Advice sought on renting out old house versus selling and taking the money

[bibsoconner]

Hi,

I’m hoping the analytic pigs here can offer some advice (or sarcasm, flames, insults) about my current happy dilemma. I own a house free and clear worth about 700,000. After prep/realtor fees I think I could net ~650,000. I bought for about $350K. I’ve done the research and believe I would have no problem renting it out for $3000. That’s 3000 gross, before management fees (I believe I probably need a prop mgr), expenses, etc.

Should I sell and invest the cash, or rent it out? The money from the sale would be all tax free. It’s not an easy decision. $3000 X 12 = 36,000 or 5.5% of 650,000. I’m not sure how I could invest 650,000 and get 5.5%. Sure, I could put it in the stock market and it may double. It could also go down by 1/2! CDs pay < 1%. I'm sure someone will point out that I'm not really getting 5.5% if I rent it out, so perhaps that should be my first specific question: 1. What is the expected earnings on a house renting for $3000/month that costs $650-700K and has management fees of 8-10%? I'm sure some experts here have a feel for repairs/disasters, etc. And then my more general question would be: 2. What would you do? Take the money and run? If so, how would you invest it? More real estate? Stocks? CDs? Or would you rent it out? For what it's worth, my own calculations and beliefs lead me to believe that renting it out, even allowing for a large amount of repairs provides a more attractive safe investment than CDs, T-bills, etc. Thanks for the advice and finally, I realize this is a happy problem to have and appreciate my good fortune. Dave

[an]

I depends on your age and if you need the rental income now for expenditure or if you’re still in the wealth accumulation stage. If you’re counting on the rental income to live, I’d rent it out. If you’re in the wealth accumulation stage, I would refi, take some money out and buy more rentals. A loan will help reduce your taxes as well, how much savings depends on large your loan is. If you have a big enough loan, you can technically count it as a loss in the IRS’s eyes because of the various deductions.

[CricketOnTheHearth]

Hi, Dave:

Fascinating to hear a property owner’s side of the story. I rent and go around saying, “I wish all these people would sell their houses instead of renting them out, so I/other people could buy one.”
But assuming you could really get that 5.5% return, yes, I can see your point that renting it out would be your best financial option.

But there are a lot of ‘ifs’.
Several of them are mentioned in the comments thread of a Doctor Housing Bubble post:

1)”A simple issue such as someone flooding out your floor (it does happen) can wipe out an entire year (or more) of profits.”
2) If you get a bad tenant, it could take you 6 to 12 months to push them out.
3) How much of a bite out of your profits will the property tax bill take? My rule of thumb here in San Diego is “about $100/month for every $100,000 of assessed house value” (so about $700/month in your case, assuming the house is here in San Diego.)
4) The aforementioned management company at 8-10% will be taking up to $300/month on a $3,000 rent nut.

One of the commentors on the above Dr. HB thread, “chris” on October 1 at 11:08 am, said he has been a landlord for 13 years. He had a lot of interesting comments, mostly about properties with mortgages on them, and the following which seems also relevant to you:

5) “You should budget at least 3% for capital expenditures and improvements.”

So out of your $3,000 a month rent, I estimate you’d be taking home roughly $1910 of it, or about 3.5% annual return. That’s if nothing drastic happens, like the water heater blowing a gasket and flooding the house, or a Tenant From Hell, or something.

Still better than market interest rates; up to you and whatever veteran landlords you can find for advice, if you/they think it is less risky than the markets.

One piece of advice I’ve gotten from house-landlords: DO NOT try to rent out a house that is in another city/state!!! Unless you get angels for tenants this can be a real pain, he told me.

[an]

Cricket, you point 1 & 2 are covered by property insurance. Since OP bought the house for $350k, his monthly property tax should be around $300. $300/month seems high for property management. Ive seen them around $100/month. 3% for improvement seems high. It’s a rental, not a primary residence. I don’t even spend that much on my primary. Keep in mind that 3&4 are deductible and so is home insurance.

[Coronita]

I don’t have an answer for you.. But here’s some questions you should probably ask yourself…

1. If you keep it, you would rent it out $36000/year less insurance/taxes/hoa/management fee, less income taxes… How much would that be?

2. Are you leaving the state? If so, do you think you might return?

3. What are you going to do about housing? Do you have another home you are living in or will live in?

[CA renter]

I vote for keeping it and renting it out. The current investment climate is pretty sketchy, IMO. Lots of reasons to think that we might have another crash in the near future (margin debt levels, the weakened position of the Fed and the US Govt to do anything should something bad happen, etc.). OTOH, asset prices might keep rising if everyone begins to fear that the USD will no longer be the world’s reserve currency, in which case your house might be one of the best possible things to own, as opposed to stocks, IMO.

