Is this rental a good deal?

Question

I have a rental house in the west coast that I've had for almost 15 years, purchased for $150K and now estimated at about $350k.  Rent is about $1800/mo and the place has been continuously rented all that time, with me managing it myself until we moved to the midwest a few years back.  Taxes are about $3k and I pay about $1k a year for management fees.

I've started buying property locally and wonder if it's time to let go of the property and reinvest it here.  I hate to let it go because it's in a high demand area with top rated schools and lots of large house new construction nearby helped drive up the prices, but I don't think the income is that great for what the property is worth now.  The only other benefit is I can possibly write off a trip there because I can say it's business, but I don't even have a good reason to fly there anymore.

Wondering if I should keep it or not.

Mike H. · Answer

So you have 350k sitting in a house getting 1800/mo rent that you're paying 4k a year in taxes and property management. Assuming another 1k a month for insurance or so? And you're looking at roughly 1,400/mo gross income. After repairs and vacancy, etc, maybe 1100 to 1150/mo net profit?

I see some of the suggestions above and I would be cautious in getting rid of a house thats done so well. Real estate makes you money in a lot more ways than just rental income. Equity capture, Principal paydown, Appreciation, and rental income.

Us folks in the midwest tend to forget how appreciation works in some of those hot zones like that one appears to be in.

I have always understood it to be that the biggest regret any investor has is selling any property.

But before you just take some 2% rule and use it or even 1% rule to determine whether to keep the property or not, I would look to see what both scenarios would look like - in the short term and the long term - and then make your decision.

Here is what you have if you do nothing:
350k in equity. 1100/mo in net profit (13k/yr). No principal paydown. Appreciation at 6 or 7% so another 20k a year there?
20 to 25 years from now = That house may be worth 850k and generating 2500/mo in net profit all by its lonesome?

1) Option 1 - Sell property and assume you end up with 320k after closing costs and minor rehab and holding costs while the house sits vacant when up for sale.  After taxes, how much would you get of that 320k? 270k?

Now what would you do with that 270k? Can you use it to buy 8 or 9 houses at 150k where you're paying 125k all in and putting down 25k total so loans of 100k. How much equity would you have now? 400k to 450k..... Lets assume your net profit is about 200 to 250/mo per house. You have 8 or 9 houses so 2k/mo in net profit.  Principal paydown on 800k to 900k in loans? Another 1k/mo? And lets say appreciation at 3 to 4% a month - on 1.2 million in real estate (8 x 150k homes)  is roughly 42k a year?

Equity: 425kNet Profit: 2k/moPrincipal paydown: 1k/moAppreciation: 42k/yr

But now lets look at that option 20 or 25 years from now - assuming these houses double in that time period whereas west coast went up faster.
Equity: 2.4 million (1.2 million x 2)
Net profit: 8,000/mo (8 houses paid off)

That seems like a no brainer to sell and move it over to some other houses in Illinois near you. But what does it look like if you keep it, take out a loan against it, and use the loan proceeds towards additional homes?

Option 2 - Cash out refi on existing home.
350k house gets you a 280k loan. That 280k lets you buy the same 8 or 9 houses as Option 1 above. You give up 280k in equity on the current house. And your cash flow becomes negative 200 to 300/mo on that house.

So now your difference in cash flow from option 1 to option 2 is that option 1 you make 2k/mo. Option 2 you only make 1700/mo. 300/mo less.

But you now have principal paydown on the current house (280k loan) is 350/mo. So Option 1 has principal paydown of 1k/mo. Option 2 has 1350/mo. Makes up for the lost rental income a tad.

And now you have appreciation from the house. 20k/yr is what we said based on west coast returns?   So you gain 20k/yr or almost 1650/mo in appreciation. Option 1 has appreciation of 42k/yr. Option 2 has 64k/yr.

Finally, what does that look like in 20 or 25 years when all the houses are paid off (including the west coast house)?

2.4 mil with option 1.  3.3mil with option 28,500/mo rental income with option 1.  11k/mo rental income with option 2

So does it really make sense to sell your west coast house?
I would suggest no. I would say that it makes the most sense to keep it. Do a cash out refi on it and plow all the loan proceeds into investing in more houses here in Illinois.

Short term, you may be bringing in less rental income a year but you'll be generating a lot more gains toward your net worth because of the additional principal paydown and appreciation you'll gain by keeping the west coast house and getting a loan on it.

And long term, you'll end up with way more in total asset value and rental profits once the homes are all paid off.

So I would always throw the 1% or 2% rules out the window when I make my decisions. Ultimately, I want to see what my numbers look like in the short term and in the long term. And then make that call.

The fact that you will be getting less rental income overall by doing option 2 may be an issue for you even if it means you'll be adding more to your net worth because of the other net worth contributors. But thats a personal preference there.

