Rent vs. Sell: My situation *updated with more info*

[Paul]

Hi,

This is my first post on MMM, though I've been an avid reader since I was introduced by Getrichslowly.org. As the post subject states, I am trying to decide whether it would be financially smarter to continue to rent and manage a property from a distance, or to sell once the current lease is complete.

Background: I purchased an older home a few blocks from the University I attend in 2010; I was able to qualify for an FHA loan, and the $8k first time home buyer tax credit, which made it a good choice to purchase instead of renting. I paid just under $100k for the 2 bed 1 bath property, and put the 3.5% down required. As I was in school, I chose to go with a 30 year repayment, and I believe the current mortgage is for $93,000. It is locked in at 5% and the payment is $760/month. I knew that I would have 3 years of didactic coursework and a intern year spent at different locations in the state/country. So, instead of financing my mortgage via student loans during my 4th year (part-time work + renting the second bedroom covered the majority of the mortgage my first 3 years), I opted to rent to a young couple that I am friends with and spend part of the internship year living with relatives/renting a cheaper place. We originally agreed to them paying $625/month + utilities with a 2 year lease. After having a child they would like to cut our lease down to 1 year and then find more affordable housing. This would complete their lease at the end of May 2014.

Dilemma/cliff notes: I accepted a great job 2.5 hours from my property (starts June '14) and am unsure on whether it would be better to continue renting (with a property manager), or to sell (hopefully making a small profit and put towards a residence in my new town/student loans.) The mortgage is $93k with 26 years remaining @5%. I believe I could rent for at least $800/month + utilities due to its proximity to a large university, or I could sell and pocket at least $10k (plus the $8k credit I received in 2010.) Frankly, I'm not interested in managing it myself, as the past 9 months have been unpleasant dealing with late rent and maintenance. As it may effect the options, my current financial status, at 25: $93k mortgage, $85k in student loans, with a few thousand (<$5k) in savings/checking. The job I accepted is salaried at ~$120K/year and is in a very low cost of living area. I am interested in purchasing a home in my new area in the next few years and plan to pay off my student loans in 3-7 years. I am leaning towards selling, but that may be because right now the opportunity for a few thousand dollars and reduced debt sounds appealing, but at the same time I want to begin growing assets and passive forms of income.

Numbers:
Mortgage amount: $93k @5%
Current payment: $760/month
Home appraisal value (2010): $110k
Current rent income: $625/month
Likely future rent: $800+/month

Thank you for any opinions and taking the time to read this novella of a post!


Paul

[Thegoblinchief]

Not super experienced in real estate myself, but I would recommend selling. 800/month is below the 1% rule of thumb (i.e. rent/mo should be 1% or greater of property value).

Keep in mind that this 800/month is barely cashflow positive, but that's GROSS cashflow. Expenses and a property manager can eat up to 50% of that over time.

If the property can be sold for profit or even break-even, I would dump it. It's not going to make you any money, and could very easily become a moneypit.

[SunshineGirl]

Why I'd consider keeping: You only put down about $3,500 on the property and it's near a university. If you can find a property manager and break even, it'll help with your taxes and be money in your pocket down the road. (Imagine if you had a 15-year mortgage on this....)

Why I'd sell: You only put down $3,500 and you can sell it for a profit of double that (after expenses) and you don't sound like you want it.

Are there other uses for the property, like Air Bnb, considering its location? I have a friend making really good money with short-term rentals (at this point, monthly only) near a university. If you could rent that furnished for a month at a time, or to visiting professors, you could probably bring in a lot more.

However, by the way you presented your post, I sense you want to sell. 

[electriceagle]

I would rent it out, but first I would reconsider the idea of getting a property manager.

Your current tenants are leaving -- you now have the chance to end your problems with late rent by choosing better tenants and managing the property in a more efficient way.

If your state/locality does not prohibit it, I would suggest that you require your new tenants to pay rent via automatic deduction from their checking account. There are several services available for this; one is erentpayment.com. Also, don't forget the applicant background check.

The last few months have been unpleasant dealing with "maintenance." Would it be more accurate to say that this time period has been unpleasant because of dealing with repairs?

Maintenance is continuous upkeep of a property; repairs are required when maintenance fails or a part reaches end-of-life.

Do a detailed tour of the house and decide what needs maintenance work. Do the maintenance (preferably yourself). A house is much like the human body; if you maintain it well, you lower the risk of needing big repairs.