The other posters bring up good points for you to consider, so definitely take some time to run the numbers and do what feels right given your circumstances.

Good luck!

[livinincali]

350,000*0.01125 = 3937.5/yr in taxes. Lets just say $4000 although it might be a bit higher than that. On the property management cost you usually assume 8-10% but for $3K a month maybe you get a discount. Let’s just say $200/mo or $2400/yr. Vacancy/Maintenance tough to judge when you only have 1 property, but let’s just assume 1 month of rent per year.

So 36000-4000-2400-3000 = $26,600/yr. Cap Rate tends to be based on the value of the house but let’s calculate it both ways. For you the cap rate is 26,600/650,000 = 4.1%. For an investor it goes down a bunch because of the increase in the tax base. So a new investor that bought your property would have property taxes of nearly $8K a year putting the revenue down to 22,600. SO 22,600/700,000 = 3.2% Cap Rate. So there’s no investor demand for your house. Your potential buyer pool is limited to owner users. An owner user that bought at $700K and put 20% down is looking at a monthly nut of about $3500/mo which isn’t that much more than renting.

The problem you potentially face is that if/when interest rates go up and there’s other investments that look more attractive the costs for potential buyers are going to go up at the same time. I.e. when you can get a safe 4% return at a bank the mortgage rates will be close to 7% which makes the monthly nut close to $4500. In order to keep the monthly nut close to the $3500 @ 7% interest the home’s price would need to be around $500K rather than $700K.

If you’re betting or guessing that rates should rise in the near future than it would make sense to sell now. If you bet that rates will stay low for a long time than it’s better to keep the property and rent it out. If you use Japan as a guide than it’s probably better to hang on to it.

[bibsoconner]

Thanks for all the comments and advice so far. To answer some of the questions. Yes, I have another home to live in (in San Diego). As I said, I realize it’s a lucky problem to have. I’m in my late 40s.

The decision to have a property manager is probably a good one for me. I’m not particularly handy, and my job takes up a great deal of my time. Quite frankly, I’d rather play catch with my kids than change a light bulb on my own house. I really don’t want to deal with problems from renters. That might well be a point for selling, rather than renting.

I’m paying 8% to the property manager. Frankly, I thought that was a fair deal. Others were asking 10%.
We’re going the renting route right now, but could easily change. I’m getting nervous that it is not renting after being on the market for about 20 days, although things seem to be heating up now (we did a price reduction from 3400 to 3100). My basic research indicates that there is not as much demand for 3+ bedroom houses in the >$3000 range. There’s just a smaller segment of the population that needs that. And those folks that can afford >3000/month can entertain the ideas of owning something. That’s why I was floating the idea of selling and perhaps getting a couple of small houses/condos. Although knowing myself, I probably would not get around to the buying part…

Property taxes are about $4000/yr by the way.
Dave

[plm]

Had the same decision to make four years ago. Bought a new house and what do with the old one (doubled in value like yours)? Held on to it and rented because it was hard to sell homes at that time. In hindsight, I should have sold it so the income would have been tax free and I don’t have to deal with being a landlord.

Missed the tax free capital gains window now so I’m stuck with it being a rental. It did appreciate nicely though so maybe its a wash now.

But it sucks to be a landlord. Renter is two months behind on rent now. Maybe should have gotten a property manager to demand rent. Its tough to demand rent when you know they are doing their best to make the payments. Income from being a landlord is not good. I get about 3 percent on investment. I think you need a mortgage to make the numbers work better.

Now with house prices so high, I don’t see why you don’t sell. Unless the capital gains tax rules change, it would be huge financial benefit to sell now.

[Coronita]

[quote=bibsoconner]Thanks for all the comments and advice so far. To answer some of the questions. Yes, I have another home to live in (in San Diego). As I said, I realize it’s a lucky problem to have. I’m in my late 40s.

The decision to have a property manager is probably a good one for me. I’m not particularly handy, and my job takes up a great deal of my time. Quite frankly, I’d rather play catch with my kids than change a light bulb on my own house. I really don’t want to deal with problems from renters. That might well be a point for selling, rather than renting.

I’m paying 8% to the property manager. Frankly, I thought that was a fair deal. Others were asking 10%.
We’re going the renting route right now, but could easily change. I’m getting nervous that it is not renting after being on the market for about 20 days, although things seem to be heating up now (we did a price reduction from 3400 to 3100). My basic research indicates that there is not as much demand for 3+ bedroom houses in the >$3000 range. There’s just a smaller segment of the population that needs that. And those folks that can afford >3000/month can entertain the ideas of owning something. That’s why I was floating the idea of selling and perhaps getting a couple of small houses/condos. Although knowing myself, I probably would not get around to the buying part…

Property taxes are about $4000/yr by the way.
Dave[/quote]

Given some of the additional details you provided..

