Should I sell or turn personal property into a rental?

Question

Good morning,

My husband and I recently purchased a new home a few miles away from our current home.  We are deciding whether to sell our property or to turn it into a rental.  Input from savvy long time investors would be much appreciated!  Here are a few of the salient facts:

1. Home purchased in 2009 for $145k with $10k put into the house for repairs.  House was rented out and 10k was recaptured after three years.

2. 2012 I moved into the home and put an additional $40k towards renovations.  I also refinanced the house to get rid of PMI and 3.125% interest rate.

3. Palmdale, CA market is "hot" right now and our realtor estimates the sale between 301-312k.  Not to mention the property gains tax we will avoid if we sell now.

4. 5 miles away is Northrop Grumman.  My friend who is in upper level management there estimated hiring to ramp up over the next two years  with 3,000-5,000 new good paying jobs.

5. Rental wise, the house will rent out for approximately $1825-$1875.  Our 15 year loan is $1305/month and expires in 2027.

Additionally, we can also hold now and sell in two years to avoid the tax.  However, this is a gamble and we have put some nice upgrades on the house that might have to be redone before selling again.

* New ceramic tile throughout downstairs, front and back landscaping, interior paint, granite countertops, new HVAC, new blinds, built in entertainment center.

Nathan Waters · Answer

Me personally, I have done the "Rent my primary residence" thing. I wouldn't do it in your case. With high end homes where you are not going to break the 1% rule, you are correct that its a gamble. If property values rise another 5% but you may end up with a big renovation after a tenant trashes the place. Not as big of a deal in a lower cost home, but in your case, it can eat up any rise in value you are hoping for. If interest rates go up further, you also might not see as much appreciation as you are hoping for. I'm selling my accidental rental now while the market is good and using the money to buy another rental that has good numbers. I only rented it because I was upside down in 2009. Right now is not the case. Good luck on whatever you decide.

David Faulkner · Answer

The main issue I have with the 1031 is you sell when the market is hot, but then you have to buy back in a very short time period into a similarly hot market. True, the market you buy into may be different (which has its own challenges if far away) and may not be quite as hot as the one you sold in, and you may still be able to find a great deal, but it will still be hot and very difficult to do without paying retail, which is always a big no no for me personally.

I'm not saying there aren't cases where this could make sense, but I don't see this as one of them as she could just as easily sell now or two years from now and still do it tax free under the primary residence exclusion and she could still roll the proceeds into another investment property or anything else she chooses for that matter without messing around with all the complex moving parts and restrictions of the 1031.

Justin B. · Answer

I have a simple response.  How much money can you make by selling?  How much money can you make by renting?  For example, if you can pull $100k out by selling (and it may be tax free if you've lived there for 2 of the last 5 years), and only make $300/month by renting, I'd sell.  You can take that $100k and turn that into $1-2k/month cash flow by buying other properties.

If selling basically nets you nothing, you rent it out.

That's oversimplified of course, but do the numbers.  If you can take the cash you make by selling and turn that into more cash flow than renting by buying other properties with it, do that.

Jeff B. · Answer

Consider renting for two years and 1031 into another property for the capital gains advantage.  That's how I moved from an SFR into a 6-unit MFU which I milked for 19yrs.

Michael Evans · Answer

I've lived in the Antelope Valley since 1994 and I've seen the ups and the downs.  2017 is equivalent to 2001 or 2002, right before the market shot up.  I heard from a new builder salesperson in Santa Clarita that there are lot of new homes that are in the pipeline to be built in the Antelope Valley over the next few years, which makes sense since LA is the hottest job market in the US.  There isn't enough housing in LA, so people move to the suburbs, starting with Santa Clarita, where they are building houses like gangbusters.  After Santa Clarita will come Palmdale and Lancaster.

So there are two ways to play this: appreciation or cash flow.  My wife's house appreciated 14% in 2016 based on 2 comp sales of the same plan model in the same tract within the last 6 months.  This has pushed the monthly rental income to sales price ratio to under 1%.  So I would hold on to the house if I am betting on appreciation, but I would sell it, do a 1031 exchange and buy a rental in the Midwest or South where the monthly rental income to sales price ratio is at least 1% and closer to 2% is you are looking for cash flow.

I am thinking of putting together an REI group in the Antelope Valley that meets every one to two weeks to discuss REI opportunities in the AV, as well as investing out of state.  Anyone interested?

