Author Topic: Rental as passive income vs. selling and investing the equity  (Read 4495 times)

Mr. Green

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Rental as passive income vs. selling and investing the equity
« on: February 24, 2015, 02:13:58 PM »
I think Investor Alley might be the best place for this question but I'm unsure.

I am 31 and intend to move in the next 2 years. For a while now I have tossed around the idea of selling the townhouse I live in vs. keeping it for the rental income. Historically, home prices rise with inflation and rents rise with house prices, so for ease I assume the house would generate $16,000 (2014 dollars) per year for the rest of my life once the mortgage was paid off (or until I sold it). Using a 4% SWR, that income is the equivalent of having an additional $400,000 in my stash.

In contrast, the $100,000 of equity I have in the place will become worth $400,000 in 24 years, based on a ROR of 6% (inflation adjusted), invested in the market. That puts me somewhere in the neighborhood of age 57.

Strictly from an investment perspective neither scenario seems to have an obvious advantage over the other to me. Keeping the house means rental income in addition to a windfall (to be invested) whenever I decided to sell it. However, there's the risk of having bad tenants as well as the upkeep. If my equity invested now will equal the "stash equivalent" of yearly income from the house after only 24 years, the investment will obviously grow larger than the "stash equivalent" over my lifetime (unless I die young). However, selling the place eliminates one means of diversifying my income.

So I thought I would pose the question in case I'm missing something, as this forum has already made me aware that I have missed plenty up to now (but I'm learning!).

Financial.Velociraptor

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Re: Rental as passive income vs. selling and investing the equity
« Reply #1 on: February 24, 2015, 04:49:19 PM »
Did you consider the tax benefits of renting the place out in you calculations?  You can count your mortgage interest as a business expense and depreciate the cost basis over 29.5 years as a rental.  Just the depreciation on 100k, comes out to 25k saved in taxes over the life assuming a 25% tax bracket.

I have yet to take the real estate investor plunge so can't speak to how much trouble tenants are.

lise

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Re: Rental as passive income vs. selling and investing the equity
« Reply #2 on: February 24, 2015, 05:04:35 PM »
I would study rental market conditions in your area/suburb.  Just don't think about inflation.  What type of people are attracted to your suburb/area to rent in?  Young responsible couples or newly graduated frat boys? 

I purchased a rental property 10 years ago thinking I would get some nice capital gains over the year.   Well of course the market dipped in that area and the property is only just come up to being the same value it was 10 years ago.  However, my rental income is high.  The apartment is centrally located but on a quiet street, so it has attracted young professionals that don't want to party.  I've been lucky to have had really good tenants over the past 10 years. 

waltworks

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Re: Rental as passive income vs. selling and investing the equity
« Reply #3 on: February 24, 2015, 05:09:50 PM »
Read the posting a rent vs. sell sticky thread at the top of the real estate forum and then modify your post. Impossible to advise you here without more detail.

Also google "50% rule". Your cash flow will not be 100% of your collected rents assuming no mortgage - it will be some portion between 50 and 75 percent, depending on the property and how you manage it.

-W

MrMoogle

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Re: Rental as passive income vs. selling and investing the equity
« Reply #4 on: February 24, 2015, 07:00:50 PM »
Is that $16k/year profit or income?  If it's income, on average 50% is expense.  I had this same option two years ago (rent vs sell), and I chose to sell, since I wouldn't be a good landlord thousands of miles away. 

Now, I wish I rented it out, since I'm moving back to the location and would love to live in it.  But that wasn't my plan.

Retired To Win

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Re: Rental as passive income vs. selling and investing the equity
« Reply #5 on: February 24, 2015, 07:22:53 PM »
Did you consider the tax benefits of renting the place out in you calculations?  You can count your mortgage interest as a business expense and depreciate the cost basis over 29.5 years as a rental.  Just the depreciation on 100k, comes out to 25k saved in taxes over the life assuming a 25% tax bracket...


Exactly.  Velociraptor beat me to making this point.  BUT it really, really bears repeating.  Tremendous tax advantages are possible IF you position yourself as a hands-on owner-manager of your rental property.  And the additional actual cash in your pocket resulting from those deductions can easily tip the scales in favor of the rental property over the stock portfolio.

humblefi

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Re: Rental as passive income vs. selling and investing the equity
« Reply #6 on: February 24, 2015, 07:47:20 PM »
You have nice feedback on the tax angle.

