Rent vs. Sell Case Study

[HydroJim]

I am moving into another home. I'm considering renting out my current home once I move out. After doing the math though, I'm not sure if it's worth it or not. In the end, I think this may be more of a philosophical/life advice type question.

My analysis is telling me renting will yield about $24k extra over a 10 year period based on the opportunity cost of historical stock market returns, home value matching future inflation, and conservative estimates for rental income & maintenance. However, by any flip of the coin, the math could go one way or the other... property values could shoot up, stock market could shoot down, etc.. Property values here have gone up ~40% in the past 5 years which is pretty much what's happening nationally for better or for worse. In the end, I think there is some unquantified value to being diversified in something others than domestic stocks. The flip side is rental properties are inevitably more work.

After reviewing below, do you believe my thinking & math is sound or would you suggest I look at anything differently? I tried to use all inflation adjusted numbers and didn't apply net present value analysis or anything like that. So, accounting for inflation, I'm assuming $1 (2020 dollar) now has equivalent value to me as $1 (2020 dollar) 10 years into the future. Debatable if that's a fair assumption or not.

Market Value: $150,000 (Conservative net proceeds in current market doing some aesthetic repairs and a for sale by owner transaction)
Mortgage P&I: $483.08 (Principal is about $200/month)
Insurance & Taxes: $77.79
Total Payment: $560.87
Remaining balance on mortgage: $110,000
Years left on mortgage: 29 years & 4 months (Finalized refinance 8 months ago, break even in 6 months. Mortgage allows for this to not be my primary residence after 12 months)
Interest Rate: 3.25%

Maintenance Notes: Home was new in 2008. Roof, HVAC, and water heater are all original so I'd say probability of HVAC repair/replacement and water heater repair/replacement are fairly high in the next 5 years. Roof "should" be good for another 12 years if it makes it the full 25 year life.

Expected Rental Income: $1,300 month * 11 months = $14,300/yr (Conservative, I think I can get $1,400 based on rates for identical floor plans in surrounding developments)
Mortgage Cost: $560.87 * 12 months = $6,730/yr (Approx. $2000 to principal)
Maintenance: 2% * 160,000 = $3,200 (Can do a lot of work myself, but not sure I'll always have time if, for example, something breaks in the middle of the work week. Can't have a tenant without HVAC/water for long so I'd have to call in a contractor. I see a lot of people do 1% but that seems low to me if you're actually keeping up with everything and not letting it degrade, especially with renters beating on things.)

Looks like my profit (cash+principal) would be ~$6,370 per year leaving me $4,778 after applying my marginal tax rate (~25%) to the profit.

Scenario 1: Rent indefinitely, eventually sell and realize capital gains taxes
Scenario 2: Rent for 2 years, sell without capital gains taxes per IRS rules. The market I'm in is expected to go up another 10% this year with no signs of slowing down. I'm sure that's what people said before the housing crisis too. In the end, nobody can predict the future.
Scenario 3: Sell and net $40,000. Expected inflation adjusted market returns: 7%=2,800/yr in first year.

10 year time frame, then sell:
Scenario 1: Assume rent grows with inflation. Invest cash proceeds each year. Cash rows to $44,000 in ten years. Remaining mortgage principal would be ~$82 so selling at 10 year period would net $68,000. Subtract capital gains tax ~$8,000. So total value would be ~$104,000.
Scenario 2: $10k rental profit, then sell for $40k net. Invest $50k for 8 remaining years. Grows to ~$86k
Scenario 3: Sell and invest $40k, grows to ~$80k

Beyond that, renting keeps outpacing stocks out to about $100k value in 30 years. Again, the +/- variability on this is high due to all the assumptions being made.

[Papa bear]

Based on the super low taxes and insurance, this is a decent place.  You will also realize some of the cash flow advantages from depreciation. 

Basically, this is going to come down to if you want to be a landlord or not.  If you want to be a landlord, go for it! This is a good place to start on. 

If you don’t want to be a landlord, will outsource all the maintenance, management, etc, then sell and take those tax free cap gains.  Outsourcing work will really eat into your profits.


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[waltworks]

No vacancy or management expenses? Even if self-managing, at least take your hourly rate at work and figure that in.

Sooner or later you will have some vacancy. This often will coincide with an unexpected repair/maintenance issue, or a bad tenant.

This place is so cheap it almost doesn't matter, though. For FI purposes, $40k is peanuts. Do whatever you want, see how it goes, and sell it if you get tired of answering the phone in the middle of the night.

-W

[PMJL34]

"Insurance & Taxes: $77.79"

Is this accurate?

How has COVID affected your area? Is there unemployment concerns?

I don't think you will make much money whether you rent or sell. One HVAC, roof, and water heater replacement in next 10 years sounds like it will wipe out a good chunk of your profits.

If you want to simplify your life, sell it and move on. If you want to give it a go at rentals, go for it! You can always sell it after a year or two if you don't like it.

Best of luck!

EDIT:

"Looks like my profit (cash+principal) would be ~$6,370 per year leaving me $4,778 after applying my marginal tax rate (~25%) to the profit."

You won't be paying anywhere near 25% taxes on this property's rent. Taxes will most likely be zero or even negative. So you will keep more profit than you think if there is some.

[HydroJim]

No vacancy or management expenses? Even if self-managing, at least take your hourly rate at work and figure that in.

Sooner or later you will have some vacancy. This often will coincide with an unexpected repair/maintenance issue, or a bad tenant.

