Case Study: Sell or Rent

[Mustache ride]

I continue to find myself trying to rationalize this decision so figured I'd open it up to the collective wisdom here to get some opinions. I've always wanted to own real estate as part of my portfolio but live in an area where it usually doesn't make sense. I market timed during covid and guessed wrong, being conservative and settling for a house on the low end of the budget. I don't mind the house, but DW is not happy here and we will eventually move to a different house in the same town.

The house is in an A/B+ neighborhood in a top school district and should attract well qualified renters. Vacancy rate should be 5% or less. Newish roof and new HW heater, overall house is in good shape.

I know using the 1% rule renting doesn't even come close based on the current market value. I'm curious if the current environment changes the equation for those holding low interest mortgages and/or higher earners. We are in the 23% fed tax bracket and 9% state. My understanding is we would be able to depreciate the paper loss against our income which would be a 23% + 9% "savings". Quite frankly it also just hurts to give up a 2.75% interest rate.

Financial details:
6 figure NW / invested
280K HHI
Over 50% savings rate

Market Value: $500,000
Original Purchase price: $405,000
Original Mortgage Amount: $380,000
Interest Rate: 2.75%
Mortgage Term: 30
Term remaining: 28.5
Amount remaining on mortgage: $369,000
Gross Rents: $3000
Principal and Interest (the P&I of your PITI - should match with the above info): $1,590
Taxes and Insurance (the T&I of your PITI): $511
HOA costs: N/A
Deferred maintenance notes: HVAC will likely need replacement in the next few years. Nothing wrong with it but very old.


So, what say ye?

[waltworks]

You can take the depreciation losses on your taxes, sure, but what's your endgame? That depreciation money has to get paid back eventually unless you're thinking *really* long term and plan to pass the house on to heirs when you die.

If you have good incomes and lots of other savings, I'd sell just to avoid the hassle of dealing with a rental that is negligibly profitable at best.

-W

[PMJL34]

OP,

Your numbers are fine and you could certain keep the home as a rental and be cashflow positive. However, like Walt said, what is your end game? You are implying that you have very strong networth and savings rate so the real question is: 

Is 8k/year (just throwing out a rough number) worth your time and effort to be a rental property owner and deal with tenants?

If you sell now, there's no capital gains tax and you get more index funds as you know.

FYI, 500K for a desirable home with top schools is nowhere is HCOL.

[Mustache ride]

Updated some of the details. Removed COL reference as I don’t think it’s a pertinent detail. Hoping to get some additional opinions as it seems we are getting near a decision to buy a new house.

I’m not entirely sure what the end game would be. Either sell when I get old enough and don’t want to deal with it, or maybe gift it to my child. In either scenario I should be FIRE so income would only be from dividends/withdrawals to cover expenses. In the event I’m still working at that time it’s likely I would have 50x expenses and wouldn’t be too worried about maximizing/optimizing every dollar.

If I sell now and net ~$65K, the hypothetical $8K/yr is a 12.3% ROE. While certainly not a passive investment, that’s not a bad return and above historic stock market yields. That also wouldn’t take into account principal pay down.


ETA: Looks like I had some bad details. Take home would be $90K according to Zillow as a quick reference. So 8.8% ROE which brings it in line historically with stocks.

[GilesMM]

You put about $30k into a property which will return about $10K/yr (including equity portion of mortgage). What's not to like?


Would you buy the property as a rental today with same mortgage and purchase price?  If not, sell.

[clarkfan1979]

Updated some of the details. Removed COL reference as I don’t think it’s a pertinent detail. Hoping to get some additional opinions as it seems we are getting near a decision to buy a new house.

I’m not entirely sure what the end game would be. Either sell when I get old enough and don’t want to deal with it, or maybe gift it to my child. In either scenario I should be FIRE so income would only be from dividends/withdrawals to cover expenses. In the event I’m still working at that time it’s likely I would have 50x expenses and wouldn’t be too worried about maximizing/optimizing every dollar.

If I sell now and net ~$65K, the hypothetical $8K/yr is a 12.3% ROE. While certainly not a passive investment, that’s not a bad return and above historic stock market yields. That also wouldn’t take into account principal pay down.

