Author Topic: Calculating the return of a house you live in where you rent out rooms  (Read 3012 times)

JayGatsby

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I'm attempting to figure out my returns on a house I live in, where I rent two rooms to friends. Can't quite seem to wrap my head around it.

Here's the info (let me know if I'm forgetting anything).

Purchase Price: $407k
Zestimate (best ballpark current value): $447k
Mortgage Payment and taxes: $2500 per month
PMI: $200 per month (so total $2700 monthly payment)
Loan Amount outstanding: $393k
Current combined rent of two roommates: $1400
Interest Rate: 4.125%
Approx $600 per month going to principal

I live in a Northeast city, so housing is expensive. I look at it as I'd be paying $1800 or so for a one bedroom, so with this setup, I can pay $1300 per month, and have $600 of that going to principal.  Now, actually being a homeowner for the first time, I definitely can see the effects of the 50% rule. Safe to say something is always coming up, and over the long term, I'll be paying $1200 per month or so to maintain the house.

I gotta live somewhere. So how poor of a job/good of a job am I doing at growing my net worth using this strategy? And should I consider selling in a few years to get a higher rate of return elsewhere?


Must_Stash

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #1 on: December 06, 2014, 07:42:37 PM »
To clarify:  Do you mean $1200 a month maintenance in addition to the $1300 monthly mortgage shortfall? Also, have you included utilities?

For myself, utilities are much higher in my old house than a modern apartment, and I have to budget for new siding.  It's definitely a lifestyle choice, as it's just about a wash to renting.  But if you're accomplishing that, and you enjoy your yard, freedom, and roommate experience, you're doing very well.

waltworks

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #2 on: December 06, 2014, 07:56:48 PM »
How much would it cost to rent an equivalent house and live with 2 roommates? That's your best comparable scenario. Given the PMI and closing/selling costs, plus the usual illiquidity/hassles of RE, probably a net worth bad choice as compared to other investments, but it's not terrible.

-W

AlanStache

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #3 on: December 06, 2014, 09:15:13 PM »
ROI may not be best here because as you know it is a bit hard to calculate.  I would try to calculate costs/networths given your current set up vs alternatives.  Assume the house and rents increases at 3% and any difference in cash goes into the market at 7% then work out net worth in 10 years including equity.

As discussed elsewhere here by the numbers buying can be a bad FIRE decision, renting a room for dirt cheap and investing the difference will get you more money quicker (or buying for dirt cheap see earlyretirementextreme.com), YMMV-etc.  There are many benefits to owing (am have a mortgage too) but it does tent to tie up a lot of money for along time at a low rate of return unless you can get some good income from roommates.

What has happened that you are paying 1200$/mon to maintain the house?  Including a new hotwater heater last year I think I average <50$/mon in strict maintenance.

clarkfan1979

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #4 on: December 07, 2014, 01:12:07 PM »
Since you are charging $700/room I think your comparison scenario should be $700 and not $1800 for a one bedroom. For maintenance, I am going to assume that you mean 1200/year.

This means that you are paying $1400/month for owning instead of doing the same thing and not owning ($700/month). If you have $600/month going toward principle, it looks as though you have a $100 shortfall.

The biggest unknown is your down payment. I think you have to assume a 7% return in the stock market with your down payment if you didn't buy. You are short $700 every month and have to consider losing 7% market returns on $700/month.

It doesn't look good but the true answer lies when you sell and how much you get for it.

Every situation is different. I bought a 4 bed/2 bath for 182K in May 2007. The total was 50K with 20% down, closing costs and repairs. I rented out 3 rooms for a total of $925 and the mortgage total is $950. I did that for 4 years. I've rented the whole house out for the last 3 years for $1450/month. Rent seems to increase by about 2%/year. I average $1200/year in repairs. If I sold next summer, I could get 250K. I have been very happy with my decision even though there are probably many people that have better numbers.

