Author Topic: How bad did we screw up?: Rent or Sell first home  (Read 2637 times)

BuffaloStache

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How bad did we screw up?: Rent or Sell first home
« on: December 13, 2017, 05:47:53 PM »
My family lives in a condo that my wife purchased many years ago in the Denver metro area. We've kept it in pretty good shape, so it doesn't need a lot of work to make it rent ready (maybe just new carpet). It is located in an area that has really become popular in the last 1-2 years. We want to move in the next year or so (and have saved up a separate 20% downpayment for that), and are trying to determine whether to rent or sell when we do. Mini-case study relevant numbers:

*Amount owed: ~$125k
*Here is the ringer: we refinanced 3 years ago to a 15 yr fixed mortgage at 3.125%. Because of this...
*Monthly mortgage payment + escrow + HOA: ~$1400

*Market monthly rent for similar properties: ~$1600 (we may be able to get $1650 or $1700, but no guarantee)
*Approximate current value: ~$295k (Zillow Zestimate is ~$310+, but I know not to trust that)

With this information, is it best to:
1) Rent it as-is when we leave, only giving us a ~$200 cash flow for the next ~11 yrs till the mortgage is paid off.
2) Refinance the condo to a 30 yr. fixed (lowering the monthly mortgage + HOA payment to ~$1000), giving us a $600 monthly cash flow but taking much longer to pay off.
3) Sell- since we purchased the house for much less than it's worth, take our gains and use them to bolster the 'stash.

FWIW I'm very interested in learning more about Real Estate investing, landlording, and related investment strategies.

waltworks

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #1 on: December 13, 2017, 06:21:58 PM »
Your condo is a miserable failure as a rental based on the numbers, but luckily for you, it's a slam dunk of a sale and you'll make a nice profit.

The usual rule of thumb is that 50% of your gross will go to expenses (management, repairs/maintenance, vacancy, insurance, taxes, etc, NOT including the mortgage P&I). For a condo where HOA should (theoretically) cover all exterior maintenance, you could use 40% instead, maybe. That would leave you with negative cash flow even if you refinanced, though. And HOA special assessments are a nasty wildcard. How well do you know your HOA's reserve study numbers?

If a property doesn't rent for 1% of it's market value per month, it's *unlikely* that you'll do well with it for cash flow. There are exceptions but you're at something like 0.5% - no bueno.

Take the money and run.

-W

BuffaloStache

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #2 on: December 14, 2017, 10:55:06 AM »
And HOA special assessments are a nasty wildcard. How well do you know your HOA's reserve study numbers?

I know these numbers fairly well- I'm not on the HOA board, but am active and go to some of the meetings. Because of the health of the reserve, I don't think special assessments are very likely in the future.

Also, Walt, are those numbers primarily for certain markets, or are they overarching goals for all real estate investors? When I plug my numbers into calculators like this one (http://www.calculator.net/rental-property-calculator.html), it seems to come out favorably to rent. I'm guessing I'm missing something here?
« Last Edit: December 14, 2017, 10:57:52 AM by BuffaloStache »

waltworks

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #3 on: December 14, 2017, 12:48:20 PM »
Also, Walt, are those numbers primarily for certain markets, or are they overarching goals for all real estate investors? When I plug my numbers into calculators like this one (http://www.calculator.net/rental-property-calculator.html), it seems to come out favorably to rent. I'm guessing I'm missing something here?

Input the *market value* of the property (subtract 5-10% depending on how much you expect to pay to sell in fees/commissions/tax) and run the calculator with that amount.

Your purchase price is irrelevant here. The question you should ask is: would I buy this property to use as a rental? If the answer is no, you should sell it.

I'm unfamiliar with the calculator or the assumptions it's making but it appears that it is ignoring capital gains taxes on the sale of the property, which (since in this case the majority of the return is from the equity/appreciation) probably cuts down the actual return pretty significantly depending on your tax bracket and how you do the sale (ie leave to heirs, 1031 exchange would avoid capital gains).

If you want an investment property, you can do much, much better in other parts of the country.

-W

HawkeyeNFO

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #4 on: December 15, 2017, 10:31:44 AM »
SELL.  This would likely be a money loser as a rental under the current mortgage.

BuffaloStache

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #5 on: December 15, 2017, 04:50:22 PM »
SELL.  This would likely be a money loser as a rental under the current mortgage.

What about if we go with option #2, refinancing to increase our monthly cashflow (or roughly break even using the 40-50% 'rule')? Do you still think it's better to sell?

daverobev

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #6 on: December 15, 2017, 06:05:35 PM »
Cashflow is king yes, but the numbers have to make sense first.

