To Sell and Make $100K or Not to Sell

[joshbrand111]

I am new to this whole mustachian lifestyle and hoping for some guidance as we work hard to become debt free and minimize our monthly expenditures.  As I work towards this new lifestyle  I am debating whether or not to sell a rental property to pay down personal debt or keep it as a long term investment.  We make a healthy profit on the monthly rent so I am in a bit of a dilemma.  So here is the breakdown and I would appreciate all of your inputs and guidance on the best approach.

Townhome: Currently, I rent our townhome for $1,750/month.  After paying all the bills associated with the property (mortgage, taxes, insurance, HOAs, etc.) it nets approx $750/month.  I could sell the townhome and make approx $100K in profit on the property.  I have only rented it a year and would not have to pay any capital gains tax on the profit.  The outstanding balance on the rental property is approx $130K at 3.75% interest.

Personal debt:
Primary mortgage: $280,000
Car:  $22,000 total for two cars.  We purchased luxury cars a few years back because we felt we deserved it since we both had long commutes and worked hard for our money (LOL here).  Interest is only 1% on the loans.  I don't think selling them is the best approach right now as I can't get two reliable cars needing little maintenance for less than $11K/each.
Student Loans:  $50K.  Approx.

So here is the dilemma.  Do we sell the townhome and pay off all of our debt minus our primary mortgate or keep the rental property and apply the monthly profits to pay off our debt.  I think short term it makes sense to sell the townhome, but longterm it seems it may be a better option to keep since the profit margin is high.

Looking forward to hear all your inputs as to what you would do in my situation.  If you need more specific information let me know!!

Thanks

Josh.

[hendlefe]

It's easier to break it down by the numbers.

First off, did you do your cash flow calculations correctly? Take your rental income and subtract potential vacancy (many people assume 8% of rent), property taxes, insurance, maintenance and repairs (~10% of gross rent), utilities, property management (you should factor this in even if you self-manage because your time isn't free).

After you find out your total rent, figure out how much cash you put in originally (down payment plus repairs).

Divide your annual cash flow by the amount of cash invested, this is your cash-on-cash return on investment.

If your CoC ROI is... lets say... 15%, then it sounds like you have a good investment.

Also, remember that you are paying down principal on the mortgage every month, which can boost your total ROI.

As an investment vehicle, rental properties are great because you can depreciate the property (shelter your profits from taxes), and also you can 1031 exchange into a larger investment property. And, when you pass away, your heirs wont have to pay capital gains because the property value "carries forward".

[ketchup]

So $130k mortgage plus $100k = $230k value of townhouse?  If that is correct, and you're renting it out at $1750/mo, that falls below the 1% rule-of-thumb so I'd be wary of the long term viability of this investment without more concrete numbers.  You claim it nets $750/mo after mortgage and HOA fees, but how much of that $750/mo will eventually get eaten up by insurance, taxes, vacancy, repairs, maintenance, property management, etc?  Conservatively, many budget at least 10% vacancy (when it takes a month to find a new tenet), 10% repairs (when tenets break stuff AND long-term big capital expenditures like eventual new floors, new kitchen every 15 years, new HVAC every 20 years, new roof, etc), 10% maintenance (when stuff just breaks), and 10% property management (like hendlefe said, even if you're doing it yourself).

My guess is that once you account for that, your yield will not look as nice as you're thinking.

As-is, your annual "return" on your $100k tied up in the house is $750*12 / $100,000 = 7.5%.

If we factor in a mere $175/month (10% vacancy) additional expense, that drops your annual return on cash tied up to be around 5%.  Extra on top of that lowers your yield further.

My guess is that this math doesn't end well.

If your overall yield is less than ~7% (average VTSMX return since 1992), you're investing in a riskier asset class than the stock market with a lower return.

Assuming that is true, I would say sell the townhouse after the current lease is up.  You're not actively bleeding money, but long-term it will likely be more trouble than it's worth as an investment.

I'm I'm totally wrong about all my assumptions here, because you already accounted for it all, feel free to punch me in the face.

I can't get two reliable cars needing little maintenance for less than $11K/each.

This I would say is completely wrong.  You could get perfectly reliable cars for half that (call it $5k).  You could for a lot less too (my cars are worth $2k combined and neither were made this century), but we'll call it $5k for two 2005~2008ish cars.

So based on everything I know so far, I'd recommend this:

Sell the house.
Buy two perfectly fine ~$5k cars that will last you many years (They are out there, I promise.)
Sell both fancypants cars.
Pay off student loans/mortgage if the interest rate is high (3~5% depending on your personal risk tolerance).
Invest what's left in VTSAX.
Relax, be happy, you're doing great.
Optimize elsewhere.
Workworkworkinvestinvestinvest.
Stop working.
Relax even more, and be even happier.

[joshbrand111]

So $130k mortgage plus $100k = $230k value of townhouse?  If that is correct, and you're renting it out at $1750/mo, that falls below the 1% rule-of-thumb so I'd be wary of the long term viability of this investment without more concrete numbers. 

thanks for all the thought put in to your reply.  I owe approx $130K on the property and have about $100K in equity.  So following your logic that puts the value of the home at $230K, which divided by monthly rent is less than 1%.  I never actually thought of it that way.

I am still embracing the idea of getting rid of the fancy pants cars.  It's much harder to do than say.  I know I need to do it.. but mentally need to get there.

[ketchup]

I am still embracing the idea of getting rid of the fancy pants cars.  It's much harder to do than say.  I know I need to do it.. but mentally need to get there.

As you think about driving your future less-fancy car, think off all the hundred dollar bills that you're not lighting on fire by driving it instead of your current fancypants car.

A $5k car can still be reasonably fancy.  I'm not saying this is the best idea in the world (nothing German is from a long-term maintenance perspective), but something flashy like this (shiny red 2004 Audi A4 Quattro in case the link dies) is only $5k.

My cars were each $700 and $1000, and both do pretty much look the part of beaters.  They both serve their utilitarian purposes flawlessly.  And I'll park either one of them at work between a 2015 Dodge Challenger and a big shiny GMC WTF truck with pride.  I'm not saying you have to go that far, but you have plenty of time, so be sure to research and get less-fancy-pants cars that are both good value and something you'll actually like.  It's not about sacrifice; it's about efficiency.  Fancypants cars (when newish especially) are some of the least efficient dollars you can spend.