Author Topic: Sell house or keep renting it in Phoenix  (Read 3908 times)

vermospan

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Sell house or keep renting it in Phoenix
« on: June 04, 2015, 05:19:22 PM »
Hello, fellow Mustachians! I was wondering if I could solicit some of your expert, experienced advice on the house I have owned since 2010 in a pretty nice area of a family-friendly suburb in the East Valley of the Phoenix metro area.

Market Value: 225k or so
Original Purchase price: 147k
Original Mortgage Amount: 113k
Interest Rate: 3.38
Mortgage Term: 30 years
Term remaining: 27 years
Amount remaining on mortgage: 107k
Gross Rents: 1200/mo (minus 80/mo for property manager fee, so it's really like 1120 in my bank account)
Principal and Interest: 499/mo
Taxes and Insurance (the T&I of your PITI): 230/mo
HOA costs: none
Notes: house built in early 90s, in pretty good condition

My 2-year contract with the renters is coming to an end in a couple of months.  I could potentially ask a slightly rent from them - but not much higher (the highest comps in the area are 1300/month or so).  The home has been good and relatively low maintenance, the renters seem to be good ones, etc.  The question is whether I should keep renting it out or "take the money (appreciated equity) and run."  If I sold it, I would immediately send the money to join my other green soldiers in my Vanguard index funds.

*Bonus question* I have been wondering about this one for a while, but haven't been able to find a concise answer in my internet searches: would the capital gains from the sale of a rental property be determined solely by my ordinary income (i.e. would I count the money made from the sale of the property into my income when determining my tax bracket?).  As for my actual normal income, I am in the 15% bracket).  Would this mean I would not have to pay capital gains? I do know I would have to pay depreciation recapture, of course.

Many thanks for reading and for your help!

waltworks

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Re: Sell house or keep renting it in Phoenix
« Reply #1 on: June 04, 2015, 06:52:02 PM »
Sell, terrible 1% rule failure. Did you read any of the other threads before you posted?

-W

vermospan

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Re: Sell house or keep renting it in Phoenix
« Reply #2 on: June 04, 2015, 07:03:50 PM »
Sell, terrible 1% rule failure. Did you read any of the other threads before you posted?

-W

Yes, I have read many of them over the past month.  That is what led me to write a case study here. 

I know it is nowhere near the 1% most would require, but the house provides a positive cash flow and decent return when considering the actual cash amount I have had to invest.  Of course, the fact that the value has appreciated so much means that there are potentially higher returns to be had if I sold the house and put the money elsewhere.

Thanks for your reply, Walt. I appreciate it.

Another Reader

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Re: Sell house or keep renting it in Phoenix
« Reply #3 on: June 04, 2015, 07:26:44 PM »
You are going to have to pay some fairly significant taxes.  The recaptured depreciation will be taxed as ordinary income at the federal level.  IIRC, the rate is 25 percent.  The capital gain will likely push you above the 15 percent bracket, but will be taxed at the capital gains rate.  I don't recall Arizona's treatment of depreciation recapture, but the state bite is much smaller anyway.

At $225k, it would make no sense to buy this property as a rental.  At $147k, the property does not quite meet the 1 percent rule and over time the cash flow will not be outstanding.  However, you have positive leverage, which helps.  It would be impossible in your market to generate 1 percent on a replacement property and you would not be able to obtain financing at anywhere near this interest rate. 

In your shoes, I would be on the fence with this one.   It affords you some tax shelter, you have an unbeatable interest rate, and over time the property should increase in value at the rate of inflation, although not consistently because of the real estate cycle.  I would compare all of the benefits against what you would expect from investing the net, after tax proceeds from the sale in the paper asset markets.

Another Reader

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Re: Sell house or keep renting it in Phoenix
« Reply #4 on: June 04, 2015, 07:40:05 PM »
One more thing.  Rents have increased significantly over the last year in the East Valley.  My Tempe rent comps are showing around 10 percent for example.  I would do a thorough market survey to make sure you have accurately estimated market rent before you make a decision.

vermospan

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Re: Sell house or keep renting it in Phoenix
« Reply #5 on: June 04, 2015, 08:22:41 PM »
Very thoughtful and helpful advice, Another Reader.  Thank you very much for your reply.  I have noticed the same thing about how challenging it is to get a decent rental return in the Valley, but how rents do at least seem to be increasing at a good clip.  The mortgage interest rate I have is, as you say, truly unbeatable.  That, coupled with the improving rents and my leverage, seems to make 'sell or rent' equation a little more difficult.

One other note: I did not originally purchase the house to be a rental.  I lived in it, but circumstances changed and I had to relocate (still in the Valley, though).  The good thing about selling now is that I think I would be able to claim the primary residence capital gains exemption by virtue of the fact that I have lived there at least 2 of the past 5 years.  The question about taxes I asked earlier was in respect to general sale of rental property and would apply if I keep renting it out.
 


Another Reader

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Re: Sell house or keep renting it in Phoenix
« Reply #6 on: June 04, 2015, 08:37:51 PM »
The rules on capital gains changed in 2009.  Your occupancy must now be pro-rated.  If you lived there for three years and the tenants lived there for two, only 3/5 or 60 percent of the gain is excludable.  Look up qualifying and non-qualifying uses for more information or talk to your tax person to verify how much of the gain would be excluded.

vermospan

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Re: Sell house or keep renting it in Phoenix
« Reply #7 on: June 04, 2015, 09:57:03 PM »
Great advice. Thanks again, AR!