Renting out a $300k property for $1500 a month is 0.5% of cost. That's terrible. 1% is generally the minimum.

Just... sell it. Don't even consider renting it out. Even with $1000 of mortgage it doesn't change the fact you are *only making $1500 gross on $300k invested*.

After expenses but ignoring mortgage that's 3% a year, and look at all the risk. Just... sell.

Spiffsome

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #7 on: December 15, 2017, 07:18:57 PM »
If you're going to rent it out, please make sure that you can view it coldly as an asset, rather than as your former home. A lot of people who rent out homes that they used to live in find it emotionally difficult when a tenant doesn't treat the place as well as they used to. Imagine if the place was completely trashed by the next person you rented it to - could you calmly call your insurer and place a claim, or would you have to stop to rage and weep at what they had done to the place you used to call home?

No judgment either way, but if you want to be a successful landlord you have to regard the place as an asset, not as a former home.

tralfamadorian

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #8 on: December 15, 2017, 07:23:10 PM »
Agree with everyone else. Sell or 1031.

BuffaloStache

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #9 on: December 16, 2017, 09:33:51 AM »
If you're going to rent it out, please make sure that you can view it coldly as an asset, rather than as your former home. A lot of people who rent out homes that they used to live in find it emotionally difficult when a tenant doesn't treat the place as well as they used to. Imagine if the place was completely trashed by the next person you rented it to - could you calmly call your insurer and place a claim, or would you have to stop to rage and weep at what they had done to the place you used to call home?

No judgment either way, but if you want to be a successful landlord you have to regard the place as an asset, not as a former home.

This is good advice- thanks Spiff. Based on what others are saying it's looking like selling seems to be the smarter move, so I may not have to deal with this problem.

Agree with everyone else. Sell or 1031.

What is 1031?

tralfamadorian

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #10 on: December 16, 2017, 09:58:45 AM »
What is 1031?

Here is a site that explains the basics-
https://apiexchange.com/what-is-a-1031-exchange/

A 1031 allows you to roll your capital gains and depreciation recapture from a current property into a new investment property so there is no tax.

Reading back over your details though, I'm not sure if you will have capital gains to pay. If you do not, then a 1031 would be moot. In that case I would recommend selling then purchasing an investment property where the numbers do work if you would like to keep investment real estate in your portfolio.

theoverlook

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #11 on: January 02, 2018, 01:16:25 PM »
Essentially you have $170,000 in equity that you could invest elsewhere if you sold the condo. Even at the higher number - $600/mo in cashflow - that is only a 4% return which is not very good. Any vacancy or repair loss would eat that up in a heartbeat, too. I would sell and invest the proceeds according to your investment rules. (IE, stock market, other rental property with higher % return, etc.)

GuitarBrian

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #12 on: January 02, 2018, 08:58:37 PM »
It doesn't sound like OP has used the property as a rental in the past, and it sounds like he lived there 2+ years... So there shouldn't be any capital gains... Right?

While 2% unicorns do exist, they aren't anywhere near Denver. And in the current market, I haven't seen anything above 1% on the front range. If it was me, I include Principal in my cash flow calculations. $720 p/m in this example. With that added, it still isn't a good rental. But, is the OP going to be willing to buy something in another state, and deal with property managers and tenants he's never met? Etc etc. I assume he's going to be living near by, and from his first post, wants to learn and be involved in rentals...

I advise you sell... But only if you have a plan to put the money in a better performing property. If not, and you have a nice cash buffer, It is not the worst performing rental out there, and you already own it...

Just my opinion.

former player

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #13 on: January 03, 2018, 02:08:19 AM »
The 1% people are of course right.  Also, unless you have a consuming interest in property, will live within a few minutes' travel of the property and have good DIY repair skills or excellent local contacts for house maintenance work renting is highly likely to be more trouble than it's worth.  (Ask me how I know.  A rental I have 5 minutes from where I live has just had one water leak 3 days before Christmas and another the second day of the new year.  Joy.  And I do live near by, have a good plumber and an understanding and competent tenant.)

Let me be wrong for a moment, though.  If you keep the condo and rent it out successfully, in 12 years time you could have a paid-off condo in a popular area of a rapidly growing and desirable city in one of the richest countries on the planet.  The 1% people are purely looking at income now.  They aren't looking at your personal needs and desires, they aren't looking at the potential for capital growth (this is only for the stock market, apparently), they aren't looking at the long term (property for me is a buy and hold), they aren't looking at diversification (a rental property enabled my grandfather to feed my mother and aunts during the Great Depression).  None of that makes them wrong, of course.  You would be taking a risk by keeping the condo and reducing your potential cash flow for the next 12 years.  Choices, choices.

