Author Topic: To sell or to rent (the primary residence)?  (Read 7975 times)

pdxvandal

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To sell or to rent (the primary residence)?
« on: April 23, 2013, 02:56:30 PM »
Hi everyone. This is my first post, so take it easy on me. :)

I live in Portland, Oregon, which has a very hit-and-miss public school system. I was raised on public schools so lean toward having my daughter (3) receive a quality public education, which means we'll likely move to a better school district in 1-2 years.

I own a house worth about 280,000 and owe 200k on the mortgage. I figure I could rent it for $1,500-$1,600 per month, which would mean a cash flow of about 400-475 per month. On paper, this is attractive.

I also know buying a house in a better school district will be more expensive. Do I hold on to the potential rental long-term, rent it for three years and avoid capital gains taxes, or sell once we find a different primary residence and net 90-100k for other investments and savings?

I've been a landlord before, for about three years, so I know the potential pitfalls. It just seems like a cash-flow positive property like this is a good path toward eventual FI by age 50 (I'm 38). I've sought other rental properties in the past year, but the supply is very tight and competition high.

Thanks.

frugalcoconut

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Re: To sell or to rent (the primary residence)?
« Reply #1 on: April 23, 2013, 07:35:44 PM »
I'm far from a real estate guru/expert but here are the things that I would like to mention...

If you are able to afford the down payment for buying a new, more expensive house without having to sell the old one ... that's a great position to be in.  I would recommend that you significantly beef up the emergency fund in case you have to carry both mortgages at once during a vacancy in the rental (or even worse, vacancy + repairs). 

It seems like it costs so much money to sell a property that it often takes away a good chunk of the on-paper "profit" (value - buyer's net purchase price) which would otherwise make selling attractive.  My preference is to hold onto the property (taking advantage of the fact that you have more favorable mortgage terms since you originally bought legitimately as owner-occupied) and convert it to a rental to diversity into another income stream ... but I don't know if the numbers make sense.
« Last Edit: April 23, 2013, 08:53:36 PM by frugalcoconut »

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #2 on: April 23, 2013, 08:57:37 PM »
How is the house cash flow positive at the rent you quote?  Are you subtracting the mortgage payment from the rent to get the income?  Are your numbers based on your previous landlord experience?  Please post your assumptions for this property.

From my perspective, this looks like a poor investment.  Using the 50 percent rule, the net operating income after all expenses except debt service (including capital improvements and property management) is $750 to $800 per month.  That's an annual free and clear net income of $9,000 to $9,600.  The free and clear capitalization rate on your $280,000 property is somewhere between 3.2 and 3.4 percent.  You haven't provided enough information about your mortgage, but I would guess your leverage is negative or at best neutral.  I would be surprised if you made any cash flow at all off this property over time after paying the mortgage.

Putting this differently, would you go out and spend $280,000 for an annual income of $9,000 to $9,600?

Finally, if the schools in this neighborhood don't measure up, the appreciation will lag the better areas.  That reduces any return on your investment from resale.  Again, this points to looking for a better investment elsewhere.


totoro

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Re: To sell or to rent (the primary residence)?
« Reply #3 on: April 23, 2013, 09:37:27 PM »
I agree that all costs are likely not properly accounted for here so it might not be a good place to keep as a rental as it might not really be cash flow positive.

I do not agree that you are spending $280,000 for an income of $9000 (if that is really net).  You are spending whatever you put down on the property -  maybe $80,000 here.  Most people don't leverage other types of investments like stocks and rates are much lower for secured real estate borrowing so this is just not an accurate comparison.  You are also not accounting for principal paydown over time.

Can you make your $80,000 make $9000 annually in other investments?  What is the condition of the big ticket items on the home (roof, foundation, perimeter drains..)?  Would taking the $80,000 out and investing it in a different home make you more?  Can you afford another down-payment without selling?


