Author Topic: SFH purchase: keep or sell two-unit owner-occupied rental  (Read 1288 times)

mrteacher

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SFH purchase: keep or sell two-unit owner-occupied rental
« on: January 11, 2024, 06:28:14 AM »
Hi all,

I'd love some input, as our path forward has become clear: within the next six months we will purchase and move into a SFH. Right now we are owner-occupants of a two-unit home. Ultimately, I'm trying to decide if it is more advantageous to sell the two-unit and have a much larger downpayment, thereby reducing our monthly payment on the SFH OR keep it and use the rental proceeds to subsidize the SFH mortgage while also building equity.

Note: I know one the most critical pieces to consider is do we still want to be landlords after moving. But I also want to wrap my head around the financial ramifications of selling vs. keeping the two-unit, to see if it's a slam dunk one way or the other.

Details:
To-be-purchased SFH: $350k-$425k

Two-unit:
Sale price: ~$315k-$375k
Mortgage balance: $140k (at 3%)
Unit 1 rent (estimate): $1,200/month
Unit 2 rent: $1,100/month
PITI: $1,000/month
Maintenance/upkeep: $400-$500/month

Other details:
Our downpayment without selling the two-unit will be 20% ($75k-$85k)
Our downpayment if we sell the two-unit it would be $75k-$85k plus after-tax proceeds (I need help to accurately estimate this) from the sale...this could be a significant sum!

Additional (and critical) considerations:
If we sell the two-unit we do not have to manage it
The two-unit will need a new roof in 2-5 years
We've done a lot of work on the two-unit, but it is still an older home and things will go wrong

Thank you in advance. Please let me know if I left out any important details.

lhamo

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #1 on: January 11, 2024, 07:25:51 AM »
Have you had a good experience renting out the second unit already and do you intend to continue to build a rental portfolio as part of your stash?  If so, I would be inclined to keep the two-unit for at least another year or two.  I am not a tax professional but I believe you should be able to continue to claim up to $500k in capital gains on the half of the unit  you lived in for the next five years (assuming you lived in it for two years).  And if for some reason the new house purchase doesn't work out or you lose income or otherwise need to dramatically reduce your costs, you could always move back in to one of the units and re-set that clock.  Nice to have options.

If you have hated being a landlord and never want to own a rental property again, then sell now. 

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #2 on: January 11, 2024, 07:36:15 AM »
Have you had a good experience renting out the second unit already and do you intend to continue to build a rental portfolio as part of your stash?  If so, I would be inclined to keep the two-unit for at least another year or two.  I am not a tax professional but I believe you should be able to continue to claim up to $500k in capital gains on the half of the unit  you lived in for the next five years (assuming you lived in it for two years).  And if for some reason the new house purchase doesn't work out or you lose income or otherwise need to dramatically reduce your costs, you could always move back in to one of the units and re-set that clock.  Nice to have options.

If you have hated being a landlord and never want to own a rental property again, then sell now.

We've been owner-occupants for around five years and been fortunate to rent to the same excellent tenant for that entire time. So we've had it pretty good, and I'm trying to be aware that we likely have a rosier-than-we-should perspective on landlording.

Adding additional rental properties is not something we are categorically opposed to, but it is not currently part of our longterm plan.

maizefolk

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #3 on: January 11, 2024, 07:47:11 AM »
Do you know what mortgage interest rate you're likely to be paying on the SFH purchase?

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #4 on: January 11, 2024, 07:49:32 AM »
Do you know what mortgage interest rate you're likely to be paying on the SFH purchase?

Generally. Somewhere around 6.5%

We are at 3% on the two-unit...

uniwelder

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #5 on: January 11, 2024, 08:30:53 AM »
Details:
To-be-purchased SFH: $350k-$425k

Two-unit:
Sale price: ~$315k-$375k
Mortgage balance: $140k (at 3%)
Unit 1 rent (estimate): $1,200/month
Unit 2 rent: $1,100/month
PITI: $1,000/month
Maintenance/upkeep: $400-$500/month

Other details:
Our downpayment without selling the two-unit will be 20% ($75k-$85k)
Our downpayment if we sell the two-unit it would be $75k-$85k plus after-tax proceeds (I need help to accurately estimate this) from the sale...this could be a significant sum!

