Sell or rent current house?

Question

Hi all,

My situation:  looking to move into a bigger house in hopes of family getting bigger.  I currently live in a 1/1 sfh that I own.  I bought in 2010 and have approximately $100,000 equity, and ow $118k.  I think I can rent this house out for approx $1300-1650.  mortgage payment is $715 PITI.  I live in Denver. the house is ~100+ years old.

My question: how do I analyze if I should sell this house when I find something new, versus rent?  I would like to accumulate some rental properties over time, but RE investing is not my primary source of income.

I'm sure more info is needed.  I'm just not sure what all I look at and what assumptions I can make.  thanks for any help.

Brandon Hall · Answer

Thanks for the mention @Steve Vaughan!

@Tim O'Brien more information will be needed to provide you with accurate advice. What price did you buy for? What price will you sell for? If you sold and cashed out, how would you apply the new capital?

We want to determine opportunity cost of the gain you will realize from selling the place. As Steve mentioned, you can shield $250k ($500k if married) of gains on a primary residence via the Section 121 exclusion. The gains do not need to be rolled into a new property, they are yours to use as you wish. You have that process confused with a 1031 exchange, in which gains would be rolled into the new property to remain tax free, but a primary residence is excluded from 1031 treatment.

So the real question is, can you cash out and apply your capital at a higher rate of return than if you held and rented it? Say your total monthly expenses are $1000 (maybe higher since it's an older property) and you cash flow $300/mo and $3,600 annually. Assuming you do have that $100k in equity, that's essentially a 3.6% return on investment. You can certainly cash out and apply that capital at a higher rate elsewhere.

Is there appreciation potential?

You can also look at doing a cash-out refi if that strategy is available to you.

*Edit: for the Section 121 exclusions, after you move out of your residence and assuming you rent it, you have 3 years to sell it to still be eligible for excluding your gains. So keep that in mind and plan carefully.

Bill S. · Answer

I completely disagree with that statement. Perhaps the current Denver market does not make for good for cash flow but neither does the stock market in most cases. Using leverage in a rapidly appreciating market makes your rate of return almost impossible to beat in the stock market unless you are doing stock options. Now perhaps you don't think the current trends will continue but that is a different argument and the same concern also exists in the stock market. For me, I would rather have $30K invested in leverage real estate in Denver that is paying for itself than $30K in the stock market. It's my opinion that properly leveraged Denver RE will beat the stock market over the long haul.

Another thought on your current home. If you keep it for more than 3 years and lose all of your owner occupied exemption then you can always do a 1031 and roll the equity into another piece of investment real estate and defer the capital gains tax.

BTW my vote would be to keep the property.

Steve Vaughan · Answer

Nope.  As far as I know you can do with it as you wish.  I see @Brandon Hallis online.  Maybe he has a sec to help?  Thanks, B!

Bill S. · Answer

@Tim O'Brien the way I was looking at it was what would do better for you in the long haul? Stocks or your small semi leveraged house. I was comparing the house against what you said you were going to do with the money (stock market). I invest in stocks and have so for about the same amount of time has I have for RE and I fave RE hands down. Sure the house doesn't meet those wonderful metrics of 50% and 2%. BTW the 50% is not vacancy but 50% of the rental income will be expenses (not including your mortgage). Be aware that you can contribute to some of that 50% through your own time so you can get away with lower metrics on a small scale. You just have to know that it's something that is going to eat up some of your time while you own it.

Tim O'Brien · Answer

@Bill S.I appreciate the feed back.  There are seemingly so many different metrics to analysis that I don't know how anybody ever makes the decision to buy a property.  I'm told use a 50% vacancy rate and the 2% rule etc.  None of  those work with this property, or anything I've seen in Denver. I know it's best to always err on the conservative side, when analyzing, but how do you pull the trigger? Are you looking at flipping, vs. renting?  I have a bit of analysis paralysis.

If I do keep the home, I want it to provide income forever.  I don't really ever plan on selling. However if an offer that I couldn't refuse came up, it is good to know there are still ways around the large cap gains hit.

Thanks for the reminder that it's apples and oranges with the leverage that RE provides compared to the stock market.

@Dan Mackin, Thanks for the heads up.  I will have to do the numbers on a lump payment for PMI when I do close.  I am planning on a 10% down payment.

@Brandon Hall, @Steve Vaughan,  Thank you for the thoughtful responses.  I hadn't really considered tax's yet

@Kevin Bellavance, Great Idea!  It may be a bit before I can make this work as I'll most likely be using equity for the new primary residence.  I like the thought of leveraging the equity for more income properties.

Travis Sperr · Answer

Sell it and cash out tax free. Assuming this is your 1st rental - a 1/1 will create its own challenges. Get settled into your new home and start looking for rentals that will be a better long term hold. Our market is going nuts - you wont want a 1/1 SFR when the market cools off.

Dan Mackin · Answer

@Tim O'Brien - something to consider for the new property is paying under 20%, but paying a lump pmi payment. I did it on one of my properties and the numbers worked out in my favor. I ended up putting 10% down and paid a lump sum instead of having the actual pmi payments. The lump sum equaled out to about 2.5 years of pmi, where I would have had quite a few more years if I had just paid the pmi. This is a good way to hold on to more funds from a lower down payment, but not have that pmi payment each month.

As for the current property your numbers are a bit better than what most diligent investors here can find right now. The big concern I always have with a 100 year old home is maintenance which can quickly eat into that potential cashflow. Add in the HELOC payment on top of that cashflow may not exist at the end of the year. Let's just say that you use 40k of HELOC to purchase a new home. At a 1% payment monthly that comes out to $400 which is a significant amount of your rent. I generally would advise to use a HELOC to purchase something that can offset the monthly payments, not to get something that will just cost you more. Just my 2 cents.

Tim O'Brien · Answer

More info:  bought the house for $130K. refinanced 2 years ago at 3.375%.  I got a HELOC on the house 5 months ago and house appraised for $205K.  I have been looking a lot at comparable houses and am confident it would sell for at least $225K, with location and current market.  I do have a small balance on the HELOC.  I was planning on using some of the HELOC for a down payment on our new house, unless it takes a while to find (6+months), in which case I would have the down payment saved.

If I sold and cashed out I would use a portion of the capital to bring my equity up to 20% in the new house, while investing the rest.  The market in Denver is not great for investing right now, so investment would mostly go in stocks.  The amount I would be able to invest would be approximately 30-50K.

The market in Denver is rising fast.  The location is on the mid to higher side of appreciation in Denver.

Thank you for your reply's. I really appreciate any advice and ideas.

Tim

Kevin Bellavance · Answer

@Tim O'Brien

Hi Tim!

Here's one scenario maybe you didn't think of :

First, I don't know your financial situation and I don't know where the cashdown for your next house will come from. However, if you have that cash in your savings account and you do not need the equity from your current house to make the down payment for your next house, you could refinance it.

Let's say you refinance the house, pull out 80K (non-taxable) and make a down payment to buy a multi-units fully rented out PLUS you rent the house you currently live in and move in the next house. This could provide you with nice cashflows AND you wouldn't have to pay capital gains (as long as you hold those properties).

How about that?

Feel free to ask if you have any questions.

Best regards,

Kevin

Tim O'Brien · Answer

Thank you Steve,

Do I have to put that cap gains back into a primary residence?  I will definitely talk to my tax adviser.

Sell or rent current house?

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