Should I rent out my house or sell?

[toby2]

Hello,
I know this question probably gets asked a lot, but I'd like to get a few opinions specific to our situation.

My wife and I currently have a mortgage on a 975 sq ft townhouse. Our balance is about $188k, with a $1240 payment per month. We have a 5 month old boy, and we're thinking we may want to move in the next year. While the size of the house is fine for us, the layout is such that having a mobile toddler and the possibility of another child in the future will be prohibitive (1 bedroom with son sleeping in converted open loft space). Plus we are an hour away from my wife's family and my job, so we have some mustachian motivations for relocating as well.

Our challenge however is that we would lose money on a sale. We owe $188k, and in current condition, I imagine we could get 175k or so at best. Add in realtor fees and repairs, we'd lose close to $20k to sell.

But we happen to live in a rather renter friendly neighborhood, and I imagine we could break even with our mortgage if we rented it out. We also have $180 in PMI coming off in 4 years, and our rate is locked at 3.25%, so we'd gain some cash flow then. Of course this would not cover vacancies, maintenance, etc. But the house is in great condition and I imagine would not need major repair to make it a rentable product.

I know that the investors will say "of course not, it doesn't follow the 2% rule, you shouldn't rent it out." Of course I would never purchase this as an investment, but given our situation I wonder if it's a good move simply for the principal pay-down. Thoughts?

 

[arebelspy]

More details needed.

I don't see where you said what the rent would be, other than a vague:

I imagine we could break even with our mortgage if we rented it out.

I'm assuming you aren't counting then all the other expenses (vacancy, repairs, turnover costs, etc. - not to mention all of your time for management, if you aren't paying for that)?

[toby2]

Yes, we think we could get $1200-$1250 or so in rent per month.

[arebelspy]

Okay, so what I'd do in your situation is create a spreadsheet based on reasonable projections about how much you'll lose per month renting it out (after all expenses and vacancies) versus how much you expect the price to recover and when you can sell and "break even" (counting both appreciation and principal paydown) and see what you'll lose by bleeding slowly over time (each month) versus the big chunk of selling now, and use the time value of money to figure out what rate your money would have to earn to make that worthwhile (for example, if it'd cost you 20k to ditch it now, but you'll bleed a total of 3-4k/year, it may be worth selling, as it's unlikely you could invest that 20k to earn that amount to cover it, and paying it down as a "debt" - i.e. coming out of pocket to sell - may net you a higher return).

Anyways, the best thing to do is analyze the situation given reasonable assumptions and see which option is preferrable to you.

[calcsam]

To follow up on Arebelspy's thoughts:

A back of the envelope calculation to get you started:

Gross Rent: $1,250/m

Less:
Property taxes + insurance: $200/m (purely a guess, fill in the correct #)
Vacancies: 7% * $1250/m = $87.50/m
Repairs: 5% * $1250/m = $62.50/m
Interest: $188k * 3.25% = $6,000/yr = $500/m.

Net income (not including tax ramifications + appreciation): $400/m

Less:
Principal = $1240 - $500 - $200 = $540/m

Net cashflow: -$140/m

I'd keep and rent it out; you're taking a slight cashflow hit but are gaining equity in the house.

Additional options/ramifications:
Property manager: You could hire one. Less effort for you guys; these typically cost ~20% of monthly rent, or for you $250/m.

Tax implications: Look into the tax implications of depreciation. You might be able to deduct $6300/yr from your taxes (=value of the house / 27.5yrs), which at a 30% marginal rates saves you ~2k a year = $160/m

Normally you have to pay more appreciation on the house later when you sell it, but since you took a bath on it (I presume you bought at >> $175k), you might actually not have to do so. Worth Googling a bit and probably spending half an hour with a tax attorney.

Appreciation: The typical house in America appreciates at the rate of inflation, ~2.5%/yr. For you, 2.5% * $175k = $4375/yr = $350/m. I have no idea if your area is typical.

Keep in mind that while you might not do this deal as an investor, you're looking at far lower rates than an investor (3.25% vs. 5%); the depreciation writeoff could look better for you than an investor b/c of the bath you took, etc.

[arebelspy]

Thanks calcsam!

A property manager is more likely 10%, but as with all the figures you'll want to tweak them anyways.

I suggested a spreadsheet so you can easily tweak the variables and see how it affects the bottom line (i.e. change the appreciation percentage, change your vacancy, etc. and see where the decision changes), but that's a great start.