage (22 years from now), I'll have pocketed $49k. If you want to get fancy and say I invest all that profit @ 7%, that gives me ~$88k. And of course at the end of the mortgage, I'd have the equity in the house. Assuming property appreciation outpaces inflation by 0.5%, that'd make the property worth about  $220k. Gives me a grand total after selling the property at the end of the mortgage of $300k (today's dollars).

The alternative is to sell now while the market is hot. Assume I get $200k. After fees, $60k in my pocket today. Assuming that gets invested at 7% for the next 22 years, it comes out to....you guessed it....$300k.

Any advice on how to evaluate this decision? Seems like if my house appreciates much more and I could sell for say $210k instead of $200k, I'd be better of selling instead of holding it. Thoughts? If this is better off in the Real Estate Forum, feel free to move it there.



Meanwhile, let's say I sell for $200k. After realtor fees, that nets me about $60k. That same $60k

FatFI2025

  • Bristles
  • ***
  • Posts: 265
  • Location: California
Re: Time to Sell the Rental?
« Reply #1 on: February 18, 2020, 08:04:11 PM »
Don't forget about capital gains and depreciation recapture, which will cut into your $60K projection.

Your rental is in the grey zone between appreciation strategy and cash flow strategy. Most investors on MMM are pro-CF strategy and would look at your numbers and tell you to sell.

You could reasonably go either way, which isn't really helpful advice for you to make a decision. Based on the fact that you are an accidental landlord and don't seem to have plans to make rentals a part of your longer term financial strategy, I recommend selling while the market's hot.

That recommendation differs from what I'd do because my long term strategy involves some allocation to rental RE.

mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Re: Time to Sell the Rental?
« Reply #2 on: February 18, 2020, 08:14:48 PM »
Yeah, totally forgot to include the capital gains and depreciation recapture. Just came back to include those, actually. That would be ~$15k if my calculations are right...so leaves me with ~$45k net at current prices. You're right...I'm in the grey zone. Feels like from a numbers perspective either would be a fine choice. I like your advice about how it fits into long-term strategy. I was (am) an accidental landlord. But you're also right; I don't really plan to make it part of my long-term strategy as of now. I re-evaluate during spring and summer. Expectation around here seems to be that the market will continue to heat up at least through summer. Will continue to weigh numbers until thne.

Kayad

  • 5 O'Clock Shadow
  • *
  • Posts: 66
Re: Time to Sell the Rental?
« Reply #3 on: February 19, 2020, 07:27:51 AM »
On the income side of the ledger, I would count mortgage principal pay down as part of your net. 

I think almost everyone will say the numbers donít make sense from a cash flow perspective.

Here is what Iíd say:  You live in the same city as your rental but are giving up half of your cash flow to a pm company.  That shows you really donít want to deal much with being a landlord.  Sell it now, or in one or two more years, to take advantage of the hot market.

mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Re: Time to Sell the Rental?
« Reply #4 on: February 19, 2020, 09:57:28 AM »
Yeah, I am definitely leaning towards selling now. Put together a pretty detailed spreadsheet last night after posting. Calculated cap rate, cash-on-cash return, and then maybe more important to me cash-on-cash return after accounting for taxes due to the sale (so basically cash-on-cash return = (Net Operating Income + Principle Paydown)/(Home Equity - Taxes Due From Sale - Realtor Fees). It puts my cash-on-cash return at about 7%. Then, over time, that return slowly decreases until mortgage payoff. Cap rate is currently ~1.7% and won't hit 4% until 2035. Again, you can play with the numbers (rent increase rate, property appreciation rate, occupancy rate, management fees, etc) and they change some. Doing the management myself (e.g. eliminating management fees completely) puts me up in the 9-10% cash-on-cash return. Which honestly, still doesn't seem that great compared to just taking the cash and dumping it in an index fund since there would be some level of effort involved with managing the property. So yeah...definitely leaning towards selling right now.

dd564

  • 5 O'Clock Shadow
  • *
  • Posts: 51
Re: Time to Sell the Rental?
« Reply #5 on: February 19, 2020, 02:35:48 PM »
I would keep it.

You have the best of a rental asset and that is one that appreciates in value.

There are two types of real estate investors.

1.  People who invest for cashflow.
2.  People who invest for wealth.

You are more in the 2nd category.

You need to figure out what you would get by selling, but I'm doubt it will be better than the appreciation, the tax benefits, and the mortgage paydown, and the hedge against inflation you have right now.

If you sell it, you'll likely regret it in 7-10 years when it sells again for $300k.

FatFI2025

  • Bristles
  • ***
  • Posts: 265
  • Location: California
Re: Time to Sell the Rental?
« Reply #6 on: February 19, 2020, 04:16:54 PM »
Cap rate is currently ~1.7% and won't hit 4% until 2035.

How did you get to that figure?

mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Re: Time to Sell the Rental?
« Reply #7 on: February 19, 2020, 04:58:28 PM »
I have a pretty extensive spreadsheet, but here's where I got it from (also note that I"m including principal paydown in the calculation...although I know that wouldn't typically be considered part of NOI).