Jo-Ann Lapin · Answer

Wow you do have a delimma. Without telling us your financials and job security it so hard to recommend. I only agree with some other comments that when the market does go down plamdale/ Lancaster has some wild swings. The renters you would be renting to over the years sounds as if they would true professionals which is a major plus.

Harold Lewis · Answer

I own a number of SFR rentals in the Antelope Valley and all of them are cash flowing and appreciating well.

Wether it's a good idea to sell your primary residence, or to rent it, depends  on wether you are comfortable with the cash flow from renting it, and the cash flow would be $545 ($1,850 minus $1,305) minus property taxes, and minus insurance, which cash flow could end up being around $285.

If you sell it right now, your gain is $161,000 ($306,500 minus $145,000) minus $18,390 realtor commissions ($306,500 times 6%) minus $24,150 capital gains taxes ($161,000 times 15%) minus $6,000 closing costs, which totals $112,460, and minus the loan balance. Depending on your loan balance, you may be under water.

If you will need to purchase another home to live in after the sale, and you purchase a home around $350,000, you may have to put down $70,000 and that will likely eat up all of your sale proceeds if any.

So, it seems like the choice is to either to rent your current property for $285 cash flow, then purchase another home to live in from your savings, or sell the current property, then purchase another home to live in from your savings, or stay in your current property and buy a new rental property from your savings,

I would stay in the current home, because you have already upgraded it to your liking, you would not have to go through the trouble of packing up everything and moving, you are already familiar with the neighborhood, and your savings could be invested in a new rental property with much better cash flow, with the tax advantages of interest and depreciation right offs, and with another property to get appreciation from.

I hope your choice works out well.

Bryan Wilson · Answer

I'm fighting this same dilemma right now.  Owe $143K on 30 year fixed at 4.25% with 23 years left.  Probably can sell for around $200k as high as $220k if I fix up a bit and it appraises that high.  Lots of potential equity, but rents in area are 1700-1800 and my payment is $1100.  Expenses are fairly low on the house as I've kept up well over the years and have replaced many CAPEX items already.  My reason it is an issue is that I want to purchase land and build up because I have a good family contract right now for a tremendous property.  If I sell I can go ahead and dive into that and keep the equity.  If I don't we could buy the land and pay it down and keep our future first rental.  I'm leaning back and forth each time I assess it.

David Faulkner · Answer

That is a really tough call ... I agree with everything in your assessment and own rental property near you in Palmdale. I'm holding, but that is because my cost basis is so low, it is cash flowing like a freight train, and I don't have the tax shelter you currently do.

I personally love the house hacking strategy of keeping and turning into a rental, that is how I built my portfolio ... however, I only execute this strategy when I find a great deal, which normally happens most after the market crashes.

I think there is still some upside in Palmdale, due to the true things you mentioned. If credit loosens up further, that upside could be significant. Having said that, though, we are probably closer to the top than the bottom, and Palmdale usually gets nailed hard an the way to the bottom, as you saw when you wisely bought then.

A few things to consider ... it will likely cost you ~10% in transaction fees to sell (could be less if you get/have your RE license and sell it yourself and/or can save money other ways)  ... so do you think that the property is overvalued significantly more than 10% at this time? Also, if you held, what would your ideal holding period be tax considerations aside? If you are willing and able to hold for a long time, like forever, then it does not likely matter much. If you say 5-10 years, then that's different, and I wouldn't bother.

In my mind, the real trade off here is short term upside potential vs short term downside risk. I do not see tremendous long term upside appreciation potential in Palmdale in spite of the nice and true things you mentioned ... just too many empty buildable lots to keep a cap on pricing. And you are certainly not going to be making great cash flow anytime soon. My opinion, all things considered, I would probably sell it rather than turn to a rental for a few years or longer in your situation even though I am holding mine and in a different situation. I have to say, though, I'm really on the fence on this one ...

Nathan Waters · Answer

That's a good problem to have. I'm going to use my profit to buy a house that meets my rental criteria. When I bought my house in upstate new york, it was never intended to be a rental, but I had to make it work. Now when I buy a house, I look at it through different goggles. Depending on your goals, (Which it sounds like buy and hold may be one of them) I would buy a home that cashflows and works as a rental. If there are none where you live, look to partner with someone as a private lender. There are areas of the country where you can hit the 2% mark. Hope this helps.

Should I sell or turn personal property into a rental?

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