Sell or Hold a Rental that has nearly Doubled in Value?

[Evie]

The market in my high cost of living area is absolutely bonkers right now. My husband and I bought a duplex in 2014 for 700k and we could likely sell it for $1.2m.  We owner occupy the front, so there is part of me that is tempted to cash out since we would still benefit from the tax exemptions on it being our primary residence.

However, if we moved out tomorrow, we could rent the front unit and generate nearly $2000 a month in extra income.  Would you take the lump sum cash payout now?  Or hold it as a long term investment that could reliably generate the equivalent of a part time job?  We refinanced to 3% and pulled out some money to put a new roof, paint and HVAC and have about 24 years left on the mortgage since we wanted to keep the payoff schedule.

This is in a University town with 1% vacancies. We've already done most of the major repairs.

If we don't sell, the plan is to buy an SFR with rental unit in two years, but might be in a different area.

Appreciate any thoughts or perspectives. 

[PMJL34]

Are you saying your rent is $2000/month for front unit? If so, I fear your rents are too low (imo). Unless you plan on returning to this exact home in the future or something similar, I'd sell.   

Edit: you mentioned you cashed out "some" money. What is your current loan value? Let's say 1.2 minus 500k loan value then you are looking at clearing 600k+.  600K would generate 2k/month at 4% rule without the hassle. I don't know anymore. I'd be open to keeping on second thought. I'd need to know more about your carrying costs vs rent. Also, how big of a portion is this home relative to your overall net worth?

Best of luck!

 

[Evie]

Thanks for the reply--a lot of good advice. I should clarify that if we rented out the front and back we would net 2k a month over and above the carrying cost of mortgage, tax and insurance.  So current monthly nut is $3400 and conservative rents for the property once we move out are $5,125 and likely closer to $5,500. Our mortgage was for $537k when we refied.

If we sold I would probably save a portion out for 20% down on another place with a studio/granny unit ($1.2m where we are minimum) and put the rest into basic Vanguard total index fund and some cash reserves.  I like having a rental unit, but would see this arrangement as essentially trading up and diversifying investments. Even though the numbers would look worse for a traditional investor, we want a bigger house for our growing family and the trade offs to get down in price don't shave that much off the purchase and have major trade offs (hour plus long commutes, etc).

Otherwise, we live in our current place for another two years (or move out to rent ourselves) and keep costs low while preparing for our next move. In that scenario we end up with two properties but not sizable stock investments (beyond retirement accounts). As far as total net worth, the duplex definitely contributes a lot, but we both have good jobs and plan to rely on W2 income for our primary income. 

I plan to talk to my accountant about the tax implications of selling versus keeping, but was curious what others were doing.   

[FINate]

If you sell the capital gains exclusion only applies to the unit you occupy. You'll have to talk to your tax person or do your own research to determine how to spilt it. And since you're selling for more than the purchase price you will also have depreciation recapture on the rental portion. Make sure you are tracking improvements (repairs don't count) for the rental portion separate from your residence, as this will reduce the capital gains on the rental portion by upping the cost basis. Some states (e.g. CA) tax capital gains as regular income. Just stuff to be aware of in case you weren't already.

We were in a similar situation last year. Owner occupied duplex purchased 2013, HCOL area. It wasn't a bad rental, but with the huge run up in prices we deiced it was worth taking the tax hit and investing elsewhere. Plus, we were getting ready to move out of state and didn't want to deal with a long distance situation and no longer wanted to be a landlord in CA. It was the right decision for us, glad we did it.

If I understand your numbers correctly, your Return on Equity is somewhere around 3.5%. After taxes and commissions, can you make more on that equity elsewhere? I wouldn't count on capital appreciation to continue growing the way it has, but that's just me and I may be wrong. Then of course, questions of diversification and desire to be in the rental business also enter the equation, though that's very contextual.

[PMJL34]

Evie,

Questions I would be asking myself:

Will you self manage? Are you handy?
What's the split of the duplex rents (50/50)?
Also, are you in Cali? That prop13 is on your side and losing that lock would be a concern for me. The property tax on 1.2 in my area alone will be $1500+/month.
Is it up/down units or side by side? Any way for you to just add on?
Are you sure you can get 1.2 for sale?
On a scale of 1-10 how much do you like this house? Is it just COVID giving your family the itch to upgrade?

