Author Topic: Renting out existing house and buying new - does it make sense?  (Read 4115 times)

Coloradostache

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Renting out existing house and buying new - does it make sense?
« on: January 18, 2017, 04:55:24 PM »
I'm looking at buying a smaller house and renting out my existing house.  The new house is currently rented out for another 6 months, so I would let that run its course before moving in.  Any advice?  Good idea?  Here's the situation:

Current house in Front Range Colorado:
$750,000
Mortgage balance ~$275K @ 3.875%
PITI $1800
Estimated Monthly Rent $3500-4000

New house
Purchase Price $325,000
Mortgage $260K @ 4.125
PITI $1500
Currently rented for $1800 per month

The appeal to me is two fold, the rent would cover both places and I would live for "free".  I also downsize my house and upsize my garage.  This doesn't meet the 1% rule, but I don't think you can make that work in the Denver area.  The way I look at it, for $65K down payment I no longer have to make a mortgage payment on either place.  Is this a poor way to justify it?

Another Reader

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Re: Renting out existing house and buying new - does it make sense?
« Reply #1 on: January 18, 2017, 05:02:04 PM »
Please read the real estate investing threads.  You can count on approximately 50 percent of you rent being eaten by expenses.  You would probably break even on the more expensive house or over time be slightly positive.  However, it's a terrible return on your investment.

If you can't meet the 1 percent rule, you don't discard the rule.  You don't buy investment properties in that area.

Overflow

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Re: Renting out existing house and buying new - does it make sense?
« Reply #2 on: January 20, 2017, 08:20:33 AM »
I agree with Another Reader.

Unfortunately PITI is only portion of the expenses you will incur with a property. You actually monthly will be much higher, and you need to think through all the categories to get a more accurate number.

Conservatively I would budget (numbers % of annual income)
5-10% Vacancy
5-8% Capital Expenses
5-8% Repairs and Maintenance

You probably easier have at least another 20% of expenses there.

Bobberth

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Re: Renting out existing house and buying new - does it make sense?
« Reply #3 on: January 20, 2017, 02:26:31 PM »
My default answer is, "If you didn't buy it specifically to rent it out, you are better off selling it than renting it." Why take on the extra risk of rental property to "live for free" when you could sell your current house and pay cash for the new one? You would be "living for free", avoiding headaches and have $150k or so left over to invest. Take that $150k and purchase a property for the purpose of a renting out if you really want to own rental property.

Now if there is a potential appreciation play in the property you are going for and just want to tread water/put a little money into for a few years to see that appreciation, that is a different story. Rarely does a house bought to live in turn out to be a good rental.

okobrien

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Re: Renting out existing house and buying new - does it make sense?
« Reply #4 on: January 20, 2017, 09:37:49 PM »
Dude,
You have almost half a million in equity! That is bad-ass.  I love the idea of moving to a smaller house.  (I live in a 750 ft house in Denver) 
Here is what I think about renting out the big house.  What is the opportunity cost of your half a mil?   What else could you be doing with that kind of money?  The reason you are interested in renting it out is because your payment is relatively low for such a valuable asset.  Because that payment is so low, you will most likely earn a profit on that property.  This isn't one of those deals where you will be SOL, paying money out of your pocket to keep the rental.  But, with so much equity, you can put your money to much better use elsewhere.

If you are interested in real estate, continue educating yourself about it, and when you feel confident, make a move.  You can put that $475,000 to use in a way that it will make 3-5x what it will make for you with the old mansion.  Don't let the easy, ok investment keep you from making much better returns with better investments.

GoBigRed

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Re: Renting out existing house and buying new - does it make sense?
« Reply #5 on: January 22, 2017, 12:05:06 AM »
Assuming you have lived in your current house for at least 2 years, I would consider selling your current more expensive house and using the proceeds to either (1) purchase the cheaper house in cash if you want to live for free (personally at such low interest rates, I would not pay all cash, but there is something to be said for having no mortgage), or (2) using anything in excess of the down payment on the new house to buy other rental properties that may generate better returns (either in Denver or possibly out of state). You can always park that cash in an index fund, money market or savings account depending on your risk tolerance until you find the right rental(s).  Even if you purchased the new house with all cash, you would have $150k to pursue other properties, invest in stocks, or whatever you choose.  As the other posters mentioned, you need to determine what the return would be based on the net rents you would expect to generate after all costs are factored in.  Given just the numbers you supplied (which doesn't factor in taxes on the rental income, depreciation, appreciation and other operating costs other posters have mentioned), it does not seem like a great return on $475k.  I would look for a better use for the equity.   