I used the rate of return calculator on bigger pockets and got a 13.5% rate of return (on a 30 year loan) with modest rent increases (1.5%) and modest appreciation (1.5%). However, most of the repairs during the first 4 years were DIY and didn't count my time. Lastly, I believe this assumes that you just put your excess rental income in a savings account. If you put the excess rental money in the stock market, I think the rate of return would be higher. I'm not sure if that is cheating. 

AlanStache

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #5 on: December 07, 2014, 04:50:17 PM »
Quote
Lastly, I believe this assumes that you just put your excess rental income in a savings account. If you put the excess rental money in the stock market, I think the rate of return would be higher. I'm not sure if that is cheating.

All's fair in love and investments.  I think for the sake of comparisons you have to assume it is invested and not sitting in a 0.01% checking account. 

Goldielocks

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #6 on: December 07, 2014, 08:54:31 PM »
Here is how I look at it,

Your rent intake from roommates is income.
You have a leveraged investment using $14k in cash input in year zero.  You acquire an asset that has gained in value and is worth the sale price, minus the realtor fees, minus the mortgage owing.

You have $1800/month cost avoidance (treat liken another income stream), assuming it MUST be paid.

What does a 10 year Internal rate of return look like?

Iintial cash used to purchase   -14000
PMI/yr   -2400
Interest + taxes   + principal payment/yr (assumes very long amortization, see below) -30000
Roomates income/yr   16800
Maintenance/yr   -14400
Cost Avoided (1 bdrm rent not required)/yr   21600
Property increase at 2%/yr   
Sale Costs 6% Fees   

Sell in 10 years:
   
8%   10 years:  IRR at 2% home appreciation / yr
8%    5 year IRR @ 2% home appreciation / yr
3%  10 years IRR at 1% home appreciation / yr


How to interpret:

If your house appreciation is only 1% or less, then your internal rate of return after 10 years is marginal.
OR if your home is sold in only 5 years,  with 2% appreciation, you still have positive cash
Greater annual home appreciation would make it show better returns, obviously.


Assumption:
Room mates pay for their share of utilities separately -- you do not pay more utilities than you would in a 1 bedroom place.
no capital gains taxes, and
 that interest is actually constant over the 10 years (it is not, but close to it, after 10 years on a 30 year amortization, this means your actual IRR is slightly better than stated).

***Principal amount would not be used elsewhere, if you did not invest it in your mortgage.  After 10 years, $600 per month is a LOT of money.  Worth about $100k if invested for 10 years at 6%...if you throw in this lost opportunity, you actually need at least 3% home appreciation PER YEAR to break even.  Or just charge your room mates $175 more a month (each)...   but it is all a numbers game, so don't get hung up on that amount.

JayGatsby

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #7 on: December 10, 2014, 12:42:57 PM »
Goldielocks - That's the exact kind of hard analysis I was trying to come up with.  The one number I think you left out, as it just occurred to me as well, is the tax break from the mortagage interest deduction. This will be my first year doing that, and I haven't calculated the number, but I imagine that is worth at least a couple of thousand dollars.

I like to think of that as reducing my monthly cost of living, by breaking down whatever that will be and dividing by 12. Certainly, that will all go to funding my tax advantaged accounts for 2015.

Goldielocks

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Re: Calculating the return of a house you live in where you rent out rooms
« Reply #8 on: December 11, 2014, 07:13:47 PM »
Goldielocks - That's the exact kind of hard analysis I was trying to come up with.  The one number I think you left out, as it just occurred to me as well, is the tax break from the mortagage interest deduction. This will be my first year doing that, and I haven't calculated the number, but I imagine that is worth at least a couple of thousand dollars.

I like to think of that as reducing my monthly cost of living, by breaking down whatever that will be and dividing by 12. Certainly, that will all go to funding my tax advantaged accounts for 2015.
Ha, ha.  yep I guess I did leave it out,  but I don't get that tax break in Canada, so I forgot!   Just make it another positive on the cash flow.  the IRR I came up with may be done differently for different persons (level of detail, assumptions, etc).   So another equally good IRR may have different results.