Should I sell?

Question

Hi all! Looking for advice and feedback, also share my experience which I think could help to new and inexperienced investors. Year Dec 2023 I bought my first rental property in Lansing MI, purchase price 95000, 25% down + closing cost end up at 30000$, 7.5% interest, so my mortgage with insurance and taxes included was 721$/month. Renting it at 1245$, so it was not too bad. However, I did not know that the taxes did not reflect the purchase price, so today I received a letter saying my new morgage payment was going to be 991$/month, which change the whole picture for us, we are paying property manager since we live in Florida. So we are cash flowing 131$, giving us about 5% ROI, I think we can make higher on another deal. Should I sell? I think we can sell it for 120000, so is it worth it? We think if the interest get lower we can make it work, home is appreciated well I think, roof is new and we pay to change the furnace recently, so I guess in that sense we would not have big expenses any time soon, at least in repairs. What do you think? Thank you for any advice !

Dan H. · Answer

Rent minus PITI is not the cash flow.  There are numerous other expenses.  This property does not have decent cash flow and is likely negative cash flow if properly allocating for sustained expenses

$1245 (rent) - $991 (PITI) - $125 (PM: allocate for it even if self managing unless you believe your time is worthless) - $60 (vacancy and uncollected rent) - $300 (sustained maintenance/cap ex) -$50 (misc: bookkeeping, asset protection, utilities that cannot ethically be charged to tenant such as slab leak, etc).  Is -$281/month.

Or via the 50% rule which is aggressive at that rent point (implying your sustained cash flow will be worse than depicted by the 50% rule):

$1245 - 622 (50% rule for all expenses except mortgage) - $498 (P&i) = $125/ month

If it really has appreciated from $95k to $120k in 25 months it could be worth holding for the appreciation if you believe that level of appreciation is likely to continue.

$120k - $95k = $25k of appreciation

$25k / 15 (months) = $1,667/month of appreciation.

Selling will not net you much after subtracting selling costs and expenses related the cap ex that you paid.

Good luck

Drago Stanimirovic · Answer

You’re in a decent spot, not amazing, but not bad either for a first deal .If you can sell at $120K, you'd walk away with a profit after closing costs, and a 5% ROI on current cash flow isn’t terrible, but it’s tight, especially with out-of-state management.

The key question: can you actually redeploy that equity into a deal with better returns, factoring in today’s rates and acquisition costs? If yes, selling could make sense. If not, holding a low-maintenance, appreciating asset with some cash flow might be smarter short-term.

Chris Seveney · Answer

When did you buy it? I would hold it for atleast a year. While it is not having huge cash flow, it is also paying down the principal and covering interest. If it were me, I would hold it, and you mention you think you can find a better deal, after paying all the closing costs now to sell and then taxes, is it going to be worth it to sell it?

I would hold it, refinance assuming no prepayment penalty on it when you can get a rate in the six's and continue to hold it.

Dayana García · Answer

Hey all! Thank you for your responses! It helped me a lot! One of you said that in Michigan they paid property taxes in advance. So I called to the back and they explained I had an outage on escrow, so that is why I'm paying such difference. My morgage definitely increase but after a year it will be 160$ less, so I will cash flow about 200$ which is not that bad considering I only invest 30000. So I would hold the property instead of selling it! Thank you all!

Jules Aton · Answer

Excellent points for those considering RE. I know many here don't feel it is valuable but I always did local deals in areas I was familiar with so I could monitor the property and neighborhood. My guess is there is an up and coming, fringe area that would provide a conservative first attempt at RE within 90 minutes of most cities, towns. You generally get what you pay for in RE and in life.

My personal strategy early on when I had limited funds was: Ugly house in the best neighborhood/school district. This covers likely appreciation both naturally and from renovations. The preferred school districts can be a significant draw for ensuring full occupancy. I also always wanted an out and reasonably priced properties in good neighborhoods will generally sell easily even in down markets. Cash flow was necessary initially but I didn't aim too high and over time as rents increased cash flow also increased.