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Re: To sell or to rent (the primary residence)?
« Reply #4 on: April 23, 2013, 10:07:35 PM »
$9,000 is the income BEFORE debt service.  There is likely zero cash flow to the equity position.  For the $80,000 currently invested, the OP is likely getting no or a miniscule cash on cash return.  The $9,000/$280,000 would be the free and clear OAR.

If the house is brand new and will not likely have much in the way of capital improvements over the holding period and the OP wants to do the property management, then the 50 percent expenses might become 40 percent or a bit less.  The OP's assumptions are not included in the post.

The overall capitalization rate is simply a ratio of first year net operating income to the sale price or value.  If you want to account specifically for the equity pay down, use a yield capitalization model that accounts for all the cash flows.

totoro

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Re: To sell or to rent (the primary residence)?
« Reply #5 on: April 23, 2013, 10:15:33 PM »
Sorry, should have read through more carefully.  Would have been obvious if I'd looked back to the OP's projection of 400-500 a month and the numbers more carefully.  I agree it i hard to imagine that this is not cash flow negative.  In addition, principal paydown is good, but not a given, depending on the investment window vs. real estate cycle.

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Re: To sell or to rent (the primary residence)?
« Reply #6 on: April 23, 2013, 10:32:36 PM »
As long as the rent checks arrive and the mortgage payments paid, principal paydown goes as scheduled.  If the value deteriorates faster than the principal is paid down, your equity decreases.

If you are a long term investor, properties are kind of like dividend paying stocks.  What the stock is worth on any given day is less important than that consistent and growing income check in the mailbox.  The value becomes important when you buy or sell, and unimportant in between.


totoro

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Re: To sell or to rent (the primary residence)?
« Reply #7 on: April 24, 2013, 09:16:54 AM »
Agreed.  I own several rental properties and I bought each with a planned minimum 10 year window for ownership.  This will vary depending on what happens with the market.  Not having to sell until you can realize appreciation is key.  My other criteria is being cash flow positive. 

Our market in Canada has fewer options for cash flow positive properties because our housing costs are quite a bit higher overall.  If I lived in Portland I would of buying a home with a suite to reduce the generally high housing costs, and investing extra money in rental properties in high roi places like Texas rather than Portland.

pdxvandal

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Re: To sell or to rent (the primary residence)?
« Reply #8 on: April 24, 2013, 09:45:15 AM »
Thanks for everyone's feedback.

To offer more info, I have about 28 years left on a fixed mortgage at 3.875%. The house was built in 1924, but has good bones and is in good condition (new tankless water heater, new basement electrical, new shed, new exterior paint, simple landscaping, 8-year-old roof, etc.) ... like all houses requires maintenance but is generally low maintenance.

The schools aren't great, but it's in a hood that's becoming trendy (brewery, coffee shop, pizza place, Italian restaurant all opened in the last 5 years, close to public transit, 7 miles from downtown) and did not suffer as much in the real estate crash as other areas of Portland.

My mortgage is $1,170 per month which includes the escrow account for homeowners insurance, property taxes, etc., and about $315 per month goes toward principal.

I do have enough of a down payment to purchase a more expensive home (~10% DP for 450k house), which like one poster said is a good position to be in.

Does this change anyone's perception/evaluation of my situation? By the time I move in 1-2 years, I could very realistically get $1,600 per month in rent, if not $1,700.

Thanks again.

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #9 on: April 24, 2013, 10:27:38 AM »
totoro:

Lots of Canadians invest in the US for that exact reason.  In fact, it seems like half of Phoenix has been bought by Canadians!  Great for the value of my rentals, but a lot more competition in the rental market...

pdxvandal:

Subtracting the mortgage from the anticipated rent and calling that cash flow is one of the biggest mistakes you can make in real estate investing.  You have not allowed for vacancy and collection loss, repairs and capital improvements, or property management.  Your property taxes and insurance will go up by at least the rate of inflation.  And you can't project that rents will go up to $1,700 at the point you decide to move.  The market could change and rents may stabilize or even go down.

