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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: broper10 on February 03, 2016, 04:56:10 PM

Title: Reader Case Study - Sell the rental house?
Post by: broper10 on February 03, 2016, 04:56:10 PM
**UPDATE BELOW**

Hi all. Long time MMM reader and forum visitor, first time poster. I feel fortunate for my financial situation but have a ways to go reach FIRE. My wife and I paid off our house almost two years ago and have since moved in to another house, keeping the paid off house as a rental. We use the rental income to pay a good chunk of a mortgage on the newer house. I would like your opinions about whether we should maintain our current situation or get rid of the rental, apply that principal to the new house, and pay down the new mortgage asap. Please let me know if I failed to include anything and thanks for your input!

Life Situation:
Married filing jointly
2 Kiddos - 4yrs & 1.5yrs
We live in Boise, Idaho. I am 34 and my wife is 30.

Gross Salary/Wages: $8,333/mth ($100,000/yr)

Pre-tax deductions:
401k - $1,468.51
Employer Match - $333.33
HSA - $273
Insurance - $153

SubTotal = $6,440

Rental Income, Actual Expenses, and Depreciation:
Rental House - $1,450
     less $309 for property tax, HOA, insurance, and misc. maintenance ($50)

Adjusted Gross Income: $7,580.49


Income Taxes:
$1068

Income before other expenses: $6,512.46

Current expenses:
Mortgage   $1,641
(Loan is with wife's parents, so refinancing to a 15 yr if/when I sell the other house would be very easy and essentially cost free.
$350,000 30yrs fixed 3.85%
Started June 1, 2015 - Feb breakdown is $529.66 Principal $1,111.17 Interest.

Property Tax   $448 
Home/Rent Insurance   $35
Car Insurance   $83
Car Maintenance, Registration, etc.   $76
Charitable contributions   $644 (10% tithing)
Child activities    $50
Christmas/Holidays   $42
Clothing/Shoes   $25
Dentist   $25
Dining (Lunch/Dinner/Etc.)   $85
Electricity   $60
Emergency Fund   
Entertainment   $25 
Fuel/Public Transport   $150
Gas/Oil for heating   $55
Groceries   $500
Hair Care   $35
Internet   $35
Life Insurance   $25
Miscellaneous   $4
Recycling/Trash $25
Water/Sewer   $25
Non-mortgage total expenses:   $2,451

After tax investable: $1,962


Assets:
Rental House (no mortgage), Zillow estimate $242,500
Taxable savings account   $5,000
401k   $48,131
Traditional IRA $5,116
Roth IRA $31,280
HSA $1,695
Total Assets: $334,470

Liabilities:
Mortgage on primary residence $350,000 30yrs 3.85% (we are only 8 months in)

UPDATE:
In an effort to compare what my situation would look like in 10 years, selling the rental vs. keeping it, I came up with the following numbers. In short, it seems like selling looks like a good idea.

Keeping the Rental
Safe Withdrawal Rate   4%
Real return on tax-deferred investments   5.00%
Real, after tax, return on taxable investments   5.00%
Expected retirement total tax rate   15%

Projected Savings at Retirement   
Taxable   $304,278
Tax-deferred (e.g. trad. IRA/401k)   $358,860
Roth + HSA   $165,092
Total projected stash   $828,229
   
Projected Expenses in Retirement   
Non-loan, non-work expenses   $29,416
Income taxes   $5,191
Total   $34,607
   
Total loan principal due at FI   $274,337
   
Stash needed for retirement @4.0% SWR   $1,139,502
   
   Need $311,273 more.


Selling the Rental
Safe Withdrawal Rate   4%
Real return on tax-deferred investments   5.00%
Real, after tax, return on taxable investments   5.00%
Expected retirement total tax rate   15%
   
Projected Savings at Retirement   
Taxable   $258,124
Tax-deferred (e.g. trad. IRA/401k)   $358,860
Roth + HSA   $165,092
Total projected stash   $782,076
   
Projected Expenses in Retirement   
Non-loan, non-work expenses   $29,416 
Income taxes   $5,191
Total   $34,607
   
Total loan principal due at FI   $47,717
   
Stash needed for retirement @4.0% SWR   $912,881
   
   Need $130,806 more.

**UPDATE**
After thinking some more about this I had a faint recollection of a simple comparison I did of holding the rental vs. selling. Looking into some old spreadsheets I found the chart below. It is simple, maybe too simple, but it is basically a balance sheet with the rental and a balance sheet without the rental. The underlying assumptions are a 30 yr mortgage (350K with the rental - 125K without). This analysis shows that holding the rental actually provides better monthly cash flows. Am I missing something with this or does this provide a better, more narrow, look at the situation?