BuffaloStache

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #14 on: January 03, 2018, 02:46:45 PM »
Thanks for the great responses. I'm still not exactly certain on what I'm going to do, but this gives me perspective.

Another Reader

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #15 on: January 03, 2018, 03:15:23 PM »
The one percent people are NOT looking at cash flow only.  They are looking  for a total return that's a combination of cash flow and appreciation.  Why would you get involved in real estate, with the work, risk and illiquidity if you could not get consistently high returns?  Free and clear, one percent per month in rent yields around six percent annually, assuming 50 percent of the gross income goes to operating expenses and capital improvements.  In your case, that includes HOA fees.  Add three percent in appreciation, use some positive leverage, harvest the tax benefits, and you will likely exceed stock market returns.

If you still want to keep the condo, it's time to pick up Gallinelli's book that Sword Guy recommends.  https://www.amazon.com/Estate-Investor-Financial-Measures-Updated/dp/1259586189/ref=sr_1_1?ie=UTF8&qid=1515017501&sr=8-1&keywords=gallinelli+frank.  When you understand the math, revisit your interest in renting out the condo.

I agree with Waltworks.  In your shoes, I would sell.

CowboyAndIndian

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #16 on: January 03, 2018, 04:18:20 PM »
What is 1031?

A 1031 exchange sells a business and within 6 months uses the money to buy another business without any tax consequences.
I went thru this process to sell two rentals and buy another rental in FL.

In this case, the house is a primary residence. It would NOT make sense to do a 1031 exchange since there are no tax consequences of selling the property (since the gain is well below the $500k tax-free limit).

As everyone before has said, your condo is not a good rental property. My suggestion is to sell, then use the gains to buy a couple of investment properties. You can use the spreadsheet at https://forum.mrmoneymustache.com/real-estate-and-landlording/evaluating-a-rental-property/ to evaluate any possible investment property.

waltworks

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #17 on: January 03, 2018, 04:36:13 PM »
To reiterate something that Another Reader said: if you are going to do rental RE (especially small-time RE where you just have <5 houses or something) you want to be *beating* stock market returns by a fair amount. Why?

-The houses are illiquid. If you have an emergency and need money, you can sell your stock/bond holdings in a day or two. Not so a rental property.

-The houses are potentially really risky. A house is sitting in one place. A really bad tenant, an act of god natural disaster, or a general exodus from the neighborhood/town/area can drop your investment to zero (or worse, since you might not be able to sell and still have to pay taxes and maintain it). Just like buying stock in just one company, concentrating a lot of money in one place is risky.

-Even if you outsource *everything* you will need to do a significant amount of work. Unlike an index fund where you can rebalance once a year (or not even bother if you want to pay .02% more to do a target date/self rebalancing thing) and otherwise forget about it, a house is going to have problems, need new tenants, etc. Your management company (which you need to do the work to hire in the first place) will have to ask you what to do on at least some of these. Don't forget the upfront work to pick out the house you want to buy and actually buy it, nor the work at the other end if you decide to sell. Both can easily use up weeks of your time (deals fall through, inspectors find problems, contracts have to be renegotiated, etc).

For those reasons, if you're going to do real estate, you want to pay close attention to the 1% and 50% "rules". You want to be kicking the stock market's ass, not just making a little money after expenses. Otherwise, you're not making your money work hard enough, and putting in too much work yourself. That's not the point of investing!

-W

BuffaloStache

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #18 on: January 03, 2018, 05:31:43 PM »
...

If you still want to keep the condo, it's time to pick up Gallinelli's book that Sword Guy recommends.  https://www.amazon.com/Estate-Investor-Financial-Measures-Updated/dp/1259586189/ref=sr_1_1?ie=UTF8&qid=1515017501&sr=8-1&keywords=gallinelli+frank.  When you understand the math, revisit your interest in renting out the condo.

I agree with Waltworks.  In your shoes, I would sell.

Thanks for this- I have been looking for a good resource to read up on. I'm definitely leaning towards selling, but I want to make sure I really think the decision through.

Cwadda

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Re: How bad did we screw up?: Rent or Sell first home
« Reply #19 on: January 06, 2018, 11:01:50 PM »
Looked at the rent amount and the market value, no need to read anything else. Selling is a no-brainer. Also, whatever walt posts, follow that. He posts gold on a regular basis.