Author Topic: Cashflow negative/neutral rental case study  (Read 2237 times)

gliderpilot567

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Cashflow negative/neutral rental case study
« on: December 17, 2015, 02:15:02 PM »
Market Value: 185k (dipped to 140k in 2011; has since recovered)
Original Purchase price: 185k in 2009 (I was a sucker that placed a full price offer)
Original Mortgage Amount: 185k (0 down VA loan)
Interest Rate: 4.25
Mortgage Term: 30yr
Term remaining: 26y0m (Refi'd in 2011)
Amount remaining on mortgage: 172.7k
Gross Rents: 1150
Net Rents: 1025 (property manager takes 9%, HOA takes $20)
Principal and Interest (the P&I of your PITI - should match with the above info): = 916/mo (currently paying about 300/mo principal)
Taxes and Insurance (the T&I of your PITI): 245/mo

Total monthly PI+TI is 1161. Receiving 1025 net from the tenant, therefore I have to feed it $136/month; though I do gain $300 in equity.

This is a small, 3br/2ba, suburban house in a bedroom community that I stupidly bought as a bachelor who had no need for a house, but my parents convinced me it was the thing to do. In 2013 I relocated, having no equity in the house and deeply in debt at the time I was unable to sell so I put it on the rental market. Fortunately, except for one 5-month spell in 2014, renting has been reliable since then, but it doesn't really make any money. It's cashflow negative though I do slowly gain equity; however, this is mostly wiped out by the 2-3 weeks per year that it's vacant in between renters for cleaning/maintenance.

It's not in a great location. On the far outskirts of a city (Tucson), and happens to be on the opposite outskirt from where all the growth is happening. It's a minimum 30 minute commute to any of the major employment areas here; mostly retirees live in the local neighborhoods. Basically the "rural metro" part of town, a bedroom community at best. Very safe, quiet, nice views, low crime, etc; but far (9-10 miles) from a grocery store, almost as far from schools, and even further from any sort of work. I enjoyed the house when I lived there, but now it's a thorn in my side.

Comps in the neighborhood have been selling VERY slowly for about $160-175k. The area (zip 85747) is on a slow rebound, but I don't expect any major growth in this part of the city outskirts based on everything I know about the area and where the businesses/growth/construction is happening. In many years it will probably appreciate; but the cap rate is so horrible right now that I don't see it to be worth holding on to it.

We moved back to the area in 2014, but I had since married and picked up step-kids, and not wanting to live so far from work we bought a different house, 0.25 miles from school and much much closer to my work. To buy this second house, we put down a little bit and used up the rest of my available VA loan amount. There was a tenant in the rental so we could not sell at the time. The primary residence house does not suck as much as the rental house from a rental or resale perspective (still a poor cap rate, since we put very little down).

We almost put the rental house up for sale in mid-2015 when the previous lease ended, but the property manager already had a tenant lined up with minimal vacancy time so we decided to hold on to the rental for at least another year. Right now it's not really doing much harm, but it is still a risk that we carry. Currently I'm trying to decide whether to try to sell again at the expiration of the current lease (June 2016). It will be a good time of year to sell, but I still expect to take a net loss after commissions. The benefit would be, of course, getting rid of the risk and encumbrance, and freeing up part of my VA loan amount for future use (I'd still have to pay off our primary residence before I can use the VA loan again, though).

So - leaning toward dumping the thing, taking the loss, and just doing basic index investing before possibly venturing into real estate some years down the road. We're right about at the point where we're about to cross the line from negative NW to positive NW, from aggressively paying off remaining debt to aggressively saving/investing, and this rental property isn't doing anything for our accumulation. However, the downside of selling it now will cost a small chunk of cash (I'd probably only get 165-170 for it based on comps, and then lose 6% to commissions) that we could otherwise invest... when keeping it would be generally harmless as long as it keeps renting reliably. We've repaired our finances to the point that we could easily afford to pay the full PI+TI if the property sits vacant for a little bit; though that is obviously undesirable. I'd rather price it to sell than have it sit vacant for 6 months and cost us monthly.

I considered dumping some cash at the principal and reamortizing to force it cash-flow positive, but from what I read it's not possible to reamortize a VA loan and I'd have to figure out some other solution (take out a different mortgage?)

Alternately, if it rents reliably for another year, the principal will be paid down to 169k... and if it appreciates to the point that I could dump it for 180, I'd break even. Is the risk worth waiting a year?