Unless you really value you this home, I think I'm leaning towards selling.

Regarding taxes, FInate is spot on imo. Most of the sale proceeds will be tax exempt, but it won't be the full 500K for the reasons he mentioned.

Best of luck!

[waltworks]

I have been in similar situations back in the day (ie, $400k paid off former primary that generated $1000/mo in net income) and have always chosen to sell.

My thinking is this: no, I don't *need* to squeeze out more return. If I only need $36k a year to live on, hypothetically, and I have 3 of these $400k properties, then I'm golden! No need to chase more returns via a better performing (ie stocks, a different rental property, etc) investments.

The problem is that having a big chunk of income from just one property is that you've got very concentrated risk, it's a bit like having all your money in one stock. A natural disaster, big change in society/employment prospects in your area, new tenant-friendly rental restrictions coupled with inflation, or just a  frivolous (or non) lawsuit could leave you high and dry. They're all low probability events, sure, but you're totally screwed if they happen.

If you have plenty of money in other investments, it's not a big problem. If you're going to make this one property your entire nest egg, terrible idea. Your strategy for what to do should be partially based on the return you expect, and partially based on your life plans/financial situation/risk tolerance, like anything.

-W

[PMJL34]

I completely agree Walt and tell others to do what you suggest...yet here I am doing the exact opposite.

[Evie]

Thanks everyone--I appreciate the thoughtful and well informed replies.  I don't have my people in my life that I can ask about this stuff so it's very helpful to hear your opinions and perspectives, especially since many of you have been doing this for a long while.

I'm pretty certain we could get that price since it appraised for close to it in July and prices are just through the roof here. I knew we would have to factor in depreciation for the rental portion (which is 30% of the property), but need to talk to the accountant to get a true number.  We are definitely on the path to a bigger place--we are two adults and two kids under four in a thousand square foot 3 bedroom 1 bath with one parent full time work from home in normal circumstances and no back yard.  We can maybe last one or two more years here--COVID makes it harder but it's always been in the cards to move on. We just planned since we bought the place that we would be keeping it long term.
 
I'm leaning toward holding tight for a year since we don't have anywhere to go at the moment--but if the right opportunity comes I would feel better about selling and taking it. I'm pretty certain prices will hold, but if they don't then hey!  More opportunity to get into the next place.

[Monerexia]

SELL!! Top is IN!! Oh wait wrong thread haha

[Jon Bon]

Thanks everyone--I appreciate the thoughtful and well informed replies.  I don't have my people in my life that I can ask about this stuff so it's very helpful to hear your opinions and perspectives, especially since many of you have been doing this for a long while.

I'm pretty certain we could get that price since it appraised for close to it in July and prices are just through the roof here. I knew we would have to factor in depreciation for the rental portion (which is 30% of the property), but need to talk to the accountant to get a true number.  We are definitely on the path to a bigger place--we are two adults and two kids under four in a thousand square foot 3 bedroom 1 bath with one parent full time work from home in normal circumstances and no back yard.  We can maybe last one or two more years here--COVID makes it harder but it's always been in the cards to move on. We just planned since we bought the place that we would be keeping it long term.
 
I'm leaning toward holding tight for a year since we don't have anywhere to go at the moment--but if the right opportunity comes I would feel better about selling and taking it. I'm pretty certain prices will hold, but if they don't then hey!  More opportunity to get into the next place.

What is projected monthly rent per side? How much do you owe, rate, maintenance, etc.

I mean this is a textbook sell, I just want to see how specially terrible it is. My 'worst' properties are running $4,200 a month on $550,000 value. or ~ .8%. I also would be taking a massive tax hit that you will be able to somewhat offset with the capital gains exclusion.

If someone offered me $500,000 to change my mailing address I would do it! I would find a place to go. How often do you get a chance at a small (medium?) fortune?

[FINate]

The rental portion is only 30% of the property? SELL, SELL, SELL!!! This isn't a great investment property, but you have the option to make a great return as your primary residence. Take the 70% cap gains exclusion and pay the most depreciation recapture on the 30%.

You have to live somewhere, so if you want to trade-up in your local area you're not really going to come out ahead, but neither will be saddled with an undiversified underperforming rental that will become increasingly more difficult to divest.

If you think you may relocate in a couple of years (as mentioned up thread) then I would rent and hold the proceeds intended for a future purchase in something conservative like a short-term bond fund.