If I was in your situation, most likely I would sell and pocket the $300k cash tax free, and put it to use for something else for a couple of reasons..

1. There’s absolutely no chance you will move back into this home for nostalgic reasons. You already have a move-me-up primary home…

2. If you’re worried about possibly losing out on more appreciation, well look at it this way..

a) If property values continue to go up, you have your current primary home to get another capital gains tax exemption on.
b) If property value goes down, you cashed out the first one, mitigating the “paper loss” on your newer primary. Besides, you can take comfort that your primary home isn’t earning income anyway if you’re living in it so you shouldn’t care…

It’s the nice thing about having a primary home now and being able to dispose of the old one.

As a wise RE guy once said to me.. “It’s not about whether you win or lose. You already won.. It’s about how much you are winning by…”

3. Where I might consider keeping the home is keeping it to let my kid(s) inherit it..But that’s a long time out, and we don’t know what our government is going to do with estate taxes moving forward both at the federal and state level.. If in doubt, just look at what’s going on right now in New York…

http://www.cnbc.com/id/101561812

The headline is misleading, because it’s not really 164% increase total… But the point is, taxman is coming to tax the crap out of your estate if not sooner, definitely later. So, maybe leaving everything in an estate isn’t such a great idea.

4. If you’re bent on being a landlord, and cashflow is what you want, maybe you can do some research into finding something like a 1/1 or 2/2 that cashflows comparable, but doesn’t require you to put the entire $300k. You might then have something leftover to spread the risk to another asset class.

Disclaimer.. I’m doing this, others are doing this.. And finding good property in SD that cash flows well at this point (in the areas I want to do this in is getting really challenging)….

5. 4% is currently what some high quality companies are paying with a dividend yield. So while I don’t recommend putting everything into stocks, it might not be such a bad idea to spread your money out among real estate, some stock, and something else, or just hold onto some emergency cash…

Altria for instance is paying around 5% dividend…
And there’s plenty other “boring” companies that are doing 4-5%… My problem is that historically, I have the opposite problem. I’m way too heavy in stocks, around 80%+ allocated into stocks a few years ago.. I wanted to move money out of the stock market into cash and something else other than stocks..

My ultimate goal that I’ve been working out is to more readily distribute my net worth between 40% stock, 40% rental property and 20% cash.

Disclaimer: don’t listen to me for financial advice. In fact, people usually find out doing the opposite of what I say works out better 🙂

[spdrun]

Assuming $4000/yr property tax, if you can rent it for $3000/mo, that’s only a 4.5% cap rate. Before management costs and insurance.

I’d consider selling and buying other rental property at 6-7% cap, which is doable these days. Maybe condos where the HOA takes care of a lot of the lifting and a management firm is less necessary.

[The-Shoveler]

I think I would go with what flu said,
You have a primary so take the tax free money now (expensive homes don’t usually pencil out well as rentals anyway)

Put some of it in a 2/2 condo or even a smaller 3/2 rental grade home a little further away.
buy some silver etc..

I really in good conscience cannot recommend stocks to anyone I used to own kmart stock (hey they have assets don’t they LOL).

Anyway never follow stock advice from me.

[flyer]

Since we bought our investment properties in San Diego many years ago, our cash flow and costs, etc., pencil out a lot differently from yours, so it makes a lot of sense for us to keep our rentals long term. We did, however, sell a couple of our properties at the last peak, because the timing was right.

IMO, and this is not advice, I don’t think you can go wrong holding onto investment property in San Diego. That said, given the volatility of the current economic climate, this would hold as long as you know you can afford to do so, even if there is another downturn in the real estate market, and, if you know you will not need the cash for any other of life’s many surprises.

[The-Shoveler]

I think what flyer said makes sense as well, but to me unless you are thinking really really long term (20-40 years) or maybe to pass down to your children etc…

I think that once you turn it into a rental for 5 years you can kiss your tax free money away and you could also pass the new rental and assets as well.

There are buy and “NEVER SELL” types that do extremely well over a long term time frame as well.

Will we see the same appreciation in coastal SD over the next 30 years as the last 30 years ?

Not so sure IMO, some other areas may do some catching up.

[an]

[quote=The-Shoveler]
I think that once you turn it into a rental for 5 years you can kiss your tax free money away and you could also pass the new rental and assets as well.[/quote]
Not entirely true. You can move back in for 2 years and then sell.

[Author]

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