Author Topic: Case Study - Effect of building equity in rent vs sell  (Read 4056 times)

mrmiyagi

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Case Study - Effect of building equity in rent vs sell
« on: February 18, 2015, 09:23:04 PM »
Hey everyone - I found MMM about a month ago, and have been learning as much as I can. I'm hoping for some help with a rent vs sell scenario, as we are moving out of state:

Market Value: $250K
Original Purchase price: $230K
Original Mortgage Amount: $230K
Interest Rate: 2.6%
Mortgage Term: 7/1 ARM
Term remaining: three years until first rate change - 26 years total remaining
Amount remaining on mortgage: $210K
Gross Rents: I could rent it out for $1800 / mo
Principal and Interest (the P&I of your PITI - should match with the above info): $950 / mo
Taxes and Insurance (the T&I of your PITI): $375 / mo
HOA costs: $25 / mo

Assuming 10% property management fee and one vacant month a year, I'd be +$1620 cash flow per year before maintenance. The goal would just be to break even or have a slightly negative cash flow after including maintenance. Then, comparing the two scenarios at sale time assuming very modest appreciation with inflation:

SELL TODAY: Sale price $250K - $210K on mortgage - $20K closing: Walk away with $20K
RENT, THEN SELL IN THREE YEARS: Sale price $270K - $190K on mortgage - $20K closing: Walk away with $60K (minus capital gains tax)

I realize my property doesn't meet the 2% or even the 1% rule. However, plotting out these numbers, it really looks like renting is the way to go. Am I missing something here? Are my assumptions about costs as a landlord too low? Should my expected maintenance be significantly more than $2K / yr? I think the low interest rate is what's making this look so good - every year I keep the house, I gain about $6K in equity. The other factor is that I didn't put any money down, so there's not a ton of opportunity cost (just the $20K I could get by selling now). If I can stay around cash flow neutral, I'd basically double that money in three years even ignoring any appreciation.

I've been thinking about this a lot, and I would really appreciate any feedback you all have to offer.

adamcollin

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #1 on: February 18, 2015, 10:15:54 PM »
 Well, I would suggest you to consult an expert for accurate information.

jda1984

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #2 on: February 19, 2015, 01:32:31 AM »
A few things will likely change when you switch to rental property.  Your insurance will most likely increase.  Your property taxes may also increase depending on your location.  Does your current mortgage allow the dwelling to be used as a rental?  You may also need to get a rental license (depending on your municipality).  In Minneapolis (at least a couple years ago) if you were looking to convert a homestead property to a non-homestead (rental) you had to have an inspection as well as a processing fee that was pretty substantial (either $1000 or $5000).  I believe the intent was to cut down on people trying to rent out underwater properties when they didn't have a good handle on how to do so.  All this to say, factor these potential changes into your number.

If you don't have a good handle on the rental market in your area certainly get some estimates from rental agencies who might be willing to manage your property for you.  They have a good handle on the market and should get you an estimate that is very close.

Finally, how confident are you that the value of the property will increase that much over the next couple years?  Would you make the same decision if it didn't increase at all?  What if the value goes down?  Also, how fast do you think you could sell it?  If it's in a currently hot market, it may cool.  If it's a market that is pretty stable, your crystal ball is probably a bit better, but still obviously flawed.  There's some risk that you end up needed to refinance or make a balloon payment before you're out of the property if you can't liquidate it quickly down the road.

mrmiyagi

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #3 on: February 19, 2015, 10:03:27 AM »
A few things will likely change when you switch to rental property.  Your insurance will most likely increase.  Your property taxes may also increase depending on your location.  Does your current mortgage allow the dwelling to be used as a rental?  You may also need to get a rental license (depending on your municipality).  In Minneapolis (at least a couple years ago) if you were looking to convert a homestead property to a non-homestead (rental) you had to have an inspection as well as a processing fee that was pretty substantial (either $1000 or $5000).  I believe the intent was to cut down on people trying to rent out underwater properties when they didn't have a good handle on how to do so.  All this to say, factor these potential changes into your number.

If you don't have a good handle on the rental market in your area certainly get some estimates from rental agencies who might be willing to manage your property for you.  They have a good handle on the market and should get you an estimate that is very close.

Finally, how confident are you that the value of the property will increase that much over the next couple years?  Would you make the same decision if it didn't increase at all?  What if the value goes down?  Also, how fast do you think you could sell it?  If it's in a currently hot market, it may cool.  If it's a market that is pretty stable, your crystal ball is probably a bit better, but still obviously flawed.  There's some risk that you end up needed to refinance or make a balloon payment before you're out of the property if you can't liquidate it quickly down the road.

Thanks for the reply. The property taxes do go up for non-resident owners, but the amount I listed includes that increase. I did not know about a requirement for an inspection or a license - I will look into that.

