Author Topic: Own + Rent /vs/ Sell + Buy  (Read 675 times)

lateralwire

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Own + Rent /vs/ Sell + Buy
« on: May 23, 2020, 07:23:46 AM »
I own and live in a condo in a highly desirable area in center city Charlotte, and I'm considering a job in a new city. In evaluating potential housing arrangements, I have to decide between keeping my current home and renting in my new city or selling my current home and buying in my new city.

Renting out my condo is virtually a slam dunk. It faces a park and has a skyline view and you can walk to: hundreds of bars, restaurants, museums, 100k jobs, and 3 of the 4 pro sports teams (or 4 of 5 if you count the MLS team that starts next year). It's also a short walk to the light rail and they're building a streetcar a few blocks away. All of that is to say that this property has a ton of upside and I don't particularly want to sell it because it's a phenomenal investment.

However, in considering all of that... looking at living options in my potential new city, I don't have enough for a downpayment on a second home, so renting seems like the most likely path if I do keep my condo. The other option, of course, is to sell and cash out on my equity and buy a home in my new city.

So, in order to properly evaluate this decision I'm trying to understand the business side of renting. Can anyone recommend any good sites to navigate the process? I have a friend who rents his place out, and he keeps saying it's not profitable because of taxes, that it just builds additional equity, and that somehow it's better financially if you own a second home while renting your first, which doesn't make sense to me. It seems like if you rent your place out at a rate that covers the mortgage/escrow/HOA/insurance + investment property taxes then it should break even if not make a bit of money. Perhaps more importantly, can you not just rent the place out without reporting the income? Seems like nobody would know.

I've been googling this morning, and I haven't found much on this process so far... I'm sure the info is out there though. Being a landlord would be worth it if I could keep this place. Thanks for your thoughts.

Papa bear

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Own + Rent /vs/ Sell + Buy
« Reply #1 on: May 23, 2020, 07:34:19 AM »
The stickies on the top of the page have a wealth of information.

The rent your condo decision can be evaluated in 2 ways.  Financially and emotionally. We can only help you financially, and we can be cold, heartless, and ruthless when evaluating whether a property is a good rental.  We canít help you with an emotional decision. 

Go off and read with other resources, and come back with numbers on the properties so we can dig and tear apart.

We can also offer ways that may be able to get you to an own and own situation or even a sell and rent situation.   Nothing is off the table!


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lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #2 on: May 23, 2020, 08:58:49 AM »
Thanks! I totally get the emotional part. I'll say that it isn't really an emotional decision for me. There are just a lot of variables to consider and I want to make sure that I'm aware of what they are in order to weigh them properly and make my decision. Fir example, I know that I could sell this place and with the equity I can buy a home in the new city and likely be 100% debt free within 10 years. I think the unknowns in the housing market make it a very difficult time to consider selling knowing what it was like just 6 months ago, thus the desire to keep this place until the returns are better.

Anyway, I will dive into those stickies a bit more and come back with some numbers!

MrThatsDifferent

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Re: Own + Rent /vs/ Sell + Buy
« Reply #3 on: May 23, 2020, 09:21:03 AM »
This isnít my area at all, but was just wondering: couldnít you rent out the current place, while renting in the new place for a year so that you can spend your time evaluating the city and the different parts of town and finding your ideal place to buy? In the meantime you can start saving for the down payment, although I would have thought you can use some of the equity in your current place for the down payment as well?

The other thing to think about, will you ever want to move back to the current place at any point in your life? If so, that might be another reason to hold it and rent, especially if you can get a rent that outstrips your costs (so as long as it is positively geared satisfying the best practice rule, you should be good).

lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #4 on: May 23, 2020, 11:02:24 AM »
Yes, that's basically my plan. I think renting my place out and renting in the new city makes the most sense in the short term (12 months) given the market. There is a chance I may want to move back someday, and it's part of the reason I want to continue owning it. It would be great to have this place available in that scenario but I don't consider it a requirement because I have no idea if/when that would happen.

The question is whether or not it makes sense to fool with renting my property out from the business side. I don't understand the income tax portion of my friend's advice. Everything I've read so far doesn't even acknowledge it as an issue. It looks like the total ROI for renting works out to about wither 3% or 19%, depending on how you do the math. I'm going to post all of the case study numbers to explain it in a bit.

lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #5 on: May 23, 2020, 01:11:27 PM »
Ok, I've read through the pinned links. Didn't realize I was asking for a case study, so here are the numbers:

Market Value: $230,000 (zillow says $263k, which I think is way too high based on comps and tax value)
Original Purchase price: $164,000 in 2009
Original Mortgage Amount: $138,300 (this reflects a refi from 2013ish)
Interest Rate: 3.5%
Mortgage Term: 25 years
Term remaining: 18 years
Amount remaining on mortgage: $110,000
Gross Rents: $1500/mo x 12 x 0.1 = $16,500/yr
Principal and Interest: $693 x 12 = $8316/yr
Taxes and Insurance: $208 x 12 + 120 = $2496/yr
HOA costs: $288 x 12 = $3456/yr
Deferred maintenance notes: None. I have been proactive about maintenance. Biggest unknown is the refrigerator because I don't know how old it is.
Anything else special or unique: I have a HELOC for a bathroom renovation and that has a minimum payment of $77/mo. I make an additional $300/mo principal payment so I can pay off the bathroom within the fixed rate period. I will pay this off in January 2023.