A year ago, I would have said that you should refi and bring your interest rate down to 3.5% with no PMI. 3.5% interest rates are a thing of the past, but I would still consider a refi if you can ditch PMI.

[scenicnights]

KEEP THE HOUSE.  I just went through a similar situation and asked two different professional financial advisors.  The advice they gave me was priceless.  Even if you break even on the rent it is still worth keeping due to tax insentives.  Also, people aren't considering home prices rebounding and appreciation of the property.  You've heard the term "Your best investment is your home".  There's a reason for that.  I think people are just scared because of the housing market crash.  Those days are behind us and we are moving forward.  Also, it's great to diversify and you having physical property is just another egg in your basket. 

Just my opinion.

[chasesfish]

I would keep it.  You paid $93,000 and can rent it for $800, so its above 0.75% in the monthly rent.

I don't know what college town it is, but I've worked as a banker for three years in a college town in my last job and its difficult to do much better than 0.75% to start on a single family.  The market(s) are usually really insulated due to lack of land within walking distance of the university and it keeps prices high relative to rents.  Your also competing with quasi-investors (parents buying the house for their kids to rent).

The nice thing is they aren't making new land next to a university, so rents have this slow and steady march up.  One of the richest clients I had explained this to me, he always had to eat a slightly negative cash flow for a couple years on a property because of the underlying dirt value/cost, but the rents only go in one direction.

[SunshineGirl]

Although, to the point of not making any more land near a university, in my town they are building UP now, which is a big change, and as such the inventory is going up quite a bit, and the newer stuff is nicer.

I didn't mean to imply that I would sell the property. Personally, I would keep it, but my advice was based off what I read into the OP's post.

[hybrid]

Sell.  Forget the potential ROI for just a moment, consider the fact that your life is about to get very, very busy in a few months and you are about to take a job where you will soon have many different ways to invest your significant excess cash.

Put another way.  It's July and you are in the other town.  Buddy approaches you and says, hey, I've got a good-not-great scoop on a rental house a couple of hours down the road.  Would you be interested in that deal?

Hell no you wouldn't be interested in that mediocre deal, the only reason you are interested now is because you already own it.  Sell, sell, sell.  If you want to buy rental property buy it in the new city or better yet, choose alternate investments if renting isn't your cup of tea, which it sure reads from where I am sitting.

Good luck!

[Paul]

Thanks for the replies everyone!

I have set up an appointment with a firm that does both sales and property management, and am having the house assessed on both ends of the spectrum. After speaking with a realtor, I'm thinking if I can come out a few thousand ahead post sale, I'll sell, unless after property management fees I can break even renting(with a manager). I do want to sell, but if I can have the investment passively building income, while being managed by someone else, I feel like that is the way to go. I agree with you, Hybrid, that if this, "opportunity" came up in a few months, I wouldn't touch it; the home wasn't initially purchased with the idea to become a rental property, and while it is a nice, small family home, it isn't an ideal rental.  Chasefish, while I agree that it is a prime location (3 blocks from the University~14k students), I'm not sure that the stress+risk+gain will outweigh/outperform a similar monetary investment in say an index fund/REIT. So, I still haven't made a decision in the last few weeks, but I will post the information I receive from the prospective property management companies and the realtor, which will hopefully make an answer clear.

Thanks again!

[Paul]

**More numbers!**

I was hoping that once I received a market assessment from a realtor and an estimate from a property management company, that I would have a clear winner, but I think they are fairly close.

Market assessment:Low Price: $89,900
High Price: $115,000
Recommended:$105,100

-the agent recommended going at or a little bit above the recommended, and she thought that it would sell fairly quickly. With my tenants I do have the opportunity to end the lease in May; so I could potentially list it in the next 30 days, and then have 90 days to close before I have to worry about an empty property.

-The current mortgage on the property is ~$92,000, so If I sold at $105k, minus the 3%, I would net about $8k {(105k*0.97)-93k], plus the benefit of the $8k first time home buyers credit I received. Even taking the down payment and cost of maintenance ($3.5k+$1.5K), this puts me around a $10-12k potential profit (which would basically be inflation if I had purchased the property outright) for 3 years of use + having my credit tied up. Kind of kickass as I had to live somwhere.

Rental Property Estimate:Rent: $750-800/month
- the management company takes half of the first months rent when placing a tenant, and then charges 9% of the rent thereafter.

