Help: Military Rental Property

[Wolverine90]

Would appreciate your thoughts on our rental property scenario.  We are in the military and purchased a home 11 years ago in coastal area. Home was built in the mid 1990s. Location is close to a couple of military bases, very good public schools, shopping, and nice beaches (15 min away).  We lived in the house for 2 years and have not had any problems finding military tenants during the last 9 years (no vacant months).  We manage the property ourselves. 

House is in good shape (Roof, HVAC,…) but project to replace carpets/flooring next year.  Property is not in a flood zone but we maintain flood insurance because of potential hurricanes.  Here are some of the financial facts:

Purchase Price: $280K ($80K Down Payment)
Zillow Market Price: $285K (Market has rebounded from real estate downturn)
Mortgage Balance: $158K
Mortgage Terms: 13 yrs left on 15 yr fixed at 3.125% eff int rate
2015 Rental Income: $20K
2015 Projected Rental Expenses w/o dep:  $21K   

We have basically broken even (including dep expense benefits) covering our expenses while the housing market recovered.  Our rents are in the ballpark to very slightly below the area average for similar size/sq ft—some of those houses have property managers.  Zillow projects area home prices to appreciate 2.5% next year. 

I will retire from the military within the next 5 years with a very good pension and prospects for a six figure job.  We do not own any other real estate (do have Vanguard REIT Index) and our equity in this home is a very small percentage of our overall net worth (Vanguard Index funds in Ret and Non Ret Accts).   Our current tenant may be interested in purchasing the property next year.

We are not averse to continuing as landlords and like the idea of having the house paid off in 13 years with another stream of income outside of the stock/bond market.  Thank you for your feedback in advance.

Wolverine90

[zephyr911]

Would appreciate your thoughts on our rental property scenario.  We are in the military and purchased a home 11 years ago in coastal area. Home was built in the mid 1990s. Location is close to a couple of military bases, very good public schools, shopping, and nice beaches (15 min away).  We lived in the house for 2 years and have not had any problems finding military tenants during the last 9 years (no vacant months).  We manage the property ourselves. 

House is in good shape (Roof, HVAC,…) but project to replace carpets/flooring next year.  Property is not in a flood zone but we maintain flood insurance because of potential hurricanes.  Here are some of the financial facts:

Purchase Price: $280K ($80K Down Payment)
Zillow Market Price: $285K (Market has rebounded from real estate downturn)
Mortgage Balance: $158K
Mortgage Terms: 13 yrs left on 15 yr fixed at 3.125% eff int rate
2015 Rental Income: $20K
2015 Projected Rental Expenses w/o dep:  $21K   

We have basically broken even (including dep expense benefits) covering our expenses while the housing market recovered.  Our rents are in the ballpark to very slightly below the area average for similar size/sq ft—some of those houses have property managers.  Zillow projects area home prices to appreciate 2.5% next year. 

I will retire from the military within the next 5 years with a very good pension and prospects for a six figure job.  We do not own any other real estate (do have Vanguard REIT Index) and our equity in this home is a very small percentage of our overall net worth (Vanguard Index funds in Ret and Non Ret Accts).   Our current tenant may be interested in purchasing the property next year.

We are not averse to continuing as landlords and like the idea of having the house paid off in 13 years with another stream of income outside of the stock/bond market.  Thank you for your feedback in advance.

Wolverine90

So you're ambivalent about cash flow and management burden. Have you considered capital gains? You've taken 13 years of depreciation, so your adjusted basis is maybe $160K (I don't know the lot value so I'm ballparking this) and you're outside the primary residence exclusion window (2 of 5 years normally, 2 of 10 years for active military). Unless you do a 1031 exchange for another rental, you're looking at a six-figure capital gain. Add that to six-figure wage income and tax time could be painful.

If I were in this position, I'd hold and sell it in a year with no wages and no other realized profits.
I'm ANG myself BTW... drilling today. :)

[Nords]

Our current tenant may be interested in purchasing the property next year.

We are not averse to continuing as landlords and like the idea of having the house paid off in 13 years with another stream of income outside of the stock/bond market.

You're either excited about having the property (and managing it for years to come) or you're looking for a chance to get out while the getting is good.

You have no compelling reason to change.  However if your tenant could purchase the property and save you both the realtor's commissions, then it sounds like you'd have a chance to reduce your risk of loss and move the after-tax gains (if any) to your remaining asset allocation.  Another aspect of this situation is "seller's regret":  if the tenant offers to buy, and you turn down that opportunity, then any time you have trouble with a future tenant (or maintenance, or repairs) will you kick yourself for not selling to the previous tenant?

If you don't have any strong feelings either way then I'd sell.

My spouse and I have been accidental landlords for over 20 years.  Our cash-on-cash return is 3%-4% per year, which is better than average for Hawaii's capital-intensive real estate.  When long-term CDs are paying 2.5% then we feel pretty smart.  But when long-term CDs were paying 6.5% we felt pretty stupid. 

The reason that we're holding is for the possibility that our adult daughter will someday return to the islands and want to send her (hypothetical) kids to school in this district.  It's a good thing that our emotional decision is still generating a positive cashflow.

[Wolverine90]

Thank you for the great thoughts Zephyr911 and Nords.

Capital gains is a concern with my current salary plus mutual fund annual cap gains and dividends--adding house sale gains would be painful although not as bad as when initially retired with pension, Vanguard annual cap gains, new job, and house sale.  Understand we are very fortunate to be in this situation and should not make investment decisions primarily (keeping/selling house) based upon tax implications.
 
Additional detail on projected 2015 Projected Expenses (majority of mortgage payment is paying down principal)
- Mortgage Payment $14,560 ($9,520 = Principal)
- Interest, Insurance, & Maintenance: $5,300
- 1 Time new appliances: $1,100

Thanks again!

Wolverine90

[Seeking the Brass Ring]

What about refinancing the mortgage to 30 year fixed rate and increasing your monthly cash flow?  Shorter term/lower interest mortgages are great for a personal residence but with a rental property the tenants are making the payments.  You always have the option to pay more down if you want to but lowering the mortgage payment should significantly increase your return.