A 10 percent downpayment means PMI unless you can get an 80/10/10 loan and are willing to pay a much higher interest rate on the second.

If you had a 20 percent downpayment on the new house, lots of reserves to cover extended vacancy and/or major repairs on this house, and a willingness to accept a minimal cash on cash return, you might be able to do this.  In your shoes, I would pass on this investment, even if I could meet these conditions.

totoro

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Re: To sell or to rent (the primary residence)?
« Reply #10 on: April 24, 2013, 11:23:35 AM »
Yes, lots of Canadians have bought in Phoenix but mostly as secondary residences that they may or may not rent out.  They are going to make a lot on appreciation on this imo. Secondary residences in a nice climate at a low price are attractive to many, but not what I am looking for.

For a Canadian investor, the problem is that you need cash because we are not eligible for the financing you get as a resident of the US.  Most Canadians take out a home equity line of credit to finance this purchase and most won't be buying multiple properties in the US because of the need to put 100% down.  There are also rules like you cannot do your own repairs, you have to hire people to do them. 

Taxation is also a PITA -  estate taxes, double taxation and capital gains issues are difficult to figure out and easy to get into trouble with. 

For someone using real estate as an investment tool it becomes less attractive to a Canadian to do business in the US.

http://www.theglobeandmail.com/globe-investor/personal-finance/home-cents/buying-a-us-vacation-home-make-sure-you-know-the-tax-rules/article7995377/

DoubleDown

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Re: To sell or to rent (the primary residence)?
« Reply #11 on: April 24, 2013, 06:15:26 PM »
@OP: I also would pass on renting out this property. If we very generously
assume you'd get to keep about $250/month in rents after paying your mortgage,
taxes, interest, insurance, vacancies, maintenance/repairs, etc., then your
$80,000 in equity would be earning only 3.75% annually. You should be able to
get a far better return on another property if you were inclined to be a
landlord; if not I would not consider investing in (or holding) rental real
estate in your area.
 
Or, you could simply invest the $80,000 in other assets like stocks and likely
do far better than 3.75% without having to do any work or assuming any of the
risk as a landlord. Even a very "low or no risk" fund should be able to return
3.75%, again with no work. I like real estate as part of a portfolio, but not
this property.
 
The ONLY reason I would consider holding this property as a rental would be if I
speculated that it would gain spectacular returns through appreciation and was
worth the risks and work involved, which of course is a significant gamble that
also opens you up to significant liability.

freelancerNfulltimer

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Re: To sell or to rent (the primary residence)?
« Reply #12 on: April 24, 2013, 08:48:52 PM »
http://www.bankrate.com/finance/real-estate/capital-gains-home-sale-tax-break-a-boon-for-owners-1.aspx

You mention avoiding capital gains as a reason to rent. You don't have to pay capital gains if you use the proceeds towards another primary residence up to $250k single, $500 married.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #13 on: April 24, 2013, 09:04:28 PM »
pdxvandal
You have gotten some very poor advice.  Seems like everyone wants to jump in with their "expertise" without knowing what they're talking about.  How can anyone tell if this is a good or bad investment with the information given?  First, how much of the $80,000 equity is the money you brought to the table? Since you still have $200,000 mortgage balance after two years can we assume that you put $40,000ish down and the property appreciated $40,000 over 2 years? did you VA in with no money down and all $80,000 is appreciation?[/b 

So lets say you put 20% down on a $250,000 house.  That means $50,000 of that $80,000 was yours to start.  To get the $30,000 out you'll spend $20,000 minimum in realtor and selling fees.  Yeah!  You got $10,000 profit and free rent for two years.  If you bought a dog two years ago then be happy and cut your loses by selling NOW, but do your figgering based on actual analysis of the financials for this property.  Do you even know what the historic rental increase rate is or the appreciation rate?  Knowing that do you think you are capable of making an informed prediction of future increases?