Since you've been living in the house for 5 years, there wouldn't be any taxes on the sale, so you'd only deduct legal and realtor fees, and 140k mortgage from whatever amount you expect to sell it for.  Let's assume you put 200k in your pocket.  The down payment for your new house could be as much as 285k, which isn't enough to buy it outright, but would give more than 67% equity.  I personally am of the belief you should keep as much cash as possible not locked up in a mortgage, so I don't see the benefit of a large down payment, even at 7%.

How far away would your new house be?  If the rental needs a lot of maintenance, being further than a 30 minute drive might be a pain to self manage. 

I hope $4-500/month in maintenance is being very conservative or do you actually expect you might spend that much?  Is this mostly budgeting for a new roof?  If so, consider that if you sold the house, you might want to deduct that amount from your anticipated sales price or get it done before it goes on the market.

edited--- to cross my out my screwup
« Last Edit: January 11, 2024, 10:12:54 AM by uniwelder »

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #6 on: January 11, 2024, 09:08:14 AM »
You would calculate your capital gains taxes as follows:

Sales Price - Purchase Price - Capital Improvements + Depreciation Recapture= Capital Gain for total property
Take the total capital gain and divide by 1/2 since only 1/2 of it is a rental. The other 1/2 you get tax free since it's your primary home.

This is more or less how you would get an estimate on the taxes you owe, but I would consult a EA/CPA to do your taxes if you're going to sell.

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #7 on: January 11, 2024, 09:09:41 AM »
Details:
To-be-purchased SFH: $350k-$425k

Two-unit:
Sale price: ~$315k-$375k
Mortgage balance: $140k (at 3%)
Unit 1 rent (estimate): $1,200/month
Unit 2 rent: $1,100/month
PITI: $1,000/month
Maintenance/upkeep: $400-$500/month

Other details:
Our downpayment without selling the two-unit will be 20% ($75k-$85k)
Our downpayment if we sell the two-unit it would be $75k-$85k plus after-tax proceeds (I need help to accurately estimate this) from the sale...this could be a significant sum!

Since you've been living in the house for 5 years, there wouldn't be any taxes on the sale, so you'd only deduct legal and realtor fees, and 140k mortgage from whatever amount you expect to sell it for.  Let's assume you put 200k in your pocket.  The down payment for your new house could be as much as 285k, which isn't enough to buy it outright, but would give more than 67% equity.  I personally am of the belief you should keep as much cash as possible not locked up in a mortgage, so I don't see the benefit of a large down payment, even at 7%.

How far away would your new house be?  If the rental needs a lot of maintenance, being further than a 30 minute drive might be a pain to self manage. 

I hope $4-500/month in maintenance is being very conservative or do you actually expect you might spend that much?  Is this mostly budgeting for a new roof?  If so, consider that if you sold the house, you might want to deduct that amount from your anticipated sales price or get it done before it goes on the market.

This isn't accurate. You would owe taxes on the 1/2 of the duplex that is being rented. The side that you live in would not be taxable.

uniwelder

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #8 on: January 11, 2024, 09:14:42 AM »
Details:
To-be-purchased SFH: $350k-$425k

Two-unit:
Sale price: ~$315k-$375k
Mortgage balance: $140k (at 3%)
Unit 1 rent (estimate): $1,200/month
Unit 2 rent: $1,100/month
PITI: $1,000/month
Maintenance/upkeep: $400-$500/month

Other details:
Our downpayment without selling the two-unit will be 20% ($75k-$85k)
Our downpayment if we sell the two-unit it would be $75k-$85k plus after-tax proceeds (I need help to accurately estimate this) from the sale...this could be a significant sum!

Since you've been living in the house for 5 years, there wouldn't be any taxes on the sale, so you'd only deduct legal and realtor fees, and 140k mortgage from whatever amount you expect to sell it for.  Let's assume you put 200k in your pocket.  The down payment for your new house could be as much as 285k, which isn't enough to buy it outright, but would give more than 67% equity.  I personally am of the belief you should keep as much cash as possible not locked up in a mortgage, so I don't see the benefit of a large down payment, even at 7%.

How far away would your new house be?  If the rental needs a lot of maintenance, being further than a 30 minute drive might be a pain to self manage. 

