Rent existing home or buy new rental property?

Question

Hi–

I'm trying to develop a 5-10 year plan for myself. I see a few paths forward and am looking for some advice as I'm relatively new at this. Any thoughts would be greatly appreciated.

Background:

I'm 31, live in Oakland, CA. Have a 30y fixed mortgage @3.75% with 10% down that i'm 4 years into. Property value has appreciated significantly, as you might expect. I have been saving diligently as well – probably half the way towards a downpayment for a new property.

Path 1:

Refinance to 15 year, and work towards renting out my existing home. Looking at refi because expected rent would exceed refinanced monthly payment. If the market is still high when I begin renting it, I would likely rent myself until the market drops a bit, all while saving as much as I can, so I'll be ready to buy again when the market is better for buyers.

Path 2:

Keep saving and patiently look for a good deal on a rental property. Live in existing home until it becomes impractical (will outgrow this house when I have kids in ~6 yrs ??). Use rental income to grow savings and continue to invest in real estate without getting personal property involved.

Basically I think my question comes down to best use of my existing property. Is it best to hold onto it and rent it out when it's no longer the best place for me to live? Considering I bought it in 2012 (a much better buyers market), should I treat the property more as an asset and work to rent it out sooner rather than later?

Again, any advice would be greatly appreciated. Thank you.

Chris May · Answer

In general, I would have preferred not to sell, and instead rent it out and just buy a second property. I looked at the math every which way, including building a second unit, but for our specific situation it made sense to sell. The reasons were both financial and personal (wanting a place that will work longer term family-wise). The kinds of properties we could qualify for without selling our house really weren't what we were looking for unfortunately.

We put a lot of sweat equity into the house, and listed it right at the two year mark, so I look at it as a very long flip with no taxes on the profit. We also spent just about every cent we had on rehab, so a reset of our finances is nice. I still can't quite believe how much money was deposited in our account yesterday. Without the tax exemption the numbers favored holding it.

One of the options we're looking at now is repeating what we did with our previous house, but adding an ADU. The numbers look very good going that route, particularly in Oakland. I'm not seeing as many candidates for ADUs in Berkeley. Berkeley multifamily properties have been selling for absolutely ridiculous prices this year, but I would prefer that option if the right one is available.

J. Martin · Answer

Hi @Ari Archer,

I own properties in Oakland and Richmond that I bought back from 2012-2014 (house-hacked first 4plex in Richmond), so have a similar experience in regards to your situation.

First, it sounds like you have a single family home. Is that right?

#2, have you thought about building an accessory unit (small "granny" house) in the back, living back there, and renting out the main house?

Personally, I wouldn't want to prepay my mortgage below 4%, or accelerate payments on a 15yr mortgage to save 1% extra, when I believe I can earn significantly more investing my money.

I recently moved my stuff back to a cheap room in San Francisco I used to live in, and have all my furnished rentals to live in when I want..

@Chris May, interesting you actually sold.. Berkeley is on fire, so I understand.. Interesting that you are looking to buy something else, although sounds like maybe a duplex.. Although, getting the homeowner exemption, maybe not as big a deal selling..

I haven't sold any of my properties - although would potentially consider selling one (shared driveway w/ PITA neighbors), and West Oakland has gone WAY up with rent controlled tenants.. Perfect owner-occ opportunity... But there are both specific reasons..

I prefer to hold real estate forever :)

Come out to some meetups and network with other investors!

Ryan Canfield · Answer

@Ari Archer  Hi Ari, It's nice to hear that others out there are thinking 5-10 years down the road.  There's lots of people out there who only live for the moment and don't think about their futures.

My personal opinion on your first path, if your current property has significantly appreciated, are you able to take out equity to use as a downpayment on your next property?  From what I've read/heard about refinancing into a 15 year mortgage, on one hand you would be forced to pay down the property quicker but it would negatively impact you when trying to buy future properties as your debt to income ratio would be higher and that could hurt you when trying to qualify on a new property a few years down the line.  If you do want to pay the property down quicker, why not look at putting extra money towards the principle?  If times got tight, you wouldn't be bound to the higher 15 year mortgage payment.

What I've told people that I know that are looking to sell their fairly recently purchased property is to reconsider and look into the option of renting the property.  In my opinion the tax benefits associated with renting your property and having your tenants pay down the principle are too good to pass up.  Obviously everyone's situation is different and selling may make more sense for others but I think it's an option you should consider if you are able to.

Have you looked into the possibility of house hacking to further accelerate your savings?  My wife and I are house hacking our second property over the past 14 months and it's honestly been one of the smartest financial decisions we've ever made.

Let us know what you decide to do!

Chris May · Answer

Your situation is almost exactly the same as mine. I'm 31 and renting in Oakland. We decided to sell our home in Berkeley and actually just closed today!

Ultimately, we looked at how long it would take to go through a full market cycle again, the risk of rents dipping, and hope much cash we could get out of our house with a refinance. I think the numbers will come out slightly different for everyone, but for us it made sense to eat the transaction costs and just sell.

We just wouldn't have had nearly enough cash to buy a multifamily property in our desired areas of Berkeley/Oakland if we cash out refinanced.

We've been submitting low ball offers on some house hacking possibilities, and actually came very close on one house with in law potential and a duplex in Berkeley. I'm still kicking myself over the duplex because our offer was slightly higher than the accepted offer, but was contingent on the sale of our home.

Chris Mason · Answer

Pretty sure my guy won that one from you. ;)

2 meters, 1 split level duplex-ish building in front, in-law in the back, unclear if it's legally a SFR, duplex, or maybe even triplex, and the listing agent has no clue in the world, probably no permits pulled within the last 50 years?

Ari Archer · Answer

@J. Martin Good ideas. Thank you.

It is a single family home (2b/1br). I've definitely thought about building a studio in back. There is plenty of room and there's already water/electrical back there. Personally though, I don't think I could live in it. It'd be really tight with a girlfriend and a big dog. I have considered doing this ahead of moving so when I rent out the house, I'd have two units, though.

So then I could reframe the options as:

1/ Use savings to build studio in backyard. Once complete, rent out studio or house until I can build enough capital for a downpayment for another primary residence.

2/ Use savings (and patience) to find a good duplex opportunity that's cashflow positive. Keep my house out of it for the time being. When it's a good time for me to move, rent out existing home, potentially doing the studio at that point...

Ari Archer · Answer

@Ryan Canfield thanks ryan. i don't think i need to get any equity out of my house. i see what you mean in terms of refi affecting debt:income though. good call.

i've thought about putting more towards the principal but at 3.75%, i could easily invest that $ for a higher return.

Ari Archer · Answer

@Chris May congrats on closing. what's next? is your plan to stay in the rental indefinitely and buy a rental? or are you looking for a multi-unit that you can live in as well?

Rent existing home or buy new rental property?

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