Sell my house now or keep leasing it out at a loss?

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TRock_IHB

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I'm a long time lurker on this blog and would like some feedback on my situation. I have a rental property, an Irvine detached condo I bought brand new at the end of 2002. It has appreciated significantly, the peak equity being 300K over the price I paid for in mid 2005. Of course it is less than that now. At best maybe I can sell with 200K over bought price right now.





The problem is this though: I have excellent renters who cause no problems at all, who started renting after I bought it, BUT they pay about 2K in rent while my expense is 3K per month. This is PITI plus HOA, etc. with a 30-year fixed loan at 6%. I don't want to increase the rent. Should I sell now and take the tax hit having never lived in it? Or should I keep leasing it out burning 1K per month? I can afford the monthly loss indefinitely but I'm not sure it's the right thing to do...
 
Let's turn things upside-down and see if you would do this:





Let's say the market is such that you could rent it for $3K a month to cover your expenses. Would you pay these renters $1K a month to live there?





That is what you are doing. Every landlord which rents at a negative cashflow subsidizes a renter. It might as well be a cash payment.





IMO, a negative cashflow to sustain a depreciating asset is not a good idea. Sell now, and buy again when prices are lower and you can get in with positive cashflow.





Happiness is a positive cash flow
 
I don't know what you should do, but I do want to empathize with your situation. I hope things work out for you, no matter what you decide.
 
<p>TRock,</p>

<p>Instead of asking what you should do. Why not ask yourself what you want to do. If you want to time the market, I do not recommend. </p>

<p>If it's my house, I might want to either hold on to it, or 1031 exchange into something larger that I could move in later to zero out the capital gain tax. You always can sell with a tenant to investors.</p>
 
It is not a matter of timing the market to anticipate fluctuations in an assets value, it is a matter of purchasing an asset only when the cashflow justifies the expenditure to obtain it. Sometimes it does, and sometimes it doesn't. Right now it doesn't, so this is a poor time to invest in residential homes as an income producing investment. At the bottom, this kind of investment will make sense; in fact, that is why it becomes the bottom because many investors buy when the numbers make sense and their buying creates the bottom.





Make no mistake, I am not a perma-bear. When the numbers make sense, I will buy.
 
<p>IR,</p>

<p>TRock would have a big tax bill -- an instant loss, if he sells now. When price drops, TRock equivalent purchase will be today price less tax. Then TRock will certain have higher property tax base. </p>
 
<p>TRock,</p>

<p>Investors I know 1031-exchanged california property to other states.


I did the same too.








-worst case


you may not find buyer. I met a couple of investor who couldn't sell their houses for a half year and decided to rent out.


I think there are so many people like that right now.


</p>
 
I have never been a proponent of spending (or losing) a dollar to save 15 cents in taxes (15% capital gains tax rate). The tax savings on the property taxes are only an issue if he reinvests in real estate -- something he wouldn't do if he just bailed out.





Making money is primary, worrying about taxes comes later.





Sell the unit, pay the taxes, and put your money into something else. Profit from this bubble while you still can. Even cash will be a better investment than real estate over the next several years.
 
<p>TRock,</p>

<p>Whatever you do, don't let sunk costs affect your thinking. What you paid and whether you would take a profit or a loss is not relevant if you are trying to make the best possible financial decision.</p>

<p>Try turning the question around this way. If you didn't own this property, but were offered the chance to buy it for what you think you could sell it for today minus the taxes you would have to pay if you sold, would you? For example, if you could sell today for $500K and pay taxes of $50K on your profits, would you be willing to buy it again at $450? There's your answer.</p>

<p>Also, an important factor in your decision is what you think the appreciation is going to be in the future. If you think you are going to see good appreciation on it over the next few years, then accepting a monthly loss now is justified. If you are like me and think that that condo will never again reach its 2005 (inflation-adjusted) price again in our lifetimes, then you should drop it ASAP.</p>

<p>JP you are wrongo-bongo. You can <strong>always</strong> find a buyer if you want.</p>
 
TRock,





Perhaps if you could give us more specific numbers, we could better advise you.





Have you factored in the tax deduction on mortgage interest and property taxes on your cost of ownership?
 
Thanks everyone for your comments, they have been very helpful. It think I see the "logical" thing to do is to sell right now...it's just the emotions that get in the way. The idea of having a nice and fairly new house in Irvine that I got at a good and lucky price (I can't claim to have seen the bubble coming), having great renters who pose no problems and will likely live there for many many more years, and knowing that it will eventually turn to positive cash flow over time as I pay off the mortgage or refinance or both. Also I think realistically I could rent my place out now for $2600 at least considering the current market--the $2000 my current renters are paying are because they are friends. I know their financial situation, so if I were to raise the rent, they would likely have to move out. Again I'm not going to raise their rent though if they were to move out all of a sudden (which seems very unlikely), I will for the next renters.