Here's the long version of my logic train. Feel free to throw wrenches, that's why I'm here!

Renting in the new city seems to make the most sense for the short term (12 months), mainly due to the housing market. Not much to buy right now... but I could probably get a better price on a home, so I'm willing and at least somewhat interested in considering purchasing as an option. I have a free place to stay until the fall, so depending on the time frame there may be an opportunity to jump in and take advantage of these ridiculously good interest rates.

In terms of downpayment on buying a second home, I could theoretically access the rest of my HELOC balance for a downpayment - roughly $15k. I have about $10k in savings too, but that includes my emergency fund so I'm not super interested in tapping into that. I'd be looking at a purchase price of $100k (for a fixer-upper) to $180k, so probably the min loan amount would be $140k depending.

This is why I think selling needs to be on the table. I have somewhere in the range of $80,000 - $140,00 in equity (depending on which source you believe for market value). If I sold here, I could likely buy a house and likely have it payed off in less than 10 years (with the caveat that I'm not sure how long I'll stay there, but probably 2-4 years). I realize that I'd need to stay in the new city for 5 years in order to avoid capital gains taxes, but the prospect of being debt free in that short amount of time is appealing, and it makes all future decisions about location and employment much easier to make.

As for keeping the condo, I think the market will only go up. I've been averaging about a 4% increase in value per year, and I'm up conservatively up 40% over the 10 years I've owned it. There is nothing that makes me thing this will stop. It could slow or drop a bit during a recession (including the current one), but long term its easy to predict a strong net upward trajectory. A house/condo in the new city would not appreciate at that rate. Also, the spreadsheet I found gave me a total ROI of anywhere from 3% if you include the HELOC payments to about 20% if you don't.
« Last Edit: May 23, 2020, 01:15:32 PM by lateralwire »

MrThatsDifferent

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Re: Own + Rent /vs/ Sell + Buy
« Reply #6 on: May 23, 2020, 04:26:20 PM »
Iíll let the people more experienced and smarter than me did into this, but it seems your only reason to sell the current is to buy something new outright and have it paid off. Iím not sure how much youíve read about the donít pay off your mortgage but it would seem that if you could use 20% deposit to get something at the lowest interest rate and just ride that mortgage out, youíd be in a really good place.

Also, you donít have to buy in the new place. Rents might be pretty cheap for the next couple years and you might want the flexibility. Itís ok to not own, especially if youíre not sure how long youíll be there. Iíd probably rent the current place so you can experiment with what that is like for you and the impacts, if after a year or two of renting out the current you find you hate being a landlord, you can always sell. Thereís no time to rush and it seems like the type of property to hold for a bit if youíre not forced to pull any triggers, and youíre not forced now.

Just my 2 cents

lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #7 on: May 24, 2020, 09:01:40 AM »
Good points! I had not considered the don't pay off your mortgage' aspect. Definitely need to consider that. That concept assumes you have other money to invest instead, though, so I have to think about my situation to see if it makes sense and how applies.

I did some more research and here's the income tax part. I feel like you have to either not claim this income (which could be risky) or factor taxes in as an expense in all of this. After doing this research, I realize this isn't a huge expense or as complicated as I my friend made it out to be, but it seems odd that it isn't referenced more often when discussing net income from rental properties.

Here's my source for working out the taxes: https://www.fool.com/millionacres/taxes/real-estate-101-how-rental-properties-are-taxed/
Here's my source for working out depreciation: https://homeguides.sfgate.com/depreciate-building-renovations-taxes-35185.html

I did an $11,000 bathroom renovation a few years ago. I have a 27.5 year depreciation period, so that works out to $407/year (I'll call it $400 for this analysis). It's disappointing that I can't deduct the annual payment or for the renovation.

Here's the breakdown:
Rental income: $18,000 ($1500 * 12; using this as a conservative estimate for highest potential taxes)
Deductions:
  • mortgage interest, $4,000 (based on CY2019)
  • insurance costs, $150
  • HOA dues, $3,500
  • property taxes $2,500
  • Maintenance, $400 (chimney sweep/inspection + heat pump checks)
  • Depreciation on renovations: $400
Total Deductions: $10,950
[/list]

Taxable income: $18,000 - $10,900 = $7,100
20% QBI Deduction: $7,100 * 0.8 = $5,680

Income tax = $5,680 x .22 (tax bracket) = $1,249

So, in truth, the cashflow for my rental property ends up being a negative cashflow (just over -$4k/yr) for the next couple of years until I pay off the HELOC, at which point it becomes about $400-500 in positive territory on the property itself, plus $4500/yr in cashflow freed up from those payments. Not bad for building equity I guess.

