Should I sell my house or hold it for a rental?

[hurricane0884]

Ok so I have been interested in investing in real estate for a long time and I finally feel like I will be able to within the next few months/years. I just graduated from college in December and I have landed a wonderful job! My wife and I currently own a house. We purchased this house for $112,000 in August of 2011, which happened to be pretty near the bottom of the market in the Phoenix, AZ market. We did a FHA 3.5% down and my wife is an agent so we actually made money on the purchase of the house. Any future real estate transaction costs will only be for the sale of the property.

On to my question… My job is about 35 miles one way from our current house so we would like to move a little closer to my job. My question is, should I sell this house pay off all the debts and move closer now and purchase my first rental in a year or should I keep the house and move closer when I have the money for a new down payment and have this house be my first rental?

Info:

Salary: $57500
Wife’s Salary: $36000

Debts:
Car 1: $9850 @ 5%
Car 2: $5376 @ 5%
CC: $2500 @ 0% until October
Student Loans: $6625 3% no payments until September
House: $105,200 @ 4.625% - Refi possibility to 3.5% if decide to keep it

The house is worth about $185k now (my wife can pull comps and I am positive of this amount the Phoenix home market has shot up dramatically) and we would probably move into a $225k house closer as the prices are much higher in town.

Rental analysis https://docs.google.com/spreadsheet/ccc?key=0AtNNyLLaQ_HjdEEwVm1yWE9hb01HZFZfS1hsTnByZGc#gid=0                  

Please let me know if there is any other information that you need. To help me with this question!

[Another Reader]

Ah, the siren song of spreadsheets.....

Having owned a large number of rental homes in the Phoenix market for over 15 years, I will suggest your assumptions are completely unsupported by reality.  Expenses have outpaced rental growth by a substantial amount over that time.  Put in 4 or 5 percent in that cell and see what happens to your cash flow and ROI.  Vacancy and collection loss should be around 8 percent and even if this is a new or near new home, you will incur substantial repair and maintenance expense.  You will replace paint and carpet every 5 or 6 years.  Water heaters last 8 to 10 years.  A/C units last 7 to 10 years, mainly because tenants never change filters.  Tenants are very hard on appliances as well.  $100 a month is too low. 

Use the 50 percent rule if this is an older house.  I don't see an HOA expense, so I'm guessing the house is pre-1990's.  If you can get $1,200, you must be in a nice area.  I assume your wife ran the comps. 

I don't see any value increase factored in, and I wouldn't add one.  The prices in the Phoenix market have skyrocketed because of interest rates and investor demand.  Once interest rates and yields on other investment types increase, property prices will stabilize and could even drop.

Your wife's income is commission based, making it unpredictable and therefore unreliable.  I would not count on that for making mortgage payments.

In your shoes, I would be patient.  I would refinance this house as an owner-occupied property.  With the equity you have, the PMI should disappear and the rete will go down.  Then I would aggressively pay off the consumer debt.  Having all that debt can be a sign you are living at or slightly above your means.  Once I had paid off the cars and the credit card, I would look for a new house nearer to work.  I would also accumulate a substantial down payment to avoid FHA hell before I bought.

If you post the location and attributes of the peoperty, a more detailed analysis can be made.  In general, I would not pay $185,000 for a property that generates $1,200 in income.  Owning one that cost $112,000 can work, and I like buying for owner occupancy and converting to rentals over time as an accumulation strategy.

[SunshineGirl]

Congratulations on graduating and getting a good job!

If you really think you can sell the house for that amount, I would be inclined to sell it and pay everything off. You'd have a clean slate and money in the bank. I'd then rent closer to your job and wait to buy until you had at least 20% down and you'd been at your job at least a year.

Also, seriously, maxing out your savings in your 20s is hugely important, so I'd put that as a far higher priority than buying another house. This way, you would never again have to finance a car, put things on CC, etc.

[hurricane0884]

Thank you for your input Another Reader. I will re run the spreadsheet as you suggested. My understanding of the 50% rule is that I should plan on expenses of 50% of the NOI is that correct? Also what kind of information would you need for a more in depth analysis?

Going to college I worked full time and probably did live slightly above my means at that time however thanks to this blog and the new job we now have substantial free cash flow at the end of the month that we can throw at the debt as you suggested. Thanks for your tips!

I do like your idea of a clean slate SunshineGirl! It is something I was mulling over but I think real estate will be part of my long term FI plan and I guess I would consider the rental as part of "maxing out my savings" however, I am starting to think maybe that is not the best idea at this point.

[Another Reader]

The other issue with your spreadsheet is that you have not discounted future income and expenses.  A dollar today is worth more than a dollar tomorrow.  Your ROI does not take this into account, nor does it consider the value at the end of 30 years.  In other words, you need to do a full discounted cash flow analysis to determine ROI.

Since you just graduated from college, I would asume you bought within easy commuting distance to ASU.  If that's the case, that is a central location in the valley.  Depending on your wife's business, that could be important to her.  How stable and long term is your current job?  Is the 35 mile commute permanent? 

With regard to the house, the location, the condition and the features are what determine the rental and resale prospects.  For example, if you bought a well-located house of 1,600 square feet on a quiet street in the Fuller school district in zip code 85283, updated the flooring and repainted but did not remodel the kitchen, I would be able to tell you what I think of the property's prospects as a rental and my best guess (sorry, my crystal ball isn't working) about resale.

And, yes, get rid of the consumer debt ASAP!

[hurricane0884]

We actually purchased a house in Gilbert on Recker and Ray. She does work in Tempe however and we would want to move there.

The house: Recker and Ray in The Gardens (85296). 1600sq ft two floor 3b/2.5ba, quiet street in Higley school district, upgraded floors and kitchen cabinets. Built in '04.

We are working hard on the consumer debt we are dropping it at about a rate of $2500-$3000 a month!

[Another Reader]

I'm somewhat familiar with that subdivision.  I have properties in San Tan Ranch and Seville (85297).  I think you would find it difficult to get $1,200, especially if you have the rear entry garage.  Looking at the current listings and recent leases, asking $1,095 and getting $1,075-$1,095 is do-able.  Gilbert is very desirable for buyers, less so for renters.  Buyers will drive to buy, renters won't drive to rent.  My rents out there have been flat for years, with only recent increases in the market.  Vacancy will be 8-10 percent, with you almost always waiting a month for the right tenant (no line at the door).  Closer to employment centers would be better.

Tempe is more centrally located, but more expensive.  Your maintenance and repair expenses will be much higher for the 1960's and 70's houses there.  Tempe is deceptive - remodeled and newer houses lease quickly, while original houses rent for less and take longer.  The 10/202 merge is hell if you are commuting downtown or west.

Other than the possibility of rising interest rates, I don't see too much harm in waiting a few months while you knock out the consumer debt.  If you sell the Higley house, you have the down payment.  In your shoes, I would wait until the consumer debt is gone and I was convinced the job was secure before making any move.  At the rate you are killing it, you will only have a few more months to wait!

[hurricane0884]

We do have a front garage and a corner lot which is why I bumped up the rent a little. Probably a little to much as I am new at this! Thanks for all your input! We will probably wait until August so we can skip the capital gains taxes and take a new look at the situation then. At this point I am thinking we will sell it and move closer to employment centers and then move that house to a rental in two years or so.

Thank you Another Reader for all your thought and inputs, I really appreciate it!