Author Topic: Reader Case Study - Should I Rent My Primary Residence?  (Read 232 times)

Gus

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Reader Case Study - Should I Rent My Primary Residence?
« on: December 01, 2017, 11:06:55 AM »
Life Situation: Married filing jointly. One child.

Gross Salary/Wages: $270k. I work, my wife is taking care of our kid full time and takes no salary.

Individual amounts of each Pre-tax deductions 401k, HSA, FSA, IRA, insurance, etc.: We max out 401k and two IRAs. We also invest in a vanguard index fund each month. We have a small-ish college fund that auto-debits for our daughter. I have no stress hitting those deposits each month.

Other Ordinary Income: No other income, save for the index dividends.

Qualified Dividends & Long Term Capital Gains: I don't have anything to worry about here, I don't think. All dividends are auto reinvested.

Rental Income, Actual Expenses, and Depreciation: none yet.

Adjusted Gross Income: $230k or so. I am self employed and have a home office deduction among others.

Taxes: Federal, state/local, and FICA.: not sure. I live in a relatively high-tax state but get a small refund each year because of my self-employment deductions.

Current expenses: Mortgage $2391 (including tax withholding). Health insurance $707. Student debt maintenance $960. Also have car insurance (300), life insurance (140), cell phone (160), internet (65), etc. We spend a fair amount on food but only eat organic, etc.

For mortgage payments, separate the P&I (which stop when the mortgage is paid) from the T&I (and anything else) which continue as long as you own the property.: $1919 for mortgage. $472 for insurance and tax withholding. Rate is great: 3.875% fixed.

Expected ER expenses: Not sure what this is.

Assets: Two cars owned outright, sum value $30k. Have $85k in various retirement stock accounts in addition to $50k in cash. On-hand cash and non-retirement stock accounts are a bit more than our total student debt, which is why, although our debt is high, it's not a stress point for me -- we could pay it off at any time but choose to invest at the moment.

Liabilities: $93k in student loans with weighted average interest rate of 4.6%. Long terms. Monthly payment is $960/mo, which is large but easily manageable for me. I understand that looks like a lot, but again we have more cash available than outstanding debt (we invest instead.) No other debt including cars.

Specific Question(s): I bought the house I'm in for $457k in 2014. It now comps for $650-700k. A local property evaluator said he could manage our property for a 6% annual fee. I like that price, because even after the fee, the house would run at a profit. He says he can rent for $2800 a month, charge the fee, and that would still keep us something like $200 in the black each month. Plus there would be approx $650/mo principal repayment on the mortgage, plus the appreciation on the house, which has been significant lately (7-10% annually on a house that currently comps for $650-700k.) So this looks like something like a $40-50k per year net worth increase. I'd like to move, rent our current place, and save for a down payment on the next place. But we do have a lot of debt (though cheap) and the new place would be expensive. Maybe $1M or more.

I have one big variable, which is that my wife wants to live in a house we own, price be damned. But our only child is 1, and won't need a decent public school for at least four years.

Thoughts?

Hotstreak

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #1 on: December 01, 2017, 01:01:35 PM »
That rent is way too low for it to make sense.  A general rule of thumb is that your monthly rents should be 1% of home value for the rental to make sense, so you would need to be pulling in $7,000 or so per month.  The only way it makes sense is if you rely on it continuing to increase in value.  Keep in mind that real estate typically tracks with inflation - the large run up over the past few years may not continue.  I would sell the house, put 20% down on the new home, and invest any remaining funds (or stay at this home, if it meets your needs).


Also, look at changing your car insurance, $300/month is insanely high for two cars.

chasingthegoodlife

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #2 on: December 01, 2017, 01:06:14 PM »
Why do you need to spend $1million plus on your next home?

Not criticising, just curious.

What would your new home have that your current home lacks?

Gus

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #3 on: December 01, 2017, 03:02:07 PM »
Why do you need to spend $1million plus on your next home?

Not criticising, just curious.

What would your new home have that your current home lacks?

I live in the greater LA area, so house prices here are pretty nuts. The things I'm looking for are decent public schools and a third bedroom. I currently live in a 2BR in a very bad part of town. Terrible schools, gangs, etc. In other parts of the country this would cost me not so much. Here, a lot.