--Profit to me would come in at $682-728/month; which I would then use to pay the $770 mortgage payment. Just from the 9%, I would have a net loss of around $1000/year. This would become a break even once I own 20% of the property and remove the PMI, which if I keep the property, would hopefully(realistically be) within 18 months.

--While the rent numbers don't look as good, while there is still a mortgage on the property, I would be able to take advantage of the mortgage interested deduction (locked in at 5%) ($4.2k), while also deducting property management costs ($1185-1264/year), repairs, and insurance ($600/year.)

Breakdown
Sale: likely $7-8k net lump sum now
Rent: -$1k/first year; likely break even or a little better + tax breaks until the mortgage is paid off~~eventually a substantial piece of cashflowing equity.

Please let me know if I am missing an obvious piece that could change my numbers and any opinions, thank you!

[Thegoblinchief]

Mortgage deduction only matters if you itemize (do you?)

I would sell. That 8K will earn 5-7% every year. The 100K you have tied up in this property won't return anywhere near that percentage, and you can very easily end up losing money. Home values very rarely outpace inflation, and only then it's highly localized.

Once you factor in vacancy and repairs, you will end most years in the red.

[marblejane]

Be aware that once you convert the property to a rental, you no longer receive the mortgage interest deduction. Instead, you claim mortgage interest as a business expense. Also, you will need to claim rental income. So the net tax effect will be:

$800*12=$9,600 annual income

Less:
$4,200 mortgage interest expense
$1,264 prop mgmt costs
$400 tenant search costs
$600 insurance

Net income: $3,136.

Assuming that your $120k income puts you at the 28% marginal tax rate, you will therefore pay an additional $878 in taxes.

I'm not a tax professional, so don't trust these numbers- run them yourself.  I am in a similar situation to you and have been looking at this a lot lately. Have you been reporting this as a rental property? If you sell for a profit and don't meet the ownership and use tests (I think the requirement is that you have lived in the property for 2 of the past 5 years), you will have to pay capital gains on the profit from the sale.

Honestly, if I were you, I would do more research on the tax implications. I think you are likely better off selling now.

[dandarc]

$800*12=$9,600 annual income

Less:
$4,200 mortgage interest expense
$1,264 prop mgmt costs
$400 tenant search costs
$600 insurance

Net income: $3,136.

Don't forget depreciation.  That could get this property close to a wash as far as taxes are concerned.

[Kaminoge]

Whichever you do I'd say there's a lesson to be learned here - don't rent to friends.

Given your circumstances then maybe selling is best for you but if you do decide to keep it and find good property managers then it really shouldn't be any hassle. I've got several properties about 10,000 km away from where I live and I only visit every couple of years. I've really learned the value of good managers. Yes I pay more than the cheapest (which aren't so cheap if things go wrong) but as far as I'm concerned they're well worth it. They've always done a great job of picking tenants and everything else become easier with good tenants. It's been over 10 years now and I'm very happy with my investments.

[honobob]

Paul, are you really considering paying $6,000+ to free up maybe $7,000-8,000?  Pretty bad move unless you think rents and value will be dropping long term.

[backyardfeast]

Just a quick question about your profit if you sell, but here (in Canada, so ymmv), the seller pays agent fees for both buyer AND seller, so that deduction is 6%, not 3%.  Looking into changing our living situation recently, someone on here commented that they use a 10% cost guideline to sell.  Between the 6% to cover both commissions, and the various taxes and fees associated with land title transfer, etc, 10% seemed a little high, but not unreasonable.

If that's true for you, I don't really think either of these options is going to win clearly on the financial numbers.  My advice would be, you're really young, and your investment life is really going to jump with your new job opportunity (which sounds awesome, btw!).  As others regularly say on these forums, ignore your sunk costs.  Ignore the fact that you already own this.  Sell, congratulate yourself on the way you handled your expenses while in school, and move on from here.

Good luck either way!

[Paul]

Just wanted to give an update and thank everyone who responded. Sold the house and made a few thousand dollars profit; decided I would rather take a more passive investing approach with less stress. I felt that the house had a few large improvements that would have to happen in the next 5 years that I did not want to deal with. The roof was 21 years old, furnace and A/C 35+ (I sunk $1400 into this system over the previous year,) and the driveway is deteriorating. I think it would have been a bit of a wash either way; I'm looking at it as a learning experience- I learned that I don't enjoy working with tenants and/or the stress of maintenance emergencies and late payments. Thanks again to everyone who weighed in!