Rental      No Rental

$1,450.00   Income      $0.00
-$1,641.00   Mtg             -$586.01
-$191.00           Sub Total     -$586.01
-$1,810.00   Taxes       $0.00
-$640.00           Insurance     $0.00
-$660.00           HOA               $0.00

-$3,110.00   Annual Total   -$7,032.12
-$259.17           Monthly Total    -$586.01
Title: Re: Reader Case Study - Sell the rental house?
Post by: neo von retorch on February 03, 2016, 10:03:55 PM
While you might have more luck posting in the Real Estate specific forum, the 1% rule (and often 2% rule) would say you're getting too little rent for the value. While it's obviously cash flow positive, I would think you'd be much better off selling the rental and investing the proceeds in a taxable account. For comparison, my rental cost me $155,900 and I collect $1650 in rent. Just squeaking by the 1% rule. I would likely sell it, but I have multiple tenants, so it would be tricky. (And the wife believes it's better to keep it.)
Title: Re: Reader Case Study - Sell the rental house?
Post by: Urchina on February 03, 2016, 10:52:30 PM
Why not move back into the paid-off house, sell the one you're living in, and not have a mortgage?
Title: Re: Reader Case Study - Sell the rental house?
Post by: broper10 on February 03, 2016, 11:02:42 PM
Thanks for input so far guys! I appreciate it.I have been leaning toward selling the rental and focusing on paying off the new mortgage. Selling the new house and instantly not having a mortgage again would be the most financially optimal thing to do, but the new house is close to family and is located where we really want to live. When we first moved to Boise we bought what is now the rental house because it was what we could afford at the time. It is far from where we want to be though. We would have to drive a lot to see family and access all of the outdoor things we like to do. So for now, we want to stay in the new house.
Title: Re: Reader Case Study - Sell the rental house?
Post by: neo von retorch on February 04, 2016, 08:40:11 AM
Why is paying off your current mortgage more "financially optimal" than investing that money instead?
Title: Re: Reader Case Study - Sell the rental house?
Post by: AZDude on February 04, 2016, 08:47:37 AM
Why is paying off your current mortgage more "financially optimal" than investing that money instead?

Great question, especially at 3.85%. The market has been down lately, making a great time to buy $240K worth of index funds.
Title: Re: Reader Case Study - Sell the rental house?
Post by: broper10 on February 04, 2016, 11:33:25 AM
That is a good question. I had not considered that as an option simply because my wife and I like the idea of having no debt, as evidenced by our paying off the first house fast. The time we had with no mortgage was pretty amazing, I must say. It is a liberating feeling. I guess my thinking now has been focused on getting back to that.

If I were to sell the house and invest the proceeds, or at least a chunk of it, you think throwing it into Vanguard Index is best? I like the idea of getting into the dividends game but that world is foreign to me.
Title: Re: Reader Case Study - Sell the rental house?
Post by: neo von retorch on February 04, 2016, 11:46:06 AM
Well "best" is a dangerous word :) I'd say "figure out your preferred asset allocation." Considering all the real estate you have now, it makes a lot of sense to part ways with some real estate, and purchase other types of investments (domestic and international equities and bonds.) I'd read about the Three-fund portfolio (https://www.bogleheads.org/wiki/Three-fund_portfolio). You can also look into Vanguard's personalized recommendations tool (https://personal.vanguard.com/us/funds/tools/recommendation). The total stock market index fund is great, and it will both grow (in the long-term) and pay out a healthy share of dividends.
Title: Re: Reader Case Study - Sell the rental house?
Post by: Mother Fussbudget on February 04, 2016, 05:02:32 PM
Running some numbers... will respond soon...

A couple of things to think about:
* Will you need / want the mortgage interest tax deduction in FI?
* Have you considered options other than all-or-nothing? (i.e. sell rental, use X% to pay down mortgage, and XX% to invest)
* In the 'sell the rental' scenario, your expenses would go down within ~3 years if you focus on paying off the $48K mortgage balance first.
* Have you thought about double-paying the principle to cut the mortgage term in half?
Title: Re: Reader Case Study - Sell the rental house?
Post by: SwordGuy on February 04, 2016, 07:19:52 PM
First of all, it looks like you are stealing from yourself. 

How much will a new roof cost?  How many years will it last?  Divide that $ amount by the number of months it will last and that will tell you how much you need to be setting aside.  Ditto for the HVAC system.   And the water heater, oven, fridge, etc.   And the times you have to pay utilities and taxes out of savings because there is no tenant to pay them. 

It looks like you are spending that money now instead of setting it aside for later.

Will you be able to cash flow paying for those items out of your salary?   Ditto for when you are FIREd.  What if you lose your job and your tenant at the same time?   Because if you can't cover the cost of getting those broken items fixed you won't get another tenant - or at least one that you want in your property.   (You can always get a bad tenant who will cost you even more money in repairs and lost rent...)


Title: Re: Reader Case Study - Sell the rental house?
Post by: broper10 on February 05, 2016, 11:05:25 AM
Great points. We are indeed spending that money now to pay for most of our mortgage on the new house. I have thought about that before but haven't changed what I am doing. My salary can cash flow most repairs excepting the biggies. The rental is relatively new, built in 2003, so I don't anticipate any big issues for a while. You never know though.

Another thought I had this morning was to hold on to the rental a bit longer to give property values a chance to go up some more. The Boise market has seen some appreciation in the last few years and the market looks like it will stay solid. We bought the rental in 2010 for $189K and as I mentioned in the original post Zillow puts is at $242K. The area of town where it is located has been selling at a price per square foot that would put it closer to $255K, so I feel pretty good about the investment as far as that aspect is concerned.

This is great food for thought everyone.