Keep or sell investment property to invest in the market?

[sj16]

Hi,
It's been a dilemma for a while and we go back and forth every time we think about it..can anyone shed a light or offer any advise that would help to a decision?

Our investment condo's market value is around $630K. We have about $170K of mortgage left at 3.5% (13 yrs left).
Rental income is $3400/mo, HOA is $600/mo and property tax is about $500/mo. I have to add that our neighborhood's value/rent has shot up so much and continues to be a very sought-after area for highly compensated professionals.

However, it is so tempting to sell it and invest over $400K in the market and imagine what the compounding interest will do for decades to come..(i'm 33 yrs old/husband 38).

Any veterans/experienced wealth accumulators have any advise for this young-ish couple?

Thank you!!

[Mother Fussbudget]

I put your numbers through my rental property analysis spreadsheet - and made LOTS of assumptions regarding insurance, maintenance & repairs, property management, 10% vacancy, a 2% annual revenue & expense increase, and other costs you didn't mention (but that I'm sure you're paying today). 

*With my very conservative assumptions* and the numbers provided, I show expenses as 47.5%. 
Annual cash-flow is only $1,700-to-$2,100 for a ROI of 2.55%-to-2.63%. 

Honestly I would SELL it.  IMHO the opportunity cost of your dollars would be greater working for you elsewhere - even the total stock market index funds would provide more ROI.  Put some of that into mortgage notes, paying >10% ROI if you want to profit from the real-estate market.  Your current property is too pricey for your investment goals.  IMHO.

[KarefulKactus15]

Wow the above post is great!  Disclaimer, I'm not a veteran... no where to close but heres what I saw if I was in that situation.

I didn't calculate maintenance cost or insurance or even the mortgage payment into my half ass arithmetic. But even still, if you sell it you should have 460k ish to invest.

Something making 6% return beats the condo rental in the first year Not calculating hidden cost.   But as the above poster (who put much more time into this a reply then me) noted, with average hidden cost, your pushing closer to 2.5% ROI all said and done.  Not fantastic for an investment IMO.

[clarkfan1979]

If it's a popular area, vacancy is not going to be 10%.

[thedayisbrave]

When facing the sell vs. rent dilemma I like to ask: would you buy it now as an investment property, all else being equal?

Honestly I would sell it.  I am a real estate investor but that's a lot of equity in one house, and the rents aren't keeping up.  Those rents are high, sure, but if you look at your cash flow, I'm getting about the same cash-on-cash return that Mother Fussbudget projected, ~2.6%.  For comparison, my properties are at around 8%-11%.  I won't consider anything under 7%.

Sell it while you can get that amount for it, and put that money toward your stash :)

[Guesl982374]

I put your numbers through my rental property analysis spreadsheet - and made LOTS of assumptions regarding insurance, maintenance & repairs, property management, 10% vacancy, a 2% annual revenue & expense increase, and other costs you didn't mention (but that I'm sure you're paying today). 

*With my very conservative assumptions* and the numbers provided, I show expenses as 47.5%. 
Annual cash-flow is only $1,700-to-$2,100 for a ROI of 2.55%-to-2.63%. 

Honestly I would SELL it.  IMHO the opportunity cost of your dollars would be greater working for you elsewhere - even the total stock market index funds would provide more ROI.  Put some of that into mortgage notes, paying >10% ROI if you want to profit from the real-estate market.  Your current property is too pricey for your investment goals.  IMHO.

I got similar numbers in my spreadsheet even assuming 0% vacancy. I would either do the following:

1) If the area is as hot as you say and there doesn't seem to be an end in sight (think NYC or San Fran) then I would be tempted to re-leverage and put the money in the market IF I could handle the negative cash flow of the unit AND the unit was easy to manage (high quality tenants). That way you get that majority of the equity invested and you still maintain the upside of the hot real estate market.

2) Sell it and invest.

[Mother Fussbudget]

If it's a popular area, vacancy is not going to be 10%.

Agreed.  Also if there are long-term renters in the property there isn't likely to be gaps between renters.  However, it's also possible OP isn't renting at market rates.  My sense is OP hasn't regularly prepared renters for increases via token annual increase.

[sj16]

Thank you all so much for providing inputs! Really helpful..to clarify a bit more, I forgot to mention that the mortgage payment is around $1400/mo, so definitely cash inflow. I'm not sure how that would change the ROI analysis you all have graciously offered.
This area has always been on the "exclusive" side but is gaining even more desirability. All the top high tech firms are coming in and the market value/rental value has grown pretty exponentially in the past several years. I don't know if this helps but the condo was bought for under $300K 10 years ago.

