Sell house or rent it out?

Question

In 2011, I bought a house for my father to live in. He died last
month and I’m trying to decide if I should sell the house or rent
it. I have no real estate investment experience.

2 BR, 2 BA, single
story, 1500 sq ft in the San Francisco East Bay (Eastern Contra
Costa) in a nice, safe neighborhood.

There’s no
mortgage. It needs $20,000 in cosmetic repairs.

If I sell …

Paid = $250,000 in
2011

Current value =
$485,000 (this is once repairs are done – paint, flooring, windows,
etc.)

Net proceeds to me =
$ 385,000. ($485,000 – 5% commission - closing costs – repairs -
taxes on capital gain = $485,000 - $24,250 - $3,000 - $20,000 –
$52,750)

If I rent it out…

For cost, I’m
presuming I hypothetically just sold the house and now, looking at
the house as a new purchase, it costs me my proceeds of $385,000 plus
the $20,000 I need to make in repairs.

Cost = $405,000

Anticipated rent =
$2,500/month = $30,000 per year.

Annual expenses are
52% gross rent (including property manager):

Net Income = $30,000
- $15,600 = $14,400

Cap Rate = 3.56%

2% expected
appreciation = $405,000 x 2% = $8,100

Total return =
($14,400 + $8,100) / $405,000 = 5.56%

How does this
compare to other Northern California real estate deals? If I take the
sale and put the $385k in a stock mutual fund, the return seems like
it would be equivalent. Diversification would be a pro for renting
it; more work and liability the con.

I’m kind of on the
fence.

Am I missing
anything? Is there anything else I should be thinking about?

Any opinions?  Thank you so much
for your advice!

Account Closed · Answer

I was being very conservative in my estimate but you're right.

Account Closed · Answer

Thanks John. You're saying the appreciation should be 6% instead of 2%.

Thanks Brian. I'm pretty sure of my cash flow numbers, but don't know what rate of appreciation to expect. I'm not up for buying out of state real estate so my basis for comparision is stock market return -- it seems that renting is an equivalent return.

Amit M. · Answer

@John Erlanger yes, the appreciation rate is very specific, not only to the city itself, but also to the neighborhood. Even in SF proper, some neighborhoods appreciated at a higher rate than others, mainly due to gentrification, civic/transportation improvements, etc. And that rate will change from decade to decade between different areas. But the chart gives a good general idea of overall appreciation in prime Bay Area markets.

It basically boils down to that old realtor adage- Location! Location! Location!
yeah I know it sounds corny as hell, but for this market it’s held true ;)

It basically boils down to that old realtor adage- Location! Location! Location! yeah I know it sounds corny as hell, but for this market it’s held true ;)

Phillip Dwyer · Answer

Account Closed Have you considered the tax benefits of renting it out versus the other investment options?  Depreciation is a great advantage of real estate.  You also have leverage options if you keep it as an investment, so you could pull out some of that equity at around 3-3.5% interest in the current market.  Then you could put that money in more real estate, a mutual fund, or some other investment.

Here's a different option:  You could move into it for a few years, fix it up, then sell it as a primary residence.  You may be able to avoid capital gains then.  I recommend talking to a CPA about your options and situation.

Account Closed · Answer

Thanks Phillip and John.

I've been taking the depreciation since my dad lived there (he paid a nominal rent) so I realize I left that out of my analysis. Depreciation has been $7,000/yr, so tax savings of a couple thousand per year.

Mortgaging the property leaves me with the problem of what to do with the money. Real estate investors like to leverage up to increase profitability but I'm not looking to create a real estate portfolio now -- sort of want to see how I feel about managing one property for now.

John, It's in Brentwood, on a 5,000 sq foot lot. 25 year old house in a 55+ community (don't know if that impacts price). I can't follow your math -- I don't see where the $54,000 comes from. Are these numbers and rates of return typical for Contra Costa?

Darius Ogloza · Answer

@Brian H. Wondering how you arrived at $52,750 in capital gains taxes on a $485,000 sale price for this property.

Amit M. · Answer

One key factor is understanding future appreciation, and your appetite for that risk. But basically, if you can hold for 5-10 years, and don’t have to sell, you significantly mitigate short term risk to appreciation.

I do think 2% appreciation expectation is way too low. But I think 8% is aggressive. You can see the chart below (one of my faves ;) to get an overall idea, based on a long history. bottom line is that many millions of dollars were made in the Bay Area strictly due to appreciation. My personal orientation is to strongly avoid selling any decent Bay Area asset, and only sell as a last resort

Another benefit of keeping is that you always have the option to mortgage the home if you need or want to borrow money for future investments, etc. Of course not only do you get the best interest rates, but you also get to write the interest off.

Brian Garlington · Answer

I have a client that is recently in a similar situation. They are not banking on short term or immediate term appreciation even though the property is owned outright. We are going to list the property and once it sells, they plan to buy a couple of multifamily properties in the midwest that will get them some very nice cash flow.

Sell house or rent it out?

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