Any other ideas? Interested to learn!

coopdog

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Re: Cashflow negative/neutral rental case study
« Reply #1 on: December 17, 2015, 05:01:36 PM »
Can your renter qualify? Perhaps try to make a deal with him and save on the commissions (though I'm willing to bet your property manager has a commission clause if they were the one who found the tenant).

gliderpilot567

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Re: Cashflow negative/neutral rental case study
« Reply #2 on: December 17, 2015, 06:07:37 PM »
Can your renter qualify? Perhaps try to make a deal with him and save on the commissions (though I'm willing to bet your property manager has a commission clause if they were the one who found the tenant).

They do have such a clause in the contract. At best I'd save the sellers agent commission. How hard is it to be your own agent in a situation like this? I've never sold a house, so I don't know what there is for me to fuck up if I don't use an agent.

nic1

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Re: Cashflow negative/neutral rental case study
« Reply #3 on: December 19, 2015, 06:33:30 AM »
I personally would wait things out another year or two.  You are not putting a huge amount of money into the property and have been able to reliably rent it.  We have a similar situation, bought a house at the height of the market in 2002 and needed to move and then values went down.  We are a bit better off as we are cashflow positive a couple hundred a month, but we were still "accidental" landlords and five years ago I really wanted to get out but knew we would have to pay to get out of the situation.  Since then we have had the same renters for the last five years and have another 20k in equity.  We are thinking about at this point just keeping it until it is paid off and then decide where to go from there.  I would try to get to the point you can at least break even, you are close, maybe another year or two. 

zephyr911

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Re: Cashflow negative/neutral rental case study
« Reply #4 on: December 24, 2015, 08:35:02 AM »
Part-time Realtor and small-time landlord here.

Generally I agree with MMM that if you wouldn't buy it, you should probably sell it. I am, however, currently tied up in a very similar situation, though my numbers aren't quite as bad, and I'm holding for largely the same reasons - transactional costs would mean a loss today, but a couple of years' hold time could help me avoid bringing cash to the table.

The biggest caveate to keep in mind, IMHO: every year of rental depreciation reduces your cost basis by a few percent, so you'll eventually show a large capital gain subject to depreciation recapture tax. If you lived in it for at least 2 years within the 5 preceding the sale, you get some preferential treatment, and active military service can extend the 5-year clock, but you should get acquainted with the particulars sooner rather than later! I keep a constant eye on the clock with mine.

Your analysis is very optimistic on costs. Are you really spending $0 on repairs, cleaning, maintenance, etc? No pest control? Nothing else? Are you doing 100% of that work yourself, counting $0 value for your time? I'm nominally clearing $250/mo after HOA (I manage it myself, though the next turnover will be the end of that) but even minor maintenance can wipe that out in a hurry. In your case it could turn your miniscule cap rate (after equity build) into a strongly negative one.

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I considered dumping some cash at the principal and reamortizing to force it cash-flow positive, but from what I read it's not possible to reamortize a VA loan and I'd have to figure out some other solution (take out a different mortgage?)
Unless the negative cash flow is hurting you, and it sounds like it's not, then don't factor it in. Return rates should be the primary determinant.
You'd be earning a guaranteed 4.25% return (ish) on that paydown. It's your call. Personally, I'm leaving my albatross alone, maximizing stock investments (historical average 7% after inflation) and more real estate (multifamilies with leveraged returns of 20% or more). This means more total NW increase over time, and I can draw on those returns later if I have to sell and it's still underwater.

If you do decide the cash flow is an issue, and you want to reduce the payment, you could look into an IRRRL (inline rate reduction refinance loan). It's a low-cost refi for a VA loan that you can do even if the home is now a rental. I just did one a few months ago. Since this is your bonus entitlement, I'm not 100% sure if all the same rules apply, but a good mortgage broker or loan officer can tell you.

If you decide to sell without an agent, find a good real estate attorney and have them do the contract for the sale. Also, review that commission clause carefully and see if it's negotiable at all, or has a timeout. Is the percentage specified? All commissions are negotiable unless/until agreed upon by the principals involved.

Also, just a side note here, for if/when you have to analyze potential rentals in the future:
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still a poor cap rate, since we put very little down
If the property was a good rental, lower equity would increase the cap rate because you'd be netting a higher return on your investment than the APR on your associated debt ("spread"). Most multifamilies earn enough rent to finance them 100% and still pay the mortgages after all costs, and that's what rental investors look for.