Based on the information you provided, it looks like you put 5% down. Is that correct? When I enter your information into a mortgage calculator, I get $1551 for the PI. You put $1590 for PI. Does that mean $39 for mortgage insurance? Not a big deal, but that seems a little low to me.

You are correct that the 1% rule does not factor in mortgage rates, property taxes or insurance. The 1% rule is a "proxy" for cash flow, but it doesn't directly measure cash flow. Because of your low mortgage rate and reasonable taxes and insurance, it looks like you have a spread of about $900/month. Based on your amortization schedule, your principal pay down at the moment is around $705/month. This deal is also unique, because it looks like you only put 5% down. 

As a pure investment, I would keep it. However, you also need to consider the hassle factor. For me personally, the hassle factor would be worth it to keep it. If you work 2500 hours/year at a high paying corporate gig, the hassle factor might not be worth it. Are you able to do any simple repairs yourself? I replaced a p-trap in a bathroom sink for $4 and took me 10 minutes. A professional plumber would cost $250. 

I put 5% down on a primary in January 2012 with an original mortgage rate of 4% that is now a rental. Original purchase price was 95K and I had 16K worth of rehab. Original PITI was $685/month, including $42 of PMI. Original mortgage today would be around $900/month with increases to taxes and insurance. The rental is now worth about 375K and rents for $2550/month.  My actual mortgage is $1519/month because I did a 107K cash out re-fi to buy my current primary home in 2019.

[Mustache ride]

Updated some of the details. Removed COL reference as I don’t think it’s a pertinent detail. Hoping to get some additional opinions as it seems we are getting near a decision to buy a new house.

I’m not entirely sure what the end game would be. Either sell when I get old enough and don’t want to deal with it, or maybe gift it to my child. In either scenario I should be FIRE so income would only be from dividends/withdrawals to cover expenses. In the event I’m still working at that time it’s likely I would have 50x expenses and wouldn’t be too worried about maximizing/optimizing every dollar.

If I sell now and net ~$65K, the hypothetical $8K/yr is a 12.3% ROE. While certainly not a passive investment, that’s not a bad return and above historic stock market yields. That also wouldn’t take into account principal pay down.

Based on the information you provided, it looks like you put 5% down. Is that correct? When I enter your information into a mortgage calculator, I get $1551 for the PI. You put $1590 for PI. Does that mean $39 for mortgage insurance? Not a big deal, but that seems a little low to me.

You are correct that the 1% rule does not factor in mortgage rates, property taxes or insurance. The 1% rule is a "proxy" for cash flow, but it doesn't directly measure cash flow. Because of your low mortgage rate and reasonable taxes and insurance, it looks like you have a spread of about $900/month. Based on your amortization schedule, your principal pay down at the moment is around $705/month. This deal is also unique, because it looks like you only put 5% down. 

As a pure investment, I would keep it. However, you also need to consider the hassle factor. For me personally, the hassle factor would be worth it to keep it. If you work 2500 hours/year at a high paying corporate gig, the hassle factor might not be worth it. Are you able to do any simple repairs yourself? I replaced a p-trap in a bathroom sink for $4 and took me 10 minutes. A professional plumber would cost $250. 

I put 5% down on a primary in January 2012 with an original mortgage rate of 4% that is now a rental. Original purchase price was 95K and I had 16K worth of rehab. Original PITI was $685/month, including $42 of PMI. Original mortgage today would be around $900/month with increases to taxes and insurance. The rental is now worth about 375K and rents for $2550/month.  My actual mortgage is $1519/month because I did a 107K cash out re-fi to buy my current primary home in 2019.

That is correct, 5% down. The delta is PMI, which as you noted is negligible. We knew this was going to be a short-term place for us. I’m not sure if it matters but we did refi about a year after purchasing to get to the current interest rate.

I should be able to handle simple repairs myself. I’m much more comfortable under a car, but getting better at house repairs.

[waltworks]

Ah, it's a "no maintenance costs because I'll DIY even though I'm rich, don't need the money, and can't buy more time in my life." situation...

-W

[uniwelder]

It doesn't sound like OP needs a rental house, considering they don't plan to retire until a time when 50x expenses will have been saved anyway. 