Poorman

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Re: Sell house or keep renting it in Phoenix
« Reply #8 on: June 05, 2015, 02:10:54 PM »
Here are the numbers as I see them:

Gross Rent: 1,300
Expenses: 950

This is assuming you self-manage so I'm not including any expense there.  This is debatable but the way I see it your personal efforts to manage the property are yielding a profit.  I'm also assuming a reserve of 150 per month and 5% vacancy.

You have a positive cash flow of 350 per month, which is 4,200 per year.  If you were to sell, I'm estimating the equity that you would net after taxes and transaction fees would be about 85,000.

So your cash return on equity = 4.9%  (4,200 / 85000)

Your yearly amortization is about 2,220 with a ROE = 2.6% (2,220 / 85,000)

Your appreciation is impossible to predict but 3% over time seems reasonable.  So your return from appreciation might be 6,750 the first year with ROE = 7.9% (6,750 / 85,000)

Therefore, you are getting a combined return of 15.4% on your equity assuming 3% appreciation.

Would I buy that as a rental?  No. 

But are the alternative investments compelling enough for you to sell?  Probably not.  It would only make sense if you are planning to take this landlording thing to the next level by acquiring properties in a different area with better rent ratios.  If that's not in the cards right now, then I would hold onto this property because it's providing a great return based on the low-yield environment we are in.

EDIT:  Messed up on the appreciation calc the first time.
« Last Edit: June 05, 2015, 02:21:46 PM by Poorman »

CashFlowDiaries

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Re: Sell house or keep renting it in Phoenix
« Reply #9 on: June 05, 2015, 02:29:09 PM »
Poorman pretty much nailed it in the head!!  However there are actually additional benefits that are not calculated that will even increase those 10% estimated returns on that property.

For example:

1)  Tax benefits.  You can write off deductions for that property.  Expenses, mileage, tax depreciation, mortgage insurance.  All that helps you come tax day and its difficult to see how much money this saves you which is why you cant really calculate that in.

2) Someone else is paying your principal down every month.  Your equity is growing not just from appreciation but from principal pay down every month.  More money to add to your net worth!

3) From what ive read in the phoenix area, the appreciation there is more then 3% so if that is accurate.  That bumps up the ROI on that investment property even more.

So in reality, youre actually getting more then 10% returns on that rental.

I would keep it.  But i do have a biased opinion because my plan is to retire early from having investment properties.

vermospan

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Re: Sell house or keep renting it in Phoenix
« Reply #10 on: June 05, 2015, 02:42:02 PM »
Extremely helpful analysis and thoughts, Poorman and CashFlow.  Thank you both!

neo von retorch

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Re: Sell house or keep renting it in Phoenix
« Reply #11 on: June 09, 2015, 01:50:02 PM »
Market Value: 225k or so
Original Purchase price: 147k
Original Mortgage Amount: 113k
Interest Rate: 3.38
Mortgage Term: 30 years
Term remaining: 27 years
Amount remaining on mortgage: 107k
Gross Rents: 1200/mo (minus 80/mo for property manager fee, so it's really like 1120 in my bank account)
Principal and Interest: 499/mo
Taxes and Insurance (the T&I of your PITI): 230/mo
HOA costs: none
Notes: house built in early 90s, in pretty good condition

A lot of parallels to my current situation. Not sure about market value (probably no more than 180k) but purchase price of 156k, original mortgage now at 101k, 3.375%. But I have a 15 year though, with about 10 years left (so my interest is rapidly declining.) Gross rents is really about $1280 after accounting for utilities which I still pay. P & I is $925 because of that 15 year. Taxes and insurance is about $305/mo. No HOA. House built in 1994.

I wish I had a better understanding of "depreciation recapture." Officially, as per my taxes filed with the IRS, this has been a rental property since 9/2014. So does that mean that when I sell, the only recapture I would be taxed on would be a partial amount since 9/2014? I would certainly hope so, since this was my residence from 6/2007 through 9/2014.

vermospan

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Re: Sell house or keep renting it in Phoenix
« Reply #12 on: June 09, 2015, 03:50:47 PM »
Neo - wow, that is indeed a very similar situation to mine!  As for the depreciation, it is my understanding that you need to deduct the depreciation on the value of your property (the "improvements," i.e. the actual house structure itself, but not the land on which it is built, as this does not lose value to the wear and tear of using it as part of your business of renting it out).  I believe you should have claimed (4/12) of one year of depreciation on your 2014 taxes, a full year's worth for 2015, and so on.  Here is an article that might help:

https://turbotax.intuit.com/tax-tools/tax-tips/Rental-Property/Real-Estate-Tax-and-Rental-Property/INF12039.html

The "recapture" part of it comes when you sell the property.  You deduct the depreciation from your taxable income when you're renting the house out, then you recapture it when you sell.  Whatever amount you have depreciated, you pay a special depreciation capture percent when you sell - I believe it is 25% of the total amount you have claimed as depreciation over the years. 

Can some more experienced mustachian landlords confirm this?