I suppose I could adjust my HELOC principle payments to spread it out over a slightly longer period of time. And now that I'm thinking about it, the HELOC rates I have are pretty good - I just want to pay it off before the fixed rate period ends... but could I just "refi" the HELOC (ie: find another bank that will give me a new HELOC, while closing out the old one, and potentially find a new fixed rate to spread out that debt payment over a longer period of time?

Papa bear

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Re: Own + Rent /vs/ Sell + Buy
« Reply #8 on: May 24, 2020, 11:21:34 AM »
Banking on appreciation for your returns is a fools errand.  It is speculation at best.   You can expect your house to increase with inflation, but more accurately, wage inflation in your area.

The house does make a ďgoodĒ rental, especially with those killer HOA dues.   There are more expenses than youíve accounted for, such as vacancies, management, and tenant caused maintenance.

You have some solid appreciation on the house now.  If you sell, you will have tax free capital gains since it is your primary. If you rent for a few years, depending on the timeframe, you lose that exemption and you will have to pay capital gains and depreciation recapture. 

From a financial perspective, it is a very poor idea to keep this as a rental.  You will do much better with your money in the market or with a better rental property.

What we canít answer is the emotional aspect.  If you expect to move back someday or have someone you know going to rent it for a year or so, then maybe you consider renting. But thatís not a financial decision.

As for buying something new, i would look to borrow as much as possible given the current rates. 
 


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lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #9 on: May 24, 2020, 11:47:22 AM »
I did account for vacancies (1 month per year). This condo is in center city, which is a highly desirable place to be. I'm confident that keeping it occupied would be easy.

I 100% agree that banking on appreciation is a bad idea for most people, but this location is phenomenal. Charlotte just became the 15th largest city in America, up from 17 just 2-3 years ago, and we're anticipating another ~400,000 people in the next 20 years. IMO, growth, density, and demand in center city are only going to increase. Call it an emotional opinion if you want, but barring some sort of world ending economic collapse its hard to see this not happening in this particular instance. Even in this weird recession people are buying houses sight unseen. The market here is crazy.

I'm interested in the capital gains on a rental, specifically how long does it take to trigger the tax? I was not aware of this and it will absolutely affect my decision making process. It definitely gives me insight into the rental world... so really renting should be about cashflow and not based on consideration of appreciation, although any appreciation could be looked at as plus and losses can be written off somehow I assume?

In terms of selling, I do like the idea of just doing it and the freedom associated with it. I have no way to predict if I ever come back other than to say it's not an unlikely scenario. But when looking at it financially, I think you're right - I could probably do better with that money in the market. Regardless of whether or not I buy in the new city, dealing with the housing situation of IF I were to return is something that future me can deal with if/when that happens.

I really appreciate the thoughts. Thanks for helping me thing through the variables. Keep the wrenches coming!


MrThatsDifferent

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Re: Own + Rent /vs/ Sell + Buy
« Reply #10 on: May 24, 2020, 02:13:26 PM »
Oh I forgot about the capital gains thing when owning, that would make a difference. Itís the bloody crystal ball that sucks for you. If you knew you were coming back, the place sounds ideal (although you might return under different familial circumstances). Otherwise, sure, take the money and run and rent in the new place for a year or two and then decide. Keep enough cash in HISA to buy something around $150k and invest the rest. That would give you the most flexibility with the least distractions. It really comes down to what you want in your life and where you want your focus?

lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #11 on: May 24, 2020, 04:57:18 PM »
Haha, exactly! Hence why I'm here. I think that regardless of the future, making the best financial decision is the only way I'll sleep at night given the unknowns. It seems like taking advantage of my equity now is the better move (per papa bear's advice).

So my question then becomes, does it make more sense to put all of my equity proceeds into a new house or put 20% down on a mortgage and then invest? With interest rates being what they are, I think starting over on a 20-25 year mortgage with low rates and investing the balance seems like the way to go. I think I'll stand to make a lot more money in the market than tying up my net worth in a house.

MrThatsDifferent

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Re: Own + Rent /vs/ Sell + Buy
« Reply #12 on: May 24, 2020, 09:46:34 PM »
Agreed with your thinking, which is strongly supported here.

SeaWA

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Re: Own + Rent /vs/ Sell + Buy
« Reply #13 on: May 25, 2020, 10:44:39 AM »
Here's the breakdown:
Rental income: $18,000 ($1500 * 12; using this as a conservative estimate for highest potential taxes)
Deductions:
  • mortgage interest, $4,000 (based on CY2019)
  • insurance costs, $150
  • HOA dues, $3,500
  • property taxes $2,500
  • Maintenance, $400 (chimney sweep/inspection + heat pump checks)
  • Depreciation on renovations: $400
Total Deductions: $10,950
[/list]

Don't you also get to take a depreciation of the entire property with a 27.5 year schedule? (or the "improvements" portion not the "land" portion of the total property value)

lateralwire

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Re: Own + Rent /vs/ Sell + Buy
« Reply #14 on: May 26, 2020, 12:57:19 PM »
I think so I'm not sure how to figure that out. I'm not sure if factoring that in would make that much of an impact on the overall number, at least not enough to adjust my overall thought process.