Cap Rate = NetOperatingIncome/MarketValue

NOI = (Principal Payment for the Year) + 12*((ManagementGross Rent - PITI - Management Fees - Maintenance*(1-Vacancy Rate))
       = 3720 + 12*(MonthlyGrossIncome - MonthlyGrossExpense)
       = 3720 + 12*((1-ManagementFee)*(1-VacancyRate)*Rent - PITI - Maintenance)
       = 3720 + 12*(0.9*0.9*1395 - 1041 - 125) = $3310

CapRate = $3,710/$200,000 = 1.65%

The increase over intervening years is due to projected rent increase and property appreciation. Won't try to recreate those numbers here and obviously depends on what assumptions you make. The timeframe to hit 4% is using "average" numbers for property appreciation and rent increases.

dd564

  • 5 O'Clock Shadow
  • *
  • Posts: 51
Re: Time to Sell the Rental?
« Reply #8 on: February 19, 2020, 05:50:08 PM »
What's the balance on your mortgage on it and how many year mortgage is it?

I assume fixed.

You might be paying your property management company too much by the way.


mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Re: Time to Sell the Rental?
« Reply #9 on: February 19, 2020, 06:34:05 PM »
Balance is $128k, 30 year (22 remaining), 4.0% fixed.

I go back and forth about the property management. I feel like I pay them too much most of the time, but they have gotten me consistently good tenants and with 3 small kids, a busy job, and in the process of building a house myself, not sure I have the margin to manage it myself (10% of collected rent is the standard rate where I'm at with any management company).

FatFI2025

  • Bristles
  • ***
  • Posts: 265
  • Location: California
Re: Time to Sell the Rental?
« Reply #10 on: February 20, 2020, 08:09:13 AM »
I have a pretty extensive spreadsheet, but here's where I got it from (also note that I"m including principal paydown in the calculation...although I know that wouldn't typically be considered part of NOI).

Cap Rate = NetOperatingIncome/MarketValue

NOI = (Principal Payment for the Year) + 12*((ManagementGross Rent - PITI - Management Fees - Maintenance*(1-Vacancy Rate))
       = 3720 + 12*(MonthlyGrossIncome - MonthlyGrossExpense)
       = 3720 + 12*((1-ManagementFee)*(1-VacancyRate)*Rent - PITI - Maintenance)
       = 3720 + 12*(0.9*0.9*1395 - 1041 - 125) = $3310

CapRate = $3,710/$200,000 = 1.65%

The increase over intervening years is due to projected rent increase and property appreciation. Won't try to recreate those numbers here and obviously depends on what assumptions you make. The timeframe to hit 4% is using "average" numbers for property appreciation and rent increases.

That was a big red flag, like saying you pay $8.75 for a gallon of gas in Raleigh. Places in the US where homes sell for $200K don't have cap rates in that range.

Sounds like you know you're not calculating the cap rate because you've added in principal payments. But you added them in as an expense, which they are not. Interest is an expense, so you could arguably enter that in the numerator, but there would be two flaws with that approach. First, you'd still end up with a calculation other than cap rate, so it would not be useful for comparing the property, which is the purpose of calculating cap rate. Second, mathematically it would still be incorrect to account for financing in the numerator, but not in the denominator. If you account for financing in the denominator, then you end up calculating CoC returns.

So I think the conclusion is that this mashup calculation should be discarded.

mrigney

  • Stubble
  • **
  • Posts: 164
    • Running of the Fools
Re: Time to Sell the Rental?
« Reply #11 on: February 20, 2020, 09:00:50 AM »
Ha. Ok, we can get rid of the mashup

NOI = Gross Operating Revenue - Gross Operating Expense
       = ((Monthly Rent*12*(1-ManagementFees))*OccupancyRate) - (HOA Fees + Maintenance + Taxes + Insurance)
       
       =((1395*12*.9)*.9) - (200 + 1500 + 1800 + 1600)
       =13560 - 5100 = $8,460

CapRate = $8460/$200000 = 4.2%

That should be better, eh?:-)

FatFI2025

  • Bristles
  • ***
  • Posts: 265
  • Location: California
Re: Time to Sell the Rental?
« Reply #12 on: February 20, 2020, 04:22:43 PM »
Ha. Ok, we can get rid of the mashup

NOI = Gross Operating Revenue - Gross Operating Expense
       = ((Monthly Rent*12*(1-ManagementFees))*OccupancyRate) - (HOA Fees + Maintenance + Taxes + Insurance)
       
       =((1395*12*.9)*.9) - (200 + 1500 + 1800 + 1600)
       =13560 - 5100 = $8,460

CapRate = $8460/$200000 = 4.2%

That should be better, eh?:-)

Yes that number is much less offensive to me :D.

Keep us posted on what you decide to do. Good luck!

YTProphet

  • Stubble
  • **
  • Posts: 213
Re: Time to Sell the Rental?
« Reply #13 on: February 26, 2020, 12:17:46 PM »
Ha. Ok, we can get rid of the mashup

NOI = Gross Operating Revenue - Gross Operating Expense
       = ((Monthly Rent*12*(1-ManagementFees))*OccupancyRate) - (HOA Fees + Maintenance + Taxes + Insurance)
       
       =((1395*12*.9)*.9) - (200 + 1500 + 1800 + 1600)
       =13560 - 5100 = $8,460

CapRate = $8460/$200000 = 4.2%

That should be better, eh?:-)

I'm a real estate investor. If I were in your shoes, I would make the decision by saying "would I invest in this deal if I didn't already own it?". And the answer to that question is no. Even in an appreciating area, a sub 5 cap rate is not good. I'd sell and the decision wouldn't be particularly difficult.