One other angle I have is: is your townhome underwater or abovewater? You say you have $100K in equity. It is hard to build up so much equity..it can come if you bought it in the real estate dip OR the area is improving in some way and the home prices are increasing. I wish I had bought in the 2008 real estate market dip :-(

If you are already sitting on a decent pile of cash, I would just let the rental continue unless you have plans of investing the capital gains in your new primary residence. If not, I would let it act as a diversification for your income.  As another poster has mentioned, please do a rental analysis in your area and make sure that there are no major cons in that area. For example, if a huge employer is leaving town in a few years, then it is better to sell now and cash out....things like that.

Hope that helps.

Mr. Green

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Re: Rental as passive income vs. selling and investing the equity
« Reply #7 on: February 25, 2015, 11:37:32 AM »
Did you consider the tax benefits of renting the place out in you calculations?  You can count your mortgage interest as a business expense and depreciate the cost basis over 29.5 years as a rental.  Just the depreciation on 100k, comes out to 25k saved in taxes over the life assuming a 25% tax bracket.

I have yet to take the real estate investor plunge so can't speak to how much trouble tenants are.
There's a bit more to the tax game than this. I would only truly save that 25% if when I sold the place I paid no capital gains. If the house was depreciated to $0, the capital gains alone from the sale would push me into a tax bracket where capital gains were higher than 0%. If I was still in the 25% tax bracket when I sold the place, may actual tax savings are only 10%, the difference between my personal income tax rate from each year I paid the interest and the capital gains rate I paid in the year I sold the house. Of course all that is as the tax rules are right now.

Mr. Green

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Re: Rental as passive income vs. selling and investing the equity
« Reply #8 on: February 25, 2015, 11:43:19 AM »
You have nice feedback on the tax angle.

One other angle I have is: is your townhome underwater or abovewater? You say you have $100K in equity. It is hard to build up so much equity..it can come if you bought it in the real estate dip OR the area is improving in some way and the home prices are increasing. I wish I had bought in the 2008 real estate market dip :-(

If you are already sitting on a decent pile of cash, I would just let the rental continue unless you have plans of investing the capital gains in your new primary residence. If not, I would let it act as a diversification for your income.  As another poster has mentioned, please do a rental analysis in your area and make sure that there are no major cons in that area. For example, if a huge employer is leaving town in a few years, then it is better to sell now and cash out....things like that.

Hope that helps.
We bought in 2005 near the peak and financed the house 100%. We took a second note at a higher rate for the 20% and I paid that off within a few years. We also refinanced to a 15 year mortgage a couple years ago so every year of ownership the mortgage balance drops $10,000 at this point. We owe about $155,000 and there have been a dozen townhomes in our community that have sold in the last year for $230,000-240,000. The sale would occur in a couple years so that's the 100k equity.

I'll check out the rent vs. sell bit in the Real Estate forums. I was more interested in the invested equity vs. cashflow from renting. I thought this forum might have inputs from the investing angle.

rmendpara

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Re: Rental as passive income vs. selling and investing the equity
« Reply #9 on: February 25, 2015, 08:17:50 PM »
If you invest in a group of strong dividend paying stocks including some REITS stocks, you could likely generate gross cash flow of ~3.5%. More or less depending on how high or low you go add what growth profile you seek.

Now whether you should invest in dividend stocks vs growth stocks or in mutual funds is an entirely different conversation.

Keep in mind that a stock portfolio will likely grow a lot faster than physical real estate and be far more diversified, although you will miss out on some benefits like the leverage and tax advantages of physical real estate.

Different choices and pros/cons to each. The better choice depends on your preferences.

Scandium

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Re: Rental as passive income vs. selling and investing the equity
« Reply #10 on: February 26, 2015, 07:38:59 AM »
You're getting $2700/month in rent for your townhouse? ($16,000/12/0.5) Rent is expensive in this part of MD at least but I've seen most townhouses for less than that. I don't think I could that much rent or my single family home.