Jeremy H. · Answer

What kind of other investments do you have? If this is simply diversification to your other investments, I think it's ok. Not great, but ok. If you don't have any other investments, I'd probably consider something else.

This is one thing that irks me when I hear "rent goes up, but monthly payment stays the same" from various gurus. The total, PITI, most certainly does go up over time. I do realize this is location dependent - some rents will outpace the increase in PITI massively, some rents won't change much, some locations will have massive PITI (Taxes and insurance primarily) increases due to storms/weather etc, while others won't change much.

Doesn't hurt anything to put it on the market and see what you could get for it either.

One thing is this is a long-distance rental. Have you seen the property? Did it get rehabbed? It's a cheap property which leads me to believe the location may not be great. What's the future outlook for Lansing? What kind of CapEx is coming in the future? Why not invest in Florida?

Michael Smythe · Answer

@Dayana García recommend you investigate the tax increase.

It's standard practice in Michigan when the taxable value is uncapped.

What I'm referring to is the increase in your mortgage payment.

Property taxes in Michigan are paid in advance and your lender has to contractually pay them when due. So, this results in the lender having to actually "lend" owners money to pay the taxes. The lender then raises your PITI payment to accommodate the new tax amount, but ALSO charges you that same increase to pay back the "loan" they gave you to cover the taxes.

EXAMPLE: property taxes increase by $1200 annually, or $100/month. Lender will raise your PITI payment by $100 for future taxes.Lender has to "loan" you $1200 to pay the current taxes. So, they TEMPORARILY raise your PITI payment by another $100/month to pay themselves back. After 12 months, this 4100 drops off your PITI.

NOTE: after the initial uncapping of the taxable value that causes all this, Michigan property taxes can only increase by the lesser of the state's COLA or 5%. So, you shouldn't have any more high-cost surprises going forward.

Dayana García · Answer

Well, that was our first investment! Yes, the area is not the best, I wouldn't say it's the worst either. I bought a turn key property, so it did not required big repairs, just small touches that did not cost more than 1000$. I have found according to statistics and my own observations that Lansing is getting better, it's seems like is growing 1-2% each year on housing prices, rent are also getting more expensive. Saw also a lot of new roads, which made me think they are growing on population too. Why did not invest in Florida... well It was too expensive for our budget at that time, however, found that Jacksonville is affordable, so we are kind of looking at that market now. We live in Miami Fl, and here I haven't get numbers that work, so. Still on the learning curve, guess it will always be! I don't know what is CapEx! I will Google it right now ! Thank you !

Marcus Auerbach · Answer

This is going to sound harsh. When you picked this financial framework you have made the classic noob mistake of looking at everything through a cash-flow lense. The good news is that this deal is a great learning opportunity and you start asking the right questions. Let me back up.

The four basic sources of wealth with RE are:

1.) Equity: forced appreciation and natural appreciation

2.) Leverage and amortization: principal pay down

3.) Cash flow

4.) Tax benefits

Cash-flow is one of the smaller benefits and should not be the primary reason you buy a property. To gain an intuitive understanding of this use the BP rental calculator, punch in 1 million property value, 10k monthly rent, 3% appreciation, 3% annual rent increase. Look at the results after 10 years and after 30. Cash flow get's dwarfed by the other components. If you increase appreciation to 5% the results get even more extreme.

Once you realize this, you start asking the right questions: how can I manipulate the input-numbers to optimize the outcome.

As far as this property: keep it and let time do it's thing. It's called buy&hold not buy&sell for a reason. Cost of selling is too high. Cash flow and property value will improve with the years.

Max Emory · Answer

Hey @Dayana García, congrats on your first deal and it actually cash flows! That's amazing.

If you sell, how will you deploy the funds to attract a higher return? Do you guys already have more properties identified with larger margins? Or, maybe a different vehicle than rental real estate?

Also, what are your goals? Are you purely after cash flow or are you concerned with appreciation at all? Rental properties make money a few different ways so the other money makers are worth factoring into your decision unless you're purely after cash flow above anything else.

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