I hope $4-500/month in maintenance is being very conservative or do you actually expect you might spend that much?  Is this mostly budgeting for a new roof?  If so, consider that if you sold the house, you might want to deduct that amount from your anticipated sales price or get it done before it goes on the market.

This isn't accurate. You would owe taxes on the 1/2 of the duplex that is being rented. The side that you live in would not be taxable.

Sorry, I really messed up there. Thanks for correcting it in your other response.

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #9 on: January 11, 2024, 10:06:43 AM »
Thank you for the input.

So we would be exempt from capital gains for 50% of the sale (the units are the same size) since it has been our primary residence. Good.

Then let's plug in some numbers.

Sales Price ($350k) - Purchase Price ($195k) - Capital Improvements ($10k) + Depreciation Recapture (online calculator says around $9k -- no idea if this is accurate or not) = Capital Gain for total property ($154,000)

So, if I have this correct, I would owe capital gains on 15% of half of $154k --> $11,550.

Would my 'cash in pocket' after sale be $350k (sale price) - $140k (mortgage balance) - $11.55k (Capital gains tax) ? Around $200k...?

Or do I also need to pay depreciation recapture out of pocket?




Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #10 on: January 11, 2024, 12:12:49 PM »
I think that is a good estimate based on the information you provided, but consult an EA/CPA if you're not comfortable filing yourself. The depreciation recapture would go the year's return that you sold the property and would increase your tax liability by the same amount that you got a deduction on depreciation in previous years. It would not be out of pocket at time of sale, just when you did your taxes. Hope that helps.

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #11 on: January 11, 2024, 12:13:51 PM »
Details:
To-be-purchased SFH: $350k-$425k

Two-unit:
Sale price: ~$315k-$375k
Mortgage balance: $140k (at 3%)
Unit 1 rent (estimate): $1,200/month
Unit 2 rent: $1,100/month
PITI: $1,000/month
Maintenance/upkeep: $400-$500/month

Other details:
Our downpayment without selling the two-unit will be 20% ($75k-$85k)
Our downpayment if we sell the two-unit it would be $75k-$85k plus after-tax proceeds (I need help to accurately estimate this) from the sale...this could be a significant sum!

Since you've been living in the house for 5 years, there wouldn't be any taxes on the sale, so you'd only deduct legal and realtor fees, and 140k mortgage from whatever amount you expect to sell it for.  Let's assume you put 200k in your pocket.  The down payment for your new house could be as much as 285k, which isn't enough to buy it outright, but would give more than 67% equity.  I personally am of the belief you should keep as much cash as possible not locked up in a mortgage, so I don't see the benefit of a large down payment, even at 7%.

How far away would your new house be?  If the rental needs a lot of maintenance, being further than a 30 minute drive might be a pain to self manage. 

I hope $4-500/month in maintenance is being very conservative or do you actually expect you might spend that much?  Is this mostly budgeting for a new roof?  If so, consider that if you sold the house, you might want to deduct that amount from your anticipated sales price or get it done before it goes on the market.

This isn't accurate. You would owe taxes on the 1/2 of the duplex that is being rented. The side that you live in would not be taxable.

Sorry, I really messed up there. Thanks for correcting it in your other response.

No worries, I mess up all the time. It's more admirable that you admitted it.

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #12 on: January 11, 2024, 12:41:33 PM »
I think that is a good estimate based on the information you provided, but consult an EA/CPA if you're not comfortable filing yourself. The depreciation recapture would go the year's return that you sold the property and would increase your tax liability by the same amount that you got a deduction on depreciation in previous years. It would not be out of pocket at time of sale, just when you did your taxes. Hope that helps.

Got it. Are capital gains taxes paid at time of sale or when I file my tax return for the year in which I sell the property?

Archipelago

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #13 on: January 11, 2024, 12:49:06 PM »
I'm not sure which side of the fence you fall about renting vs. selling, but if you decide to sell, the first thing I'd personally do is go straight to the existing tenant and ask if they want to buy it off-market.

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #14 on: January 11, 2024, 12:50:44 PM »
I think that is a good estimate based on the information you provided, but consult an EA/CPA if you're not comfortable filing yourself. The depreciation recapture would go the year's return that you sold the property and would increase your tax liability by the same amount that you got a deduction on depreciation in previous years. It would not be out of pocket at time of sale, just when you did your taxes. Hope that helps.