Depending on the current condition of the interior, whether it's freshly painted or you would plan to paint before selling, you might want to rent it out for the next couple of years.  That would allow you to try out landlording, then decide if it matches your personality, with the ability to sell and not get taxed for capital gains--- being your primary residence 2 years out of 5.  If your house was ready to put on the market right now, you might not want to take the chance with renters, however.  Not that they're likely to trash your house, but they might be harder on it than you would be.

[Mustache ride]

Ah, it's a "no maintenance costs because I'll DIY even though I'm rich, don't need the money, and can't buy more time in my life." situation...

-W

Not sure why you feel the need to make a snarky comment. No where in my post did I say I would handle all maintenance or that I wasn't valuing my time for maintenance/PM work as part of the overall analysis for profitability. All I did was answer a direct question about could I handle simple repairs.

I'm a numbers person, but don't have the experience when it comes to RE. I'm looking for experienced landlords to help provide insight into my particular situation. The one thing I hear about a lot is the ability to defer taxes. Given my current tax brackets (32% Fed/State) and that dropping significantly after FIRE, it seems like something that may be worth exploring more. I focus on this as an example, but I'm interested in other unique scenarios as well that may be applicable.

It's hard to read through all the noise on the internet and cut through the BS. This is why I'm hear asking you folks that have been through it before.

[Mustache ride]

It doesn't sound like OP needs a rental house, considering they don't plan to retire until a time when 50x expenses will have been saved anyway. 

Depending on the current condition of the interior, whether it's freshly painted or you would plan to paint before selling, you might want to rent it out for the next couple of years.  That would allow you to try out landlording, then decide if it matches your personality, with the ability to sell and not get taxed for capital gains--- being your primary residence 2 years out of 5.  If your house was ready to put on the market right now, you might not want to take the chance with renters, however.  Not that they're likely to trash your house, but they might be harder on it than you would be.

Great point about trying it out for a year to see. That is something I thought of and was going to validate my assumption as being an option.

My previous comment may have been a little confusing about expenses. I have no intent to get to 50x expenses before FIRE'ing. That comment was about my "end game". I would be FIRE'd with no income hence a low tax bill, or if I was still working for some reason I would be at 50x expenses. Hope that helps clear up the confusion.

[clarkfan1979]

Ah, it's a "no maintenance costs because I'll DIY even though I'm rich, don't need the money, and can't buy more time in my life." situation...

-W

Not sure why you feel the need to make a snarky comment. No where in my post did I say I would handle all maintenance or that I wasn't valuing my time for maintenance/PM work as part of the overall analysis for profitability. All I did was answer a direct question about could I handle simple repairs.

I'm a numbers person, but don't have the experience when it comes to RE. I'm looking for experienced landlords to help provide insight into my particular situation. The one thing I hear about a lot is the ability to defer taxes. Given my current tax brackets (32% Fed/State) and that dropping significantly after FIRE, it seems like something that may be worth exploring more. I focus on this as an example, but I'm interested in other unique scenarios as well that may be applicable.

It's hard to read through all the noise on the internet and cut through the BS. This is why I'm hear asking you folks that have been through it before.

Because that who Walt is and that is what he does. Walt was a DIY landlord for a few years and made a bunch of money doing it. Now he spends his time telling others not to do what he did.

I'm not a CPA, but I have a couple comments regarding your income tax concerns. If you want to geek out on how the rental will impact your income taxes, fill out the 1038 form for rental real estate. How much would you estimate the value of the lot when you purchased? 100K? This means you are depreciating $305,000 over the next 27.5 years, which is $11,090/year. Because your mortgage rate is so low and your principal pay down is high ($705), I would ball park your gains to be around $15,000. Then after depreciation, your gains are going to be around $4,000. The $4,000 would be added to your W-2 income and you would be taxed at your current rate.

After depreciation, most rentals are paper losses in year 1. If your rental is actually a gain after depreciation in year 1, I would consider that evidence that it's a good rental and keep it.   

[waltworks]

Snark gets attention, and DIY maintenance is a standard trope in failed landlording situations.

-W

[Mustache ride]

Figured I'd circle back to provide some closure in case anyone cares. It turns out the house is likely worth a bit more than anticipated, which changes the math in favor of selling (imo). We'll take the tax free capital gains and buy more VTSAX.

[uniwelder]

It's always nice to find out your house is worth more than originally thought.  Thanks for the update.  I'm curious what you end up selling it for.