Selling vs Renting out

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OCVillager said:
Hello,
We had a conversation with friends on whether it's beneficial to sell the home or renting it out. To give more details,  the house is a new construction owned for less than 2 years in Eastwood. There's a possibility that our jobs may get relocated to other state with much lesser rents or mortgages.
We have started to evaluate options on renting out through a property management company or renting out directly or selling it. With current prices, I believe selling is safe.  As we will still end up paying out of pocket on our current mortgage on this house with reasonable rent, it'sgoing to be burden and also we don'tthe how the housingmarket will be next year.
Need suggestions and directions on how to decide. Anyone with prior experience please provide some insights. Thanks in advance.
Click to expand...

Here is how I would approach this problem:

1) Calculate your expected return on the property ~ (Estimate 12 months future appreciation - 12 months negative cash flow / Current property equity - selling costs)

2) Compare it to your expected return in the stock market ~ (Estimate 12 months of stock returns / Current property equity - selling costs)

3) Choose the investment that yields the greatest return.

4) You may also want to adjust for risk by assigning a probability to your estimates of future appreciation and stock returns.  Recalculate and choose the investment that yields the greatest risk-adjusted return.

---------------------------------------------------------------

Also, make sure you are including ALL costs when calculating your negative cashflow:

-Mortgage interest
-Taxes
-Hazard Insurance
-Liability umbrella policy (if you have one)
-Mello Roos
-HOA(s)
-Management (8% of gross rent).  Include this "cost" even if you self-manage to compensate for your time.
-Gardener
-Maintenance/Capital Expenditures (10% of gross rent)
-Vacancy (3% of gross rent)
-Home Warranty (I personally don't think these are a good deal, so wouldn't recommend, but include this cost if you get one.)

The thing I wouldn't include is your principal payment, because this accrues to your equity and is a type of return.
 
Liar Loan said:
OCVillager said:
Hello,
We had a conversation with friends on whether it's beneficial to sell the home or renting it out. To give more details,  the house is a new construction owned for less than 2 years in Eastwood. There's a possibility that our jobs may get relocated to other state with much lesser rents or mortgages.
We have started to evaluate options on renting out through a property management company or renting out directly or selling it. With current prices, I believe selling is safe.  As we will still end up paying out of pocket on our current mortgage on this house with reasonable rent, it'sgoing to be burden and also we don'tthe how the housingmarket will be next year.
Need suggestions and directions on how to decide. Anyone with prior experience please provide some insights. Thanks in advance.
Click to expand...

Here is how I would approach this problem:

1) Calculate your expected return on the property ~ (Estimate 12 months future appreciation - 12 months negative cash flow / Current property equity - selling costs)

2) Compare it to your expected return in the stock market ~ (Estimate 12 months of stock returns / Current property equity - selling costs)

3) Choose the investment that yields the greatest return.

4) You may also want to adjust for risk by assigning a probability to your estimates of future appreciation and stock returns.  Recalculate and choose the investment that yields the greatest risk-adjusted return.

---------------------------------------------------------------

Also, make sure you are including ALL costs when calculating your negative cashflow:

-Mortgage interest
-Taxes
-Hazard Insurance
-Liability umbrella policy (if you have one)
-Mello Roos
-HOA(s)
-Management (8% of gross rent).  Include this "cost" even if you self-manage to compensate for your time.
-Gardener
-Maintenance/Capital Expenditures (10% of gross rent)
-Vacancy (3% of gross rent)
-Home Warranty (I personally don't think these are a good deal, so wouldn't recommend, but include this cost if you get one.)

The thing I wouldn't include is your principal payment, because this accrues to your equity and is a type of return.
Click to expand...

I would use a vacancy factor of 1 month to be more conservative and also include real estate commission (which can replace the property management fee).
 
USCTrojanCPA said:
and also include real estate commission (which can replace the property management fee).
Click to expand...

Maybe I misunderstand, but how would you amortize this on a monthly basis?
 
Liar Loan said:
OCVillager said:
Hello,
We had a conversation with friends on whether it's beneficial to sell the home or renting it out. To give more details,  the house is a new construction owned for less than 2 years in Eastwood. There's a possibility that our jobs may get relocated to other state with much lesser rents or mortgages.
We have started to evaluate options on renting out through a property management company or renting out directly or selling it. With current prices, I believe selling is safe.  As we will still end up paying out of pocket on our current mortgage on this house with reasonable rent, it'sgoing to be burden and also we don'tthe how the housingmarket will be next year.
Need suggestions and directions on how to decide. Anyone with prior experience please provide some insights. Thanks in advance.
Click to expand...

Here is how I would approach this problem:

1) Calculate your expected return on the property ~ (Estimate 12 months future appreciation - 12 months negative cash flow / Current property equity - selling costs)

2) Compare it to your expected return in the stock market ~ (Estimate 12 months of stock returns / Current property equity - selling costs)

3) Choose the investment that yields the greatest return.

4) You may also want to adjust for risk by assigning a probability to your estimates of future appreciation and stock returns.  Recalculate and choose the investment that yields the greatest risk-adjusted return.