Got it. Are capital gains taxes paid at time of sale or when I file my tax return for the year in which I sell the property?

When you file your tax return.

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #15 on: January 11, 2024, 01:02:26 PM »
I think that is a good estimate based on the information you provided, but consult an EA/CPA if you're not comfortable filing yourself. The depreciation recapture would go the year's return that you sold the property and would increase your tax liability by the same amount that you got a deduction on depreciation in previous years. It would not be out of pocket at time of sale, just when you did your taxes. Hope that helps.

Got it. Are capital gains taxes paid at time of sale or when I file my tax return for the year in which I sell the property?

When you file your tax return.

Got it. So if we sell, I'll receive a payment of sale price, less mortgage balance, less fees? In other words, I'll need to budget for a hefty tax bill the following winter/spring.

Thanks for walking me through this. This is really helpful.

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #16 on: January 11, 2024, 01:06:48 PM »
I think that is a good estimate based on the information you provided, but consult an EA/CPA if you're not comfortable filing yourself. The depreciation recapture would go the year's return that you sold the property and would increase your tax liability by the same amount that you got a deduction on depreciation in previous years. It would not be out of pocket at time of sale, just when you did your taxes. Hope that helps.

Got it. Are capital gains taxes paid at time of sale or when I file my tax return for the year in which I sell the property?

When you file your tax return.

Got it. So if we sell, I'll receive a payment of sale price, less mortgage balance, less fees? In other words, I'll need to budget for a hefty tax bill the following winter/spring.

Thanks for walking me through this. This is really helpful.

You're welcome. To think about it another way, the title company that will manage the sale (and give you a check) will have no idea what you spent on capital improvements, what depreciation you've reported, etc. They couldn't withhold capital gains if they wanted to. There are just too many variables.
« Last Edit: January 11, 2024, 01:12:09 PM by Midwest_Handlebar »

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #17 on: January 12, 2024, 12:19:26 PM »
Curious if there are others with ideas, input, and opinions.

Midwest_Handlebar

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #18 on: January 12, 2024, 01:16:53 PM »
What would you do with the money if you sold the rental? Assume you would put it against the new mortgage or invest it into equities? What does your overall portfolio look like currently and how old are you? If you are ahead of your plan financially I would put it against the new mortgage and lower your monthly payment. If you are behind financially I would invest it in broad index funds. If you love rentals, which it sounds like you don't, I would keep it and buy more.

You've done well with the duplex and have a lot of equity. Your current return on equity isn't great and I would personally sell it and redeploy the money in something that has a higher cash on cash return.
« Last Edit: January 12, 2024, 01:19:44 PM by Midwest_Handlebar »

srad

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #19 on: January 12, 2024, 01:48:21 PM »
I'd like to add if you are still on the fence after reading all the good points mentioned above.  You have a 3% mortgage, that's something likely to never be seen again.  So personally, I'd keep the duplex for 2 more years then decide if its time to sell based on how enjoyable being a landlord was.   

You also need to look more into what you could get for rent.  Not knowing where this place is, your estimates seem low compared to the value.  I bet your rents are closer to 1400.  Rents have gone up A LOT in the last 3 years.


Archipelago

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #20 on: January 12, 2024, 01:48:46 PM »
Curious if there are others with ideas, input, and opinions.

How about posting your full numbers on the duplex and getting more granular?

Monthly income

Monthly expenses
P&I
Taxes
Insurance
Management
Vacancy
CapEx
Utilities
Lawn and snow

How much money you've put into repairs:

Down payment funds + total cash put in for repairs:

This will allow us to calculate your cashflow and CoC return so that you can create more of an apples-to-apples comparison.
« Last Edit: January 12, 2024, 01:50:46 PM by Archipelago »

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #21 on: January 13, 2024, 07:52:24 AM »
We are in our early 30s and have nearly $600k in retirement accounts, so I'd lean towards using the proceeds from the two-unit sale towards the purchase of the new SFH, and in doing so dramatically reducing our monthly mortgage payment.