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #14 on: April 24, 2013, 09:07:51 PM »
http://www.bankrate.com/finance/real-estate/capital-gains-home-sale-tax-break-a-boon-for-owners-1.aspx

You mention avoiding capital gains as a reason to rent. You don't have to pay capital gains if you use the proceeds towards another primary residence up to $250k single, $500 married.

More incorrect information.

freelancerNfulltimer

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Re: To sell or to rent (the primary residence)?
« Reply #15 on: April 24, 2013, 09:15:35 PM »
How is that incorrect?

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #16 on: April 24, 2013, 09:29:57 PM »
First, the OP can likely exclude $250,000 of capital gain if single, $500,000 if married.  It does not matter what you use the proceeds for.

Second, the OP has in fact paid "rent" and the "profit" is illusory.  Look at the cash flows to and from the equity position in your example.  The OP put down $50k plus closing costs.  Let's say a total of $55k.  The OP gets $60,000 at closing after selling expenses.  In the interim, the OP paid $1,170 per month in PITI.  For 2 years, that's $1,170 x 24, or $28,080.  Before considering the time value of money, the OP is out $$23,080.

Whether the OP has made a good investment to date is irrelevant to the OP's question.  What the OP is trying to do is to analyze the property as a potential rental going forward.  The information the OP provided shows the initial cash on cash return to be meager at best.  If more information is provided, more analysis can be done.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #17 on: April 24, 2013, 09:30:20 PM »
Read your own link. You are stuck in the 90's!

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #18 on: April 24, 2013, 09:57:20 PM »


 
Whether the OP has made a good investment to date is irrelevant to the OP's question.  What the OP is trying to do is to analyze the property as a potential rental going forward.  The information the OP provided shows the initial cash on cash return to be meager at best.  If more information is provided, more analysis can be done.

The OP has NOT given enough information to determine a cash on cash return.  Your earlier posts are also incorrect where you think you have derived a cap rate.

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #19 on: April 24, 2013, 10:05:59 PM »
Let's see your math and reasoning.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #20 on: April 24, 2013, 10:18:42 PM »
Uh...there's no math because there is not enough information.  At best you could come up with a GRM which actually would be more appropriate for a non commercial property.

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #21 on: April 24, 2013, 10:33:18 PM »
The OAR is an estimate, using the 50 percent rule.  The purpose of estimating an OAR in this case was to demonstrate how meager the overall return likely is.  Most people understand a P/E ratio, a cap rate is really just the inverse of a P/E ratio.  GRM's are useful for comparing properties with similar expense percentages.  The GRM is not useful for understanding why the numbers presented for this property might indicate it is not a very good investment.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #22 on: April 24, 2013, 10:55:05 PM »
Fity cent?  You are just making up a number to subtract from gross rents.   A cap rate on a specific property

Is NOT an estimate.  You use an operating statement to determine expenses (actual).



Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #23 on: April 24, 2013, 11:28:07 PM »
An estimate is exactly that.  Generally, property types fall into expense percentage ranges.  There's a fair amount of evidence, some anecdotal, supporting a range around 50 percent, including annualized capital improvement allowances, for SFR's.  There's a range for large apartment complexes, one for limited service hotels, one for single tenant R&D properties, etc., although the ranges most often used in the analyses of these properties exclude capital improvements.   You can even (gasp) look up recent capitalization rate ranges for various property types in proprietary publications.

If you know the rent and the value of a property, you can estimate a net operating income and therefore the OAR.   I wouldn't write a check based on such an estimate, I would review the operating statement.  But for the purpose of looking at the OP's free and clear investment return in this case, an estimate is close enough.



jamccain

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Re: To sell or to rent (the primary residence)?
« Reply #24 on: April 24, 2013, 11:32:33 PM »
I agree with honobob that the advice in this thread is not very helpful, or good.  Part of that is not all the needed information is provided, part is much of the information is just estimates or assumptions by the nature of the question, and finally only pieces of the matter are being discussed.

The bottom line is it's up to you and how you prioritize your life and finances....no amount of advice will ever change that. 