Gus

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #4 on: December 01, 2017, 03:08:59 PM »
That rent is way too low for it to make sense.  A general rule of thumb is that your monthly rents should be 1% of home value for the rental to make sense, so you would need to be pulling in $7,000 or so per month.  The only way it makes sense is if you rely on it continuing to increase in value.  Keep in mind that real estate typically tracks with inflation - the large run up over the past few years may not continue.  I would sell the house, put 20% down on the new home, and invest any remaining funds (or stay at this home, if it meets your needs).


Also, look at changing your car insurance, $300/month is insanely high for two cars.

I agree about the cars. I have tried a few times this year to change the car insurance. The options seem to be to go down to a deductible I'm not comfortable with at about 220 a month or have the coverage I like at 300. It doesn't make me happy, but Los Angeles is... full of cars. High rates. I would move, but my job is here.

As for this 1% thing you're saying... Are you sure this is right? Some brief searches seem to show this doesn't hold up, for example a 2M apartment in Brooklyn would have to rent for 20k a month, when they actually rent for about 4-5k a month. Here in LA, a $1.5M house rents for about $5-6k a month, even in relatively wealthy neighborhoods.

robartsd

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #5 on: December 01, 2017, 04:41:10 PM »
Gross Salary/Wages: $270k. I work, my wife is taking care of our kid full time and takes no salary.

Adjusted Gross Income: $230k or so. I am self employed and have a home office deduction among others.
Self employed? Are all of your salary/wages from your business? Any other employees? If you're a one man business you should look into setting up an employer match to shelter more of your savings (I think total contributiosn can get to 54k/yr in a solo 401(k)).

Should you rent out a house you can sell for $600-700k for a mere $2800/month? Not a chance. Your $200/month cash flow goes negative really fast as soon as something goes wrong. Your non-appreciation upside tops out at about $850. It only takes $170,000 invested at 6% to match that return - and that's your maximum upside sans appreciation - I estimate that your equity is somewhere close to that.

robartsd

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #6 on: December 01, 2017, 04:49:37 PM »
I have one big variable, which is that my wife wants to live in a house we own, price be damned. But our only child is 1, and won't need a decent public school for at least four years.

As for this 1% thing you're saying... Are you sure this is right? Some brief searches seem to show this doesn't hold up, for example a 2M apartment in Brooklyn would have to rent for 20k a month, when they actually rent for about 4-5k a month. Here in LA, a $1.5M house rents for about $5-6k a month, even in relatively wealthy neighborhoods.

I think there is a correlation between these statements. Many americans choose to own a home when the math says it's better to rent. Some fools hold on to houses in hot real estate markets counting on continued appreciation then get soaked by the real investors when they are forced to sell after the market collapses.

Hotstreak

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Re: Reader Case Study - Should I Rent My Primary Residence?
« Reply #7 on: December 01, 2017, 06:17:11 PM »
That rent is way too low for it to make sense.  A general rule of thumb is that your monthly rents should be 1% of home value for the rental to make sense, so you would need to be pulling in $7,000 or so per month.  The only way it makes sense is if you rely on it continuing to increase in value.  Keep in mind that real estate typically tracks with inflation - the large run up over the past few years may not continue.  I would sell the house, put 20% down on the new home, and invest any remaining funds (or stay at this home, if it meets your needs).


Also, look at changing your car insurance, $300/month is insanely high for two cars.

I agree about the cars. I have tried a few times this year to change the car insurance. The options seem to be to go down to a deductible I'm not comfortable with at about 220 a month or have the coverage I like at 300. It doesn't make me happy, but Los Angeles is... full of cars. High rates. I would move, but my job is here.

As for this 1% thing you're saying... Are you sure this is right? Some brief searches seem to show this doesn't hold up, for example a 2M apartment in Brooklyn would have to rent for 20k a month, when they actually rent for about 4-5k a month. Here in LA, a $1.5M house rents for about $5-6k a month, even in relatively wealthy neighborhoods.


So, it might be the 2% rule, maybe someone with more expertise can chime in.  People do still buy and rent properties that don't cash flow, especially after vacancy and maintenance, or that DO cash flow but not as well as if they had put their down payment in the stock market instead.  There are a lot of different pieces that need to be looked at when considering a rental, for starters, check out this sticky https://forum.mrmoneymustache.com/real-estate-and-landlording/evaluating-a-rental-property/