Below are more granular numbers:

Monthly income: $2300-$2500 for both units combined, depending on what we can get for rent in our current unit

PI: $640
Taxes: $350
Insurance: $70
Management: $0 (self managed)
Vacancy: Never had a vacancy and not sure how to best calculate
CapEx: Not sure how I should calculate this number ... but I listed $400-$500 as 'maintenance/upkeep'
Utilities: $75
Lawn and snow: $0 (we do this)

We put around $40k down and have spent $10k on one big capital improvement and another $10k or so on smaller repairs, improvements, and maintenance -- inside and outside. That said, barring the roof, we should not be doing nearly as many projects moving forward.

Archipelago

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #22 on: January 13, 2024, 11:51:37 PM »
Quote
Management: $0 (self managed)
Lawn and snow: $0 (we do this)

Ah, OK. I suspected this. There's a bit of an issue with these assumptions. Sure, you may not have to pay anybody for these things and even prefer/enjoy doing them yourself, but your time is never worth zero. If someone were to ask you to manage their duplex, you wouldn't do it for free, right? Same thing goes with lawn and snow removal. I'm going to drill down on this point because we're on a forum about financial independence and maximizing our time. A lot of people have disagreed with me about this, but I'd be willing to die on a hill for it. Time is not worth zero.

Quote
Vacancy: Never had a vacancy and not sure how to best calculate
I own and manage multifamily rentals, too. As a general rule of thumb and to be conservative, I like to plan for 1 unit to be empty for two weeks out of year. If a tenant were to leave unexpectedly, renovations were made to a unit, the unit took longer than expected to market and lease, etc. there'd be a 2-week period having an empty unit for turnover, each year. This could also break out into both units being vacant for 1 week out of the year. This comes out to 2.1% vacancy rate = $52/month.

Let's run your numbers again a few ways.

A property manager would likely charge 10% of your gross rent roll. For CapEx let's use $250 for repairs and $250 for allocating for roof, furnace, fixtures, etc. I think that's fair. For lawn and snow I'll just throw out a figure of $100, but that's likely a bit low. You know how long it takes you for lawn care, snow, leaves, etc. You should be able to estimate what a landscaping contractor would charge.

Income: $2,500/month

PI: $640
Taxes: $350
Insurance: $70
Management: $250
Vacancy: $52
CapEx: $500
Utilities: $75
Lawn and snow: $100
Total expenses: $2,037/month

Cashflow: $463/month = $5,556 annually
Total cash into your property is $40,000 down payment + $20,000 in repairs = $60,000
Annualized ROI = 9.3%

~~~OR~~~

PI: $640
Taxes: $350
Insurance: $70
Management: $0
Vacancy: $52
CapEx: $500
Utilities: $75
Lawn and snow: $0
Total expenses: $1,687/month

Cashflow: $813/month = $9,756 annually
Total cash into your property is $40,000 down payment + $20,000 in repairs = $60,000
Annualized ROI = 16.3% BUT you've given yourself a part time job of $350/month for X hours per month. You should already be able to approximate what X is. Btw, if you no longer live on the property, X goes up.

You can choose to look at the calculations either way. But if we're comparing real estate to another passive investment (or in your case, paying a mortgage interest rate for a guaranteed rate of return), I'm one to think it's imperative we use the numbers from Scenario A.

Does this help with any more clarity?
« Last Edit: January 13, 2024, 11:57:39 PM by Archipelago »

mrteacher

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #23 on: January 14, 2024, 11:46:34 AM »
Thanks so much, Archipelago, for taking the time to offer valuable insight and sketch out those two scenarios.

Should I also factor in the gradually building of equity, or is it better to look at just cash flow?

At the end of the day, I'm comparing 9.3% return with the rental to a return of whatever our new mortgage rate is, right? Or, better to compare the monthly rental cash flow of $463/month vs. the reduction in mortgage cost after applying the proceeds of the rental sale to the new mortgage?

srad

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #24 on: January 14, 2024, 01:33:38 PM »
Yes, you add in the gradual building of equity.  Principal paydown by the tenants is a taxable event.  The principal on your mortgage is what, around $300 a month? If so add in an additional profit of 3600 a year. 

uniwelder

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Re: SFH purchase: keep or sell two-unit owner-occupied rental
« Reply #25 on: January 14, 2024, 01:40:34 PM »
Besides the mortgage paydown, I also assume an appreciation of 2% on the property.  It certainly could lose value, but generally speaking, I think 2% is a conservative estimate.