---------------------------------------------------------------

Also, make sure you are including ALL costs when calculating your negative cashflow:

-Mortgage interest
-Taxes
-Hazard Insurance
-Liability umbrella policy (if you have one)
-Mello Roos
-HOA(s)
-Management (8% of gross rent).  Include this "cost" even if you self-manage to compensate for your time.
-Gardener
-Maintenance/Capital Expenditures (10% of gross rent)
-Vacancy (3% of gross rent)
-Home Warranty (I personally don't think these are a good deal, so wouldn't recommend, but include this cost if you get one.)

The thing I wouldn't include is your principal payment, because this accrues to your equity and is a type of return.
Click to expand...

Wouldn't you exclude some portion of taxes and mortgage interest since you do get returns?
 
Mety said:
Wouldn't you exclude some portion of taxes and mortgage interest since you do get returns?
Click to expand...

Yes, you could include all the tax benefits of owning a rental and add that to the return as well, but it starts getting more complicated at that point.  I've never purchased a rental based on the tax breaks involved, but rather by calculating whether it was a good investment based on traditional ROI metrics.  If OCVillager decides to keep the house, he is effectively making the decision to "buy" a rental based on the opportunity costs involved, and I would rather not muddy the waters by figuring out the tax breaks involved.

Of course, if it's a close decision maybe it would make a difference to OCV to know what the tax benefits are, but I wouldn't worry about that at first.
 
OP will need to clarify but it sounded like rent didn?t cover the mortgage. Not sure what ?mortgage? includes. 
 
To me this is nothing more than an Return on Equity (ROE) analysis.  The OP didn't give a ton of details on the equity he has in the property so it's hard to determine.  Only info we really have is that the rent wouldn't cover the mortgage, which means he's CF negative even before taking into account taxes, insurance, mgmt fees, etc. 

But let's say he's run up $200k in equity due to recent market appreciation and from paying down part of his loan, he'd get that tax free since the house was his primary residence.  He gets up to $250k gains tax free if single, $500k if married.  So the analysis is what return should he seek on the equity? In this case it's negative, so a no brainer IMHO.  Even if he was making $500/month after all the expenses, I'd still say sell.  $500/month = $6k a year return (pre-tax).  If the equity is $200k, that's a paltry 3% ROE. There are plenty of investments that will perform better than that.  But again it's irrelevant since OP says it's CF negative.

Yes this does assume no appreciation on the value of the house.  Most RE investors will tell you that rental investments should be looked at from a pure CF perspective rather than betting on appreciation.  Betting on appreciation is risky.  Yes it's a conservative view, but we're starting to see some softness in the market so might be the prudent way to look at it.
 
ChiKid24 said:
To me this is nothing more than an Return on Equity (ROE) analysis.  The OP didn't give a ton of details on the equity he has in the property so it's hard to determine.  Only info we really have is that the rent wouldn't cover the mortgage, which means he's CF negative even before taking into account taxes, insurance, mgmt fees, etc. 

But let's say he's run up $200k in equity due to recent market appreciation and from paying down part of his loan, he'd get that tax free since the house was his primary residence.  He gets up to $250k gains tax free if single, $500k if married.  So the analysis is what return should he seek on the equity? In this case it's negative, so a no brainer IMHO.  Even if he was making $500/month after all the expenses, I'd still say sell.  $500/month = $6k a year return (pre-tax).  If the equity is $200k, that's a paltry 3% ROE. There are plenty of investments that will perform better than that.  But again it's irrelevant since OP says it's CF negative.

Yes this does assume no appreciation on the value of the house.  Most RE investors will tell you that rental investments should be looked at from a pure CF perspective rather than betting on appreciation.  Betting on appreciation is risky.  Yes it's a conservative view, but we're starting to see some softness in the market so might be the prudent way to look at it.
Click to expand...

This is deep analysis. Good stuff ChiKid24
 
I checked the return on equity for my house bought in 2012 and it is 5.6% on just the cash flow alone.

I won't go into specific numbers, but here is the calculation:
Rent
Less Mortgage
Less Property Tax
Less Home Insurance
Less HOA
Less Gardener/Pool
Less Misc Expenses (set at 8% of rent)
I get a positive cash flow here

Then I take the expenses plus depreciation deduction and multiply it by .24 which is my tax bracket for 2018 and add it to the positive cash flow.
Then I add back the principal paid by the mortgage.

I take this this final amount and divide by my equity and get 5.6%.

Did I screw up the math?
 
Please calculate a rent or sell scenario if you had bought Delano back in phase 1.

I'm in a "never sell my property" mind set.
Change my view.
 
After you add back the principal paid after 6 years, I think you also need to add the rental expense deduction. 
One can assume a 24% tax bracket, but for people with higher incomes, it can be up to 37%.

In my particular case, I can deduct $55,000 of rental expense from my income.  (The big deductions are mortgage interest, property tax and depreciation) At the 24% tax bracket it's like making $13,200. (You owe the IRS 13,200 less)

So a HOA of $326 = (326*.24 = $78.24 in tax savings)

Do you think rental expense deduction should be included in the calculations of a rent or sell debate?
 
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