Our market is pretty stable, and we live in a nice little neighborhood where houses are bought and sold pretty frequently. I wouldn't expect prices to plummet but of course there's no way to know for sure. My desire to keep the house is not really based on appreciation, but on building equity. I think I'm in a fairly unique situation with such a low interest rate and no money down or PMI (I got this loan because we bought at a good time and people are falling over themselves to lend money to physicians). Even with zero appreciation, my money just about doubles in 3 years, assuming I can break even with the monthly cash flow.

waltworks

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #4 on: February 19, 2015, 10:55:24 AM »
Maintenance will cost more than you think, probably. 50% rule says you aren't going to break even, you're going to slowly lose money.

You have to assume you are making some gains for a few years on your $20k of current equity, as well, of course.

Every case is different, though. If your place is in perfect mechanical shape and you don't expect to have to fix any big-ticket items, maybe you make more money renting it out.

-W

mrmiyagi

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #5 on: February 19, 2015, 12:20:49 PM »
Maintenance will cost more than you think, probably. 50% rule says you aren't going to break even, you're going to slowly lose money.

You have to assume you are making some gains for a few years on your $20k of current equity, as well, of course.

Every case is different, though. If your place is in perfect mechanical shape and you don't expect to have to fix any big-ticket items, maybe you make more money renting it out.

-W

I am pretty dang close to the 50% rule though, right? $1800 in rent with a $950/mo mortgage. By the 50% rule I'm -$600 cash flow per year, which I'm happy to pay while gaining $6K / yr in equity.

I agree that I need to consider investment gains on the $20K I could have now. At 7% for three years, that money becomes $24,500, but that still falls short even if you assume no appreciation.

waltworks

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #6 on: February 19, 2015, 12:40:06 PM »
I wouldn't count appreciation (who knows what happens there, and in general I just expect it to track inflation), but yeah, I would say that thanks to the crazy low mortage rate, you will come out slightly ahead renting here. 

-W

Maintenance will cost more than you think, probably. 50% rule says you aren't going to break even, you're going to slowly lose money.

You have to assume you are making some gains for a few years on your $20k of current equity, as well, of course.

Every case is different, though. If your place is in perfect mechanical shape and you don't expect to have to fix any big-ticket items, maybe you make more money renting it out.

-W

I am pretty dang close to the 50% rule though, right? $1800 in rent with a $950/mo mortgage. By the 50% rule I'm -$600 cash flow per year, which I'm happy to pay while gaining $6K / yr in equity.

I agree that I need to consider investment gains on the $20K I could have now. At 7% for three years, that money becomes $24,500, but that still falls short even if you assume no appreciation.

arebelspy

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #7 on: February 21, 2015, 08:49:00 AM »
thanks to the crazy low mortage rate, you will come out slightly ahead renting here

Agreed.

The biggest issue though is that it's an ARM, so you can't count on that to continue.

Keep an eye on it, and refi if/when possible.
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Blindsquirrel

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #8 on: February 22, 2015, 07:58:20 PM »
IMO- I would sell. Your ROI is poor I think and unless you are in a very rapidly appreciating market there is no real reason to hold. If you have to count on prices rising to make a good return it is a speculative investment. I am conservative by nature but I have been a RE investor for a long time. Cash flow is king IMO. I am a purist as far as yield goes and this does not meet any standard of ROI in my book.  There are better investments available with much less hassle than being a landlord. Unless the return is higher than a good dividend stock, it is not worth the pain in the rear factor. Unless you have the economy of scale factor, ie 20 units or so that have a good return, I think it is a dog.  I am neither an expert nor a great investor so take that with a grain of salt.

Bicycle_B

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #9 on: February 24, 2015, 08:16:17 PM »
If you're a physician, consider the possible time suck of remote landlording.  Counting in your time, plus the risk that property values may not be as predictable as we'd like, it seems like the low short term interest rate could be baiting you into a trap.

Maybe you could just maximize the sale by setting a high price since your current cost to hold is low.

mrmiyagi

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Re: Case Study - Effect of building equity in rent vs sell
« Reply #10 on: February 25, 2015, 02:12:54 AM »
If you're a physician, consider the possible time suck of remote landlording.  Counting in your time, plus the risk that property values may not be as predictable as we'd like, it seems like the low short term interest rate could be baiting you into a trap.

Maybe you could just maximize the sale by setting a high price since your current cost to hold is low.

Yeah, that worries me a little, as does the potential PITA of trying to sell a house from several states away. We would definitely hire a property management company if we do end up renting. The house should also show better if we sold now with our stuff in it, my semi-active landscaping, etc. Anyone with experience in selling from afar - how difficult is it?

Arebelspy - definitely agree that the ARM could change things in three years when it adjusts. Initially would be planning on doing this for just the three years left at the current rate.