Congrats on building up that equity and being willing to downsize.  That's not something that is easy to do, but sounds like you are in a good situation.

I live in a similar market where the 1% rule just doesn't work.  I have started to look in other markets for rentals, but always keep an eye open for the right deal!  Having funds available lets you act fast if it does come along.

SeattleCPA

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Re: Renting out existing house and buying new - does it make sense?
« Reply #6 on: January 22, 2017, 08:36:11 AM »
Assuming you have lived in your current house for at least 2 years, I would consider selling your current more expensive house and using the proceeds to either (1) purchase the cheaper house in cash if you want to live for free (personally at such low interest rates, I would not pay all cash, but there is something to be said for having no mortgage), or (2) using anything in excess of the down payment on the new house to buy other rental properties that may generate better returns (either in Denver or possibly out of state). You can always park that cash in an index fund, money market or savings account depending on your risk tolerance until you find the right rental(s).  Even if you purchased the new house with all cash, you would have $150k to pursue other properties, invest in stocks, or whatever you choose.  As the other posters mentioned, you need to determine what the return would be based on the net rents you would expect to generate after all costs are factored in.  Given just the numbers you supplied (which doesn't factor in taxes on the rental income, depreciation, appreciation and other operating costs other posters have mentioned), it does not seem like a great return on $475k.  I would look for a better use for the equity.   

Congrats on building up that equity and being willing to downsize.  That's not something that is easy to do, but sounds like you are in a good situation.

I live in a similar market where the 1% rule just doesn't work.  I have started to look in other markets for rentals, but always keep an eye open for the right deal!  Having funds available lets you act fast if it does come along.

GoBigRed hints at something really, really, really important here. You may now qualify for a Sec. 121 exclusion, meaning you can sell your house and not pay income taxes on the gain.

If you turn the house into a rental, you may easily lose that Sec. 121 exclusion.

Given your numbers--and I don't think we have the details to really know--this might be a $125K mistake.

Something to check out...

GoBigRed

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Re: Renting out existing house and buying new - does it make sense?
« Reply #7 on: January 22, 2017, 09:22:43 AM »
Exactly, Seattle CPA.  We don't have all the numbers and details, but also all of his rental income would be taxed based on his tax bracket.  I'm not a tax expert, but something that always has to be considered.

rothwem

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Re: Renting out existing house and buying new - does it make sense?
« Reply #8 on: January 25, 2017, 08:44:39 AM »
Maybe this is a dumb question, but do people actually rent $750,000 houses?  I can't imagine that someone who can afford a $4000/month rent payment wouldn't have the money to buy their own house, but obviously the real estate market in Denver is different than here in Raleigh. 


Nick_Miller

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Re: Renting out existing house and buying new - does it make sense?
« Reply #9 on: January 25, 2017, 09:28:43 AM »
I had the same question as @rothwem. Who exactly is the market for such high-end rentals? Executives who are relocating to the area and need a space to stay for a year or so?

I can't imagine how nervous I'd be about letting tenants into a home in which I have soooooooo (deep breath) oooooo much of my net worth.


Another Reader

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Re: Renting out existing house and buying new - does it make sense?
« Reply #10 on: January 25, 2017, 09:36:22 AM »
Maybe this is a dumb question, but do people actually rent $750,000 houses?  I can't imagine that someone who can afford a $4000/month rent payment wouldn't have the money to buy their own house, but obviously the real estate market in Denver is different than here in Raleigh.