Three things missing entirely from this thread is a discussion about inflation, risk, and your willingness to give up your free time.  1) Your current mortgage is serving as an inflation hedge.  2) Risk created by the leverage has to be accounted for against your personal tolerances. 3) Your personal desire to own rental property. 

At the end of the day, I don't think this is simply a math question (because whatever assumptions you use will be wrong anyway), but instead it's a question of what makes sense for you and your family based on your gut feel. 

Personally, I would want as many properties as I could get my hands on with a 30 yr fixed mortgage at sub 4% interest.

« Last Edit: April 24, 2013, 11:34:28 PM by jamccain »

Another Reader

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Re: To sell or to rent (the primary residence)?
« Reply #25 on: April 24, 2013, 11:54:01 PM »
Leverage has to be positive for that sub-4 percent loan to benefit you.  If you borrow at 3.75 percent in an area where the OAR averages 2.5 percent, you are not making much of an investment in terms of cash flow or total return.  For example, in my neighborhood in Silicon Valley, market rent runs about 0.3 percent per month.  The annual rent is 0.3 x 12, or 3.6 percent of value.  If we use a conservative 40 percent expense ratio before debt service, the net income is 3.6 x 0.6 or 2.16 percent of the value.  If I borrowed 80 percent of the value at 3.75 percent, I'm hugely negative on the cash flow.  It's going to take a heck of a lot of appreciation and/or rapidly rising rents for me to break even on this investment.

I don't invest on gut feel.  I analyze the property to see if it will make money.  If I conclude it will make enough money to meet my yield requirements, then I pull out the checkbook.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #26 on: April 25, 2013, 08:47:16 AM »
GRM's are useful for comparing properties with similar expense percentages.  The GRM is not useful for understanding why the numbers presented for this property might indicate it is not a very good investment.

But YOU are the one saying ALL properties have EXACTLY the SAME EXPENSE PERCENTAGES (50%)!!  You are not making sense.

pdxvandal

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Re: To sell or to rent (the primary residence)?
« Reply #27 on: April 25, 2013, 09:52:03 AM »
Not sure if this will help dissenting opinions, but I put 5% down on the 225k overall price in 2005 (~11k), then spent $35k on a basement remodel to bring the livable square footage from 700 to 1,350.

I've refinanced twice, the first time included wiping out the second mortgage.

In doing a quick search, there is a similar property, a slightly trendier area (1 mile away) asking for $1,800 in rent.

Hard to say what the RE market will look like in 1-2 years, but Portland will continue to be a desirable destination.

If I put my house on the market today, I would have multiple offers within a week.

As far as capital gains, I would not have to roll the proceeds into another property. I rented my previous house for 2.5 years (after living in it for four years), sold it and paid no capital gains taxes.

honobob

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Re: To sell or to rent (the primary residence)?
« Reply #28 on: April 28, 2013, 03:01:59 PM »
An estimate is exactly that.  Generally, property types fall into expense percentage ranges.  There's a fair amount of evidence, some anecdotal, supporting a range around 50 percent, including annualized capital improvement allowances, for SFR's.  There's a range for large apartment complexes, one for limited service hotels, one for single tenant R&D properties, etc., although the ranges most often used in the analyses of these properties exclude capital improvements.   You can even (gasp) look up recent capitalization rate ranges for various property types in proprietary publications.

What you aren't saying or don't know is that these publications, like Korpacz report by city/market/submarket and by usetype/size etc of property.  They also report EACH expense item (not just some random/made up) per cent. 
I don't know of any publication showing this information for single family residences which pretty much makes any SFR "cap" rate useless.

SunshineGirl

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Re: To sell or to rent (the primary residence)?
« Reply #29 on: April 28, 2013, 03:14:42 PM »
I would re-think moving at all, if schools are the only reason for doing so. You are your kid's most important teacher when they're young, and if it's a decent school that you can walk to and that has lots of parental involvement, it's "good enough." I'd be much more concerned about the quality of the middle school.