Explain math/logic of my sell vs. rent situation

[pnw_guy]

We have a house in Seattle that we purchased a couple years ago for $725K. Housing has gone crazy in Seattle during the pandemic (and everywhere I suppose) and the current Zestimate for our home is approximately $900K. We're thinking about selling and getting cheaper housing out of Seattle, but we also recently learned that we could rent it for approximately $3.6K, which would completely cover our PIMI.

I know we still would need to pay the maintenance on the home if we rented it, but can anyone walk me through how they'd reason about financial aspects of the sell vs. rent situation? Here's how I'm thinking of it:

Sell: If we sell, we'd get $175K and then need to subtract out fee's etc. (e.g., agent commission). Not sure how much we'd have left after that, but in any case we could invest this in the market and get 7% per year. For the sake of getting a concrete dollar amount, if we got $125K in our pocket after the sale and invested it at 7% a year for 30 years we'd have $951,531.

Rent: There's a lot going into this that seems to make the math tough. For example, we'd be losing money initially because we would need to pay maintenance costs out of pocket. However, rents will rise over time as our mortgage payment stays the same. Because this seems like a complicated situation, one way you could look at it in a simple way is that we'll own the home outright in 30 years with renters paying it off for us. Assuming that housing prices only keep up with inflation and assuming that long term inflation is 2%, a $900K house would be worth $1,630,225 in 30 years.

So in my simple analysis, renting seems like the better financial decision. What did I mess up? I'm sure people have better ideas on how to think through this decision, so I would be delighted to get that input! Thanks in advance!

[nereo]

Honestly, it’s not as complicated as you are making it out to be.

First, your purchase price doesn’t matter in the “sell-vs-rent” calculation.  That’s a sunk cost - what matters is what you could get now for selling vs what you could get if you rented it out.  Factor in what you anticipate it might be worth in future years if you like, but realize the further out you extrapolate, the less confidence you will have with those numbers.

Selling:  you could likely get $900k minus ~6%. Again, it doesn’t matter what you bought it for.  You could have inherited the home and it wouldn’t change the sell-vs-rent calculation, or you could have paid $1.5MM and the answer would still be the same.
 
Renting: My rule of thumb is if you can’t get 1% of the sale price renting per month, walk away.  Great rentals go for more (the golden unicorn is 2%, though that’s impossible to find in many markets). Some will go down as low as 0.5%, but that’s pretty razor-thin.  If you are looking at $3,600 you will be taking a bath at 0.4%. 
Consider that - long term average - roughly 50% of your rent goes towards maintenance, vacancies and insurance.  That leaves you with $1,800/mo. 

I’d say where you “messed up” (your words) is not considering opportunity cost from not selling, using overly optimistic assumptions about your expenses to rent (again, factor 50% long-term) and then price-anchoring yourself in the past.  If $3.6k/mo would “completely cover your PITI (today), what would $1.8k/mo do? Some quick calculations suggest your PI is around $2,500/mo (assuming 20% down on $725k @ 3%). Adding in taxes and insurance and I'm guessing you are well over $3000k/mo for your total mortgage payment. That doesn't leave hardly anything to cashflow your property. Now consider the opportunity cost of selling - you’d have six-figures in your pocket after paying off your PITI. That, over the next few decades will compound, whereas you are likely not even going to cash-flow renting at $3.6k/mo

[srad]

Investing, its not a one size fits all...  For many here that 1% rule is all they look at. Which is fine, it provides excellent cash flow.  However, that 1% rule will rarely get them a property that is now worth 900k (and growing).  I don't mind not having 1%, but I do mind if I have to pay to keep a property.  If the property cant support itself, I won't touch it. 

For me to tell anyone who has your Seattle property to keep it and rent it, I'd want you to have a few mil in the bank.  That would mean all this property is is an hedge against inflation. Which isn't bad.  You are allowed to own different assets in this game, however this asset won't be paying you very much at all for the next decade.  I'd also recheck your rent numbers, I bet you could get more than 3600. 

So, if you aren't already "rich" and you are thinking of leaving the Seattle area. Sell this, take the tax free cash and move to that cheaper area, invest in the VTSAX and have a wonderfully relaxed life. Or if you are really itching to become a landlord, take the proceeds from the seattle house and buy a rental in the lower cost of living area you plan to move to.  The rent to value there will be much better than the Seattle area.

[PMJL34]

OP,

You've gotten good advice already. You are trying to take a snapshot of 30 years in the future and guess which one comes out ahead in the simplest form. As you know, life is never that simple.

Focus on projections of 1 year up to 5 years. My projection is that you will be cash flow negative every month, by a lot. Some months, you will be deeply negative. Lol actually, you will be negative cashflow as long as you have a mortgage, which is an eternity at this point.

The only reason to keep this is like SRAD said or to hope for appreciation. Or if you plan on returning to the home as you will be priced out in  the future.

This is a clear sell case study.

Best of luck.

[ericrugiero]

Your projection looks OK because you are not factoring in maintenance.  If you want to be a landlord, you are likely to be much better off to take the profit from selling your home and buy a rental property in the LCOL area you are moving to. 

Don't forget the exemption for capital gains tax if you sell a home you lived in at least 2 of the last 5 years.  https://www.investopedia.com/ask/answers/06/capitalgainhomesale.asp  If you rent the home out for more than 3 years you lose this tax break when you go to sell. 

[pnw_guy]

OP here. Thanks for all the great and thoughtful advice in this thread. I didn't have a conclusion in mind when I started it and I'm glad I solicited the advice.

While we'll be moving elsewhere in Washington state (which is generally pretty expensive), we can get a nicer house in a place more suitable for us and save $200k to $300k. Sounds like selling the Seattle house is the best way to get there.

[clarkfan1979]

So, if you aren't already "rich" and you are thinking of leaving the Seattle area. Sell this, take the tax free cash and move to that cheaper area, invest in the VTSAX and have a wonderfully relaxed life. Or if you are really itching to become a landlord, take the proceeds from the seattle house and buy a rental in the lower cost of living area you plan to move to.  The rent to value there will be much better than the Seattle area.


I also like the idea of selling tax free and buying a rental in the new location that is lower cost of living. Buying a lower price point house with tons of cash in the bank puts you in a great position to learn how to be a landlord. It's much less stressful when you have plenty of money to pay for repairs.

One of the biggest questions I get from friends is how I pay for repairs on my rentals. If it's a close friend I usually reply with a heavy dose of sarcasm and say something like, "with money from my checking account"