Someone in my neighborhood is doing short term relocation rentals.  The house is worth around $1.5 MM.  Trying to dig up the details, but it's not advertised on the MLS or Zillow.

cchrissyy

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Re: Renting out existing house and buying new - does it make sense?
« Reply #11 on: January 26, 2017, 11:22:03 PM »
I wouldn't worry at all about the 1% rule. It is just a guideline for quickly rule properties out when looking to buy and is not meant to be applicable to deciding whether to keep a property you already own.

that said, I agree with the above, who said the reason this looks good to you as a rental is your mortgage balance and payment are low relative to how much rental income it would bring and the huge problem is also good news - you have lots of equity tied up in this place! it's fabulous you have it but it is all tied up right now, and the opportunity cost of keeping this rental is whatever else you could have done with that money.


I'd buy the cheap place (mortgage or cash, your call) and invest the difference. Lowest hassle, no location-specific economy risk or tenant risk.

How much of the 1st house's value is appreciation since you bought it? Are you single? I'm just wondering if you have already passed the limit for tax free gains and that's why you leaned toward keeping it. 

Another Reader

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Re: Renting out existing house and buying new - does it make sense?
« Reply #12 on: January 27, 2017, 03:27:48 AM »
I wouldn't worry at all about the 1% rule. It is just a guideline for quickly rule properties out when looking to buy and is not meant to be applicable to deciding whether to keep a property you already own.

that said, I agree with the above, who said the reason this looks good to you as a rental is your mortgage balance and payment are low relative to how much rental income it would bring and the huge problem is also good news - you have lots of equity tied up in this place! it's fabulous you have it but it is all tied up right now, and the opportunity cost of keeping this rental is whatever else you could have done with that money.


I'd buy the cheap place (mortgage or cash, your call) and invest the difference. Lowest hassle, no location-specific economy risk or tenant risk.

How much of the 1st house's value is appreciation since you bought it? Are you single? I'm just wondering if you have already passed the limit for tax free gains and that's why you leaned toward keeping it.

If you want to go broke, or at least have the property be a huge drag on your cash flow and investment returns, ignore the one percent rule.   You are implicitly betting on appreciation to bail you out.  That's worked out well in recent years, but won't go on forever.  In your shoes, I would consider the tax implications of selling and run accurate numbers to determine if you are better off redeploying the equity elsewhere.

rothwem

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Re: Renting out existing house and buying new - does it make sense?
« Reply #13 on: January 27, 2017, 07:59:12 AM »
Maybe this is a dumb question, but do people actually rent $750,000 houses?  I can't imagine that someone who can afford a $4000/month rent payment wouldn't have the money to buy their own house, but obviously the real estate market in Denver is different than here in Raleigh.

I have tenants paying me $3350/month to rent my home purchased for $400,000 also in the Denver area.  Rough estimates tell me that I may be able to get $475,000 for the home now.

Damn, that's nutty.  Glad to know there's a market though. 

tralfamadorian

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Re: Renting out existing house and buying new - does it make sense?
« Reply #14 on: January 27, 2017, 11:23:07 AM »
Maybe this is a dumb question, but do people actually rent $750,000 houses?  I can't imagine that someone who can afford a $4000/month rent payment wouldn't have the money to buy their own house, but obviously the real estate market in Denver is different than here in Raleigh.

I have tenants paying me $3350/month to rent my home purchased for $400,000 also in the Denver area.  Rough estimates tell me that I may be able to get $475,000 for the home now.

Damn, that's nutty.  Glad to know there's a market though.


There are plenty of places with high rent.  One of my rentals is a 1bd for $3000/mo.  And no, it's not in NYC/SF.  Most of my renters are either in the area on a contract and know they will probably be leaving in a couple of years or would like to rent for a year while they shop for a house. 

effigy98

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Re: Renting out existing house and buying new - does it make sense?
« Reply #15 on: January 27, 2017, 01:48:21 PM »
Maybe this is a dumb question, but do people actually rent $750,000 houses?  I can't imagine that someone who can afford a $4000/month rent payment wouldn't have the money to buy their own house, but obviously the real estate market in Denver is different than here in Raleigh.