IR,


I can see that I can still make a good profit right now if I were to sell immediately. No I would not want to subsidize 1K/month for tenants, but off on a slight tangent, the more one subsidizes, the "stickier" tenants would be and in the long run one might get more income due to fewer months of no rent while looking for new tenants. Is there a case for a "small" subsidy? If so how much?





NIR,


I'm not going to buy any residential housing anywhere in the nation for three years at minimum so a 1031 is not going to apply. I will have to take the tax hit if I sell.





bigmoneysalsa,


I agree with most on this blog that housing prices have a long way to go down and may not recover to non-inflation adjusted prices until 10 years later. I will have paid off the house in about 20 years (I make extra payments at times) if I were to keep it.





momopi,


I did NOT include the tax deduction in my expenses so I guess I was incorrect in saying that I was losing 1K per month, rather it is less than that. My remaining mortgage is approx. 390K. I'm in my 5th year of payments, so it is still mostly interest rather than principle I am paying. The recent listings are for about 750K--not selling so overpriced. I'm betting a drop to 600K will sell my place fast, which I'm willing to do if necessary.
 
<p>2007 15% cap gains on $200k= $30k. 2008 20% cap gains on $200k (assuming that profit is still there) = $40k. Loss on rental YTD = $6k. Loss on rental June of 2008 = $13k.</p>

<p>June 2007 loss = $26k = $174k net.</p>

<p>June 2008 loss = $53k (again assuming the profit is still there) = $146k net.</p>

<p>Changes in the cap gains tax rate and further depreciation could easily put that loss over $100k and I didn't even factor inflation in. But hey "reason" wants to buy a rental property so you might have a buyer. I sincerely wish you luck in whatever path you take and I recommend speaking with an accountant to make sure it is the best decision to make.</p>
 
Just to add my 2 cents... From what I've read above, you have a Net Cash Flow of -$1000 per month. If you factor in the tax deduction, it's probably more like $-600 per month. Also, every month you are paying down about $400 in principal. So about $200/month is what is being 'lost'.





Good tenants are hard to find. When you do get them, you need to take care of them. If there is a maintenance issue, get it resolved quickly and to their satisfaction. Keep them happy. But don't use extremely low rent to keep them around. If the rental rate in the area is $2600/month, then I think you should be entitled to that. Since they are your friends and are good tenants, I can understand that you want to keep them there. Is a rent increase out of the question? Can you tell them that the unit should be renting for $2600 and that you need to raise the rent but you really would like them to stay so you'll raise it to only $2300?





If you can comfortably afford a negative cash flow of $1000/month indefinitely on this property, what do you have to lose by keeping it (forever)? Are there other things you want to do with the money that is in this property? Do you own your current residence? Is this detached condo a place you could retire to some day?





It's a complicated decision and I think we'd need to know more about your situation.
 
zovall asked an interesting question; At a neg cash flow of $1000 per month, what do you have to lose by keeping it? Answer; You can lose $1000 per month or $12,000 per year, plus whatever depreciation the property incurs in the next few years. Whereas, if TRock sells, he takes his gains now, has an extra $12,000 per year to save or spend, and has potential gain depending on ROI instead of a yearly loss. Or he can pay off his primary residence mortgage off quicker with his extra monthly. And if TRock sells, he can later buy a better property with his gains and maybe have enough to put down to have a positive cash flow instead of a negative.<p>

I changed my mind. I have an opinion. Sell.
 
<p>Hi TRock -</p>

<p>I appreciate your situation. You are a great friend, but with all due respect, you really are giving them $$ out of your pocket each month. They are getting a great deal. I understand they are in a tough situation, but do your friends really need to live in Irvine if they can't afford the higher rent? I'm sure they could find a rental property for $2,000 outside of Irvine. My two cents would be to sell and take the profit and run. As stated above, you could either put the money towards your primary mortgage or invest the money. We sold our house last year and invested the gains. We can now pay our monthly rent with the interest earned from those gains. Best of luck to you. Let us know what you decide to do.</p>

<p> </p>
 
TRock - Check w/an accountant on the tax hit. We had a situation where we got hit with capital gains <em>and</em> the profit was added to our AGI as income. That set us up nicely for the AMT, so the tax hit was much larger than anticipated. Profit is still profit, and I'd be inclined to take it, but it's a good idea to know exactly what your options are.
 
BethN - Yes, I know many, including myself, but the easiest and least expensive way to check your options is to enter your data in Turbotax. Enter the info as if you don't sell, and then again as if you did sell. Even using last years version, enter the info using your projected income for this year and the results will be close enough to make any necessary decisions.
 
<p>Research your options....but sounds to me you should do as CalGal did. Sell now, pocket the profit (well, invest it conservatively), wait a few years....and buy again. Good luck and keep us posted on what you decided to do.</p>
 
<p>To consider and research my options, could someone with MLS access please check the particulars (DOM, etc.) for MLS #S402228? This property is a very close comparable to mine. Thanx a bunch.</p>
 
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