I'm interested in the leveraging the equity and investing idea by Lady M..do you mind shedding some light in this? Do you mean, getting a HELOC or home equity loan to invest in the market? If so, which of the two methods do you prefer?

Thank you all again! :)

[Bearded Man]

Too low a return for that much equity in a single asset. I'd get a HELOC and use the money to buy either more rentals with favorable price to rent ratios like in the midwest and take the rest of the money and stick it in an index fund. Split the difference. In the long run, stocks will provide better returns due to the higher interest. Real estate doesn't appreciate as much in the long run and largely just keeps pace with inflation. It's good for cash flow when highly leveraged, but as the leverage wears off, the advantage wears off. Better to tap the equity and use it to invest in other assets, and in this case, I'd split the difference.

[Mother Fussbudget]

Ah... it sounds like you're asking for back-of-the-envelope "simple math" pencil musings...  let me know if I got that right.  Here you go.

TODAY you have an LTV of 25% ($170K remaining on $670K value).  For that, you could go just about anywhere and get a 3.75% HELOC - Pentagon Federal Credit Union as an example [I refinanced with them this summer]. 
If you take the 50% leverage option, and take out a $250K HELOC...
If you treat it like a 20 year loan, you'll pay $1,482/month (using Google's 'Mortgage Calculator') and the payments should end at about the same time as your original loan.   That's $2,882/month in payments which mostly come from the $3,400 rent.  [let's ignore the other expenses for now: HOA, taxes, etc. we're scribbling...]  This could work well.

Put $250K in VTSAX (or another Total Stock Market index fund), and *ASSUME* the proverbial average 10%/year (YMMV - some years will be less, some better).  After 19 years of re-investment, you should have  $1.5M in that account thanks to our old super-powered friend compound interest.


The other option - sell the house, and net ~$500K, then:
1) $250K invested in a NEW rental unit that cash flows + $250K invested in VTSAX, 10% average. = $1.5M in 19 years + whatever ROI you can get from the new rental unit.
2) $500K invested, 10% average.  = $3M after 19 years [NOTE: 100% tied to stock market long term performance].
BUT... with both these options you're STRICTLY CASH - no mortgage payment (or a low mortgage payment if you buy a new unit for more than $250K) AND no HELOC loan payment.

[aspiringnomad]

Those numbers scream sell to me. The only reason to hesitate is if you honestly forecast even more significant price appreciation in that neighborhood. Where I am, it's pretty obvious which hoods will get hot next, but the areas that have already run up in price, like yours, tend to cool off and stabilize over time. Absent continued appreciation above the norm, the ROI on your place isn't pretty.

[Bobberth]

Some excellent analysis so far. I would like to add that if you sell for $630k, after a 5% realtor fee, you will net $599k. Subtract out the $170k loan, you have $429k cash left over. You have a gain of $330k+ of which you will owe long term capital gains tax of $50k (15%) plus recaptured depreciation-if purchased for 300k, around $11k depreciation annually for 10 years=$110k of depreciation * 25% tax= another $27k in federal taxes.  So $429k cash-$77k in taxes=~$350k. If you owe 5% in state or local taxes on the $330k gain, that is another $17k of gains leaving you with ~$333k. Plus or minus for seller concessions/expenses, different realtor fees, repairs to sell and increased basis over the years.

Another way to tap that equity would be to do a cash out refinance. On a $630k property, an 80% LTV would be about $500k. Subtract out your current loan of $170k and you could pull $330k out of the property tax free. You now have a larger monthly payment for the same rental income so the investment's risk profile changes. You still own the property and will receive the benefit of any future price increases (decreases), cash flow (positive or negative), locking in a low interest rate, tax deductions and tenant headaches.   This way you could keep the rental property AND have an investment portfolio. If your actual after tax numbers are close to what you can pull out via a refinance, I would suggest going the refinance route. Put those tax savings to work for you instead of the government. Even if the rental just breaks even with cash flow, it's worth it. This is what I did with a rehab of mine-it made more sense to refinance and collect rent than to sell and pay taxes.

You could also do an exchange on this house to buy a bigger/better rental property if you want to stay with rental properties. Both ways allow you to use your equity without paying such a large chunk of it in taxes. 

[zinethstache]

Bobberths first paragraph is CRITICAL for you you understand. You definitely want to be thoughtful on your approach to keep as much cash in your pocket as possible.

I am an investor with highly appreciated properties and am constantly analyzing ways to pull out equity. I don't want to mess up and end up losing $$. We mustachians pride ourselves on making very sound financial decisions. I will be following this thread closely and can't wait for an update on what you decide to do.

Good luck!