This place is so cheap it almost doesn't matter, though. For FI purposes, $40k is peanuts. Do whatever you want, see how it goes, and sell it if you get tired of answering the phone in the middle of the night.

-W

Only accounted for 11 months of rent in the income so I'm assuming 1 month vacancy per year.

Planning to self manage although there may be some small misc expenses associated with paperwork and gas to drive to showings and similar

[HydroJim]

"Insurance & Taxes: $77.79"

Is this accurate?

How has COVID affected your area? Is there unemployment concerns?

I don't think you will make much money whether you rent or sell. One HVAC, roof, and water heater replacement in next 10 years sounds like it will wipe out a good chunk of your profits.

If you want to simplify your life, sell it and move on. If you want to give it a go at rentals, go for it! You can always sell it after a year or two if you don't like it.

Best of luck!

EDIT:

"Looks like my profit (cash+principal) would be ~$6,370 per year leaving me $4,778 after applying my marginal tax rate (~25%) to the profit."

You won't be paying anywhere near 25% taxes on this property's rent. Taxes will most likely be zero or even negative. So you will keep more profit than you think if there is some.

Good point on the taxes and insurance. Those are incorrect for these purposes and will certainly eat into my profit. Taxes will double since I'll lose the "homestead exemption" for what was previously my primary residence. Also, I'm not sure how a landlord policy will compare to a homeowners policy in terms of insurance cost but I can only assume it will go up. I submitted for some quotes.

As far as COVID goes, according to the BLS unemployment did spike to ~11% in April but is now back down to 3-4%. There continues to be a housing shortage in my area for homes and rentals. There is about a 1 month supply of houses on the market in my area and friend's rents seem to be going up. The near-term outlook is a continued shortage, but what the future holds is anyone's guess.

As far the HVAC, roof, and water heater replacement, I believe I've accounted for those in my 2% annual maintenance line item. That should be about $30k over a 10 year period which seems ample to cover all those major systems along with some other minor repairs.

I looked into the taxes a bit more and it looks like I should be able to deduct at least $4,000 a year due to depreciation. I'll have to dig into a bit more and see where else I can save since, as usual, the tax rules are fairly nuanced. Either way, that will save a significant amount of my profits from income tax.

[waltworks]

Houses are going for $150k in an area with crazy high demand for housing?

Wow. I mean, I know some places with houses that cheap, or cheaper, that aren't crappy places. But they also are not places in high demand.

If you're self-managing, I'd assume something like 50-100 hours of work per year. So your management "cost", if you have a halfway decent $50/hour job, is in the ballpark of $2500 at the low end.

-W

[PMJL34]

OP,

Sounds like you are doing your homework and leaning towards renting it out. I think that's an OK choice.

I'll also add that Maintenance and CapEx is not the same. Maintenance is things like clogged drains, replacement items, and repairs of whatever breaks. CapEx is the known big ticket items like HVAC roof, siding, sewer lateral, driveway, etc. 

[HydroJim]

Houses are going for $150k in an area with crazy high demand for housing?

Wow. I mean, I know some places with houses that cheap, or cheaper, that aren't crappy places. But they also are not places in high demand.

If you're self-managing, I'd assume something like 50-100 hours of work per year. So your management "cost", if you have a halfway decent $50/hour job, is in the ballpark of $2500 at the low end.

-W

Huntsville, Alabama area.

I might be able to sell the place for $170k at this point. This house isn't zoned for the best schools in town but it's in a desirable area nonetheless. Everything in the better school districts goes for a hefty premium but kids were (still are) a long way off when I purchased the home.
1,407 sq ft, 3 bed, 2 bath home.

The good times are coming to an end in my opinion as property values in the area have gone up which was a lot of the appeal for this place. Property values are up 45% since 2016.

At this point I'd say values are on par with somewhere like Cleveland, OH. A bit cheaper than Nashville, TN, Atlanta, GA, and Tucson, AZ type places. Still below national median price and still well below most major metro areas. Definitely cheaper than anything on the coasts.

[HydroJim]

OP,

Sounds like you are doing your homework and leaning towards renting it out. I think that's an OK choice.

I'll also add that Maintenance and CapEx is not the same. Maintenance is things like clogged drains, replacement items, and repairs of whatever breaks. CapEx is the known big ticket items like HVAC roof, siding, sewer lateral, driveway, etc.

Are you making the distinction for tax reasons or something else? To me it's all maintenance with some items just being more expensive than others. I expect some years will be low (near 0) and other years will require replacement of those major systems.

[SndcxxJ]

It appears your numbers are conservative, but not overly conservative, great job that balance is hard to achieve. I also consider capex and maintenance in the same category, for me I run about 1.1% of the value of the properties annually in my HCOL area.  This is with me doing pretty much everything myself. 
The depreciation and other write offs will be a large source of return on your investment, particularly so if you self manage the property because some expenses that you are now spending will become tax write offs at least in part if not in whole.  Things like your vehicle, gas, insurance, registration, tools, cell phone, internet, etc.  Rental property is running a business with a lot of overlap with a person's normal life so there is a ton to consider deducting.  The best part is that you will be deducting these items on a schedule E and you can still take the standard deduction on your 1040, and not itemized there.
Selling after a couple years of renting will be a good exit strategy that is very tax efficient, otherwise if you hold the property for many years you may find a 1031 exchange is better.  I tend to hold for the long term myself as it justifies better inputs into the prooerty all along the way.
Overall, the numbers look like they work, there is profit to be made, you already own the property, you live in the area, are willing to manage it yourself, and you are somewhat handy.  These are the things that make for a successful venture.  I hope you go this route.