I'd much rather give up 100/mo in rental income today if it means I can gain 1k/mo in net worth today by doing so. I understand that appreciation is not easily predictable. But I have no problem using historical standards to come up with a rough idea. The one thing I'm positive about though is that you can definitely count on principal paydown.....

Bill Larsen · Answer

Paid off house that isn't a headache, appreciating at a good rate and making you $10k/year? I wouldn't sell.

I'd keep it AND buy more rentals in your area

But I don't think exchanging into a few properties near you would a mistake either. I'm more conservative than most people on this site and prefer paid off rentals

Cameron Davis · Answer

I regularly find 2% rents on the MLS... in Indianapolis, and NOT in war zones. My most recent purchase: A duplex listed for $60k, lowered to $55k, and I negotiated for $50k cash. It needed no work, and I had both sides rented within 10 days of closing, each paying $600/month. I'd say it's a C+ area.I'm not going to try to convince you to sell. I would sell... in fact, I did with my $450k house in Los Angeles. But getting a HELOC would also be a very good move. Or doing a refi to pull some money out. If you pay 5% interest to borrow money, but can get a 15% return, keeping your money tied up won't get you much farther than where you are now.

Matt K. · Answer

2% rents are in war-zones...... with the very rare exception.

Cameron Davis · Answer

If you do much research on this site, you'll hear over and over about the 2% rule: People try to get rent of about 2% of the value of the property. You are getting around .5%. My simple advice is that you should sell and invest that money in a different property with a better return.

I'm not sure how much you owe on that property, but I would suggest using leverage. For example, if you own this property free and clear, you could sell and buy 3 different $200k properties and put 50% down on each.

OR buy 6 different $200k properties and put 25% down on each. If you could get a 1% rent return on each property, that's $12k/month gross, and you're currently getting $1,800/month gross. Subtract your mortgage payment of $3,200 (5% mortgages, 30 years) and you are bringing in almost $9k/month. [None of this math includes insurance, taxes, repairs, etc.] But you are more diversified with more properties.

Mike D'Arrigo · Answer

@Mar Now Rather than making a decision on some meaningless, arbitrary 2% rule which says nothing about profitabilty, you need to do a full ROI analysis that includes cash flow, appreciation and depreciation write off. Compare that number to the returns you can get by selling and redeploying your equity somewhere else. The 2% rule isn't a measure of return. It is simply a way to quickly get an idea of whether any investment has any possible merit and should be taken with a grain of salt.

Cameron Davis · Answer

Repairs and vacancies always need to be factored in, of course. You could get yourself a nice 3 bed/2 bath house in Indianapolis for $75k that rents for $900/month. Tenants would probably stay more than 3 years if you properly screened and treated them right while they live there. If you make connections and do the work, you can find a better deal than that.

If you pulled $75k from your house, 5% interest for 30 years, your payments are $400/mo. Taxes & insurance = $150/mo. Property Manager = $90/mo. This puts $260/mo in your pocket (not counting vacancies/repairs). If you use the 50% rule (which factors that stuff in) you are pocketing $50/mo.

You keep your current property for it's rent and appreciation, you get more cash every month, and you have another property that might appreciate. Milwaukee seems to have even better returns than that. A few months ago I flew into Chicago, drove to Mke, then drove to Indy, and then flew out of Chicago. You can do this!

Mar Now · Answer

Yes it's paid off. It's funny that about  4 years ago it was appraised at $200k and $1600 rent was a good deal. But now that it's gone up to $350k at $1800 rent it's all of a sudden considered as losing money?? (Thomas S. ) When I didn't add a cent to it and rents went up.

Cameron Davis,  your $600 tenants are single people, may not stay too long, more vacancies, etc? My tenants were usually families w a baby, kept the place spotless.  most stayed 2+ years. I need a ggood way to factor those types of things into the equation.

Mar Now · Answer

Thanks for your thoughts on this.  Like you point out, it is easy to oversimplify the situation.

I believe appreciation to 850k in 25 years may even be an underestimation since people are still flocking to the Pacific NW for high tech jobs.  Also I've consistently averaged ~ 80% of the rent because, being new, it has few repairs (yet) and we turn over tenants in about 3 days (we always have 30 days notice or an early termination fee).  Plus I expects rents to increase due to the quick rise of housing prices in the past ~2 years.  So yes it looks like an easy decision to sell, but these three factors are in favor of keeping it.  It's not so easy to just look at only market estimate and rent.

I like your option 2).  I actually hadn't really thought of that.  The one issue with those numbers is it's almost impossible to find anything in Chicagoland for $150k except where you don't want to live or deal with section 8 tenants.  I could buy foreclosures but you have to remodel before you can even rent, then they'll just get trashed.  I don't know where people find decent places for $150-200k.

Thomas S. · Answer

350K with a conservative opportunity value of 10% = $2916/ month in lost income.

$1800/ month  Rent - 50% expenses - $2916 equity return value =

Holly Sh*t .....Net loss of $2016/month. OUCH

Is this rental a good deal?

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