In my area the tech worker bees all around me rent 3k to 4k a month. These are no executives or "rich" people compared to the rest of the area. Compared to most of the world sure, but here they are just average. 750k is like an average fixer upper house around here that needs a new roof.

flyersman

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Re: Renting out existing house and buying new - does it make sense?
« Reply #16 on: January 30, 2017, 08:45:04 PM »
Dude,
You have almost half a million in equity! That is bad-ass.  I love the idea of moving to a smaller house.  (I live in a 750 ft house in Denver) 
Here is what I think about renting out the big house.  What is the opportunity cost of your half a mil?   What else could you be doing with that kind of money?  The reason you are interested in renting it out is because your payment is relatively low for such a valuable asset.  Because that payment is so low, you will most likely earn a profit on that property.  This isn't one of those deals where you will be SOL, paying money out of your pocket to keep the rental.  But, with so much equity, you can put your money to much better use elsewhere.

If you are interested in real estate, continue educating yourself about it, and when you feel confident, make a move.  You can put that $475,000 to use in a way that it will make 3-5x what it will make for you with the old mansion.  Don't let the easy, ok investment keep you from making much better returns with better investments.

How would you invest that $475k that would make one 3-5x? In real estate rentals? Please explain

Jon Bon

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Re: Renting out existing house and buying new - does it make sense?
« Reply #17 on: January 31, 2017, 05:39:17 AM »

How would you invest that $475k that would make one 3-5x? In real estate rentals? Please explain




Easy, leverage!


If you have 475k you can buy four 200k rental houses generating  total cash flow of $8000 a month (2000 per house) and STILL have 200k plus left in the bank!

I would have your house for sale yesterday. That is life changing money, and you probably could keep most (all?) of it tax free. Lots of people work their entire lives and get nowhere near 475k in cash. As others have said renting that house can hurt you with the tax man, look up the 2/5 year rule.

Maybe I missed it but why would you want to hold onto that house? Why would you risk it as a rental with all your eggs in one basket?! I would sell the house (or at least borrow a bunch of money against it) to spread some of that risk out.  Personally I am sitting on 100-150k in equity and I want to sell to lever up again. I cant imagine having that much equity in a home.

« Last Edit: January 31, 2017, 05:45:11 AM by Jon Bon »

adamcollin

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Re: Renting out existing house and buying new - does it make sense?
« Reply #18 on: February 06, 2017, 04:57:35 AM »
Selling your home can be more profitable for you.

Coloradostache

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Re: Renting out existing house and buying new - does it make sense?
« Reply #19 on: February 08, 2017, 10:25:42 AM »
Thanks for the replies everyone.  I think you've all successfully talked me out of renting out the expensive house.  I am going to shift my plan and likely sell and then buy something in the $400K range.  I'll likely keep a small mortgage on it, and invest some of the equity from the sale. 

What is my tax liability if I sell?  I bought the house in 2010 for $545K, so there is approximately $200K in appreciation over 7 years.  I have lived in it myself the entire time. 

It is excessive, 3400 square feet on a acre of land for 1 person, but it has made me some pretty good equity in that time.  Now time to cash out, and move to something more reasonable.  When I bought it, I had no FIRE plans but now a I sure do.  I've got about $400K in other investments as well, so this is a huge part of my net worth. 

GoBigRed

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Re: Renting out existing house and buying new - does it make sense?
« Reply #20 on: February 08, 2017, 11:04:36 AM »
I am not a tax expert and can't give tax advice, but here is that applicable IRS code Section 121 that Seattle CPA mentions above.  You will have to look at Section 121 and the qualifications to confirm you are eligible (which it sounds as though you are).  Its pretty straight forward for primary residences.  Hopefully this helps.  https://www.law.cornell.edu/cfr/text/26/1.121-1

Here is a good article that came out last week regarding live and flips with 1500 Days to Freedom and Coach Carson (recently featured on Mad Fientist Podcast).  Its a great way to build wealth if the market is favorable.  http://www.coachcarson.com/getting-rich-live-in-flip/


SeattleCPA

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Re: Renting out existing house and buying new - does it make sense?
« Reply #21 on: February 15, 2017, 07:02:41 PM »
You might also find the first paragraphs of this blog post useful for understanding how to not botch the Sec. 121 exclusion:

http://whitecoatinvestor.com/real-estate-tax-loopholes-for-unintentional-investors/