Maximize gains - cash out refi? sell outright? continue to rent?

Question

Hi everyone, need some help here.  I currently own a 2 family property that I will have paid off in a few years and starting to think about how to reduce taxes and maximize gains.

Background:

• purchased 2 family (2 2 bedroom units) in CT as owner occupied in 2010 for $230k - financed with FHA loan at 4.5?% and 3.5% down payment
• lived there until 2015, rented 1F unit for $1000/avg over that time
• refinanced into a 15 year loan in 2013 at 3.875%
• rented both units 100% since then
• rents now cash flow positive about $400/month
• been doing capital improvements to offset income and keep net profits close to $0
• paid down a lot of extra principal over last 2 years
• currently owe $80k 
• valued at $260 conservatively, $300k optimistically
• Will finish loan in 2022 or 2023, i forget without looking at my schedule

I'd like to get out of the property since it's not returning that great of an investment relative to just investing that money in the market and earning 5%.

1. first thought was considering selling it ouright but after capital gain taxes, realtor fees, paying back taxes on depreciation owed and losing the tax benefits of having a property i dont think thats the right move.

2. My second thought was to do a cash out refinance once I own the property outright and invest that money.  Put the property on autopilot at that time, get a property manager, cash flow $0 or close to it and setup a new 20 year loan.

3. recently i started thinking that with interest rates still low and expecting them to go up in the future, maybe i should be looking to do the refinance now, although it would be with less equity at this point vs in a few years.

Ultimately, I'd like to have access to my equity and invest that and earn interest on that or use for other potential projects.  Im concerned that selling outright will yield me the least and has a lot of cons from giving up the tax benefits of having a rental and that if i just let this project run its course, ill have to start paying taxes on the additional income in 2022, since right now i can write down some of that against interest.

thoughts on how to maximize yield over say the next 5-10 years?

TIA

Jaysen Medhurst · Answer

@Luca Mastrangelo: Sell. No doubt. Sell.

You're nowhere near the 1% rule and appreciation will likely continue to outstrip rent growth, further depressing your ROI. A refi just doesn't make sense.

Take your ~$165-200k and 1031 exchange into a larger property to defer your capital gains taxes. Depending on the market you can probably get into a 5-10 unit property pretty easily. You'll be generating much better returns.

Out of curiosity: where is your duplex and what market would you likely invest in?

Thomas S. · Answer

Absolutely sell. This property is a poor investment. Eventually it is going to bite you in the a** and it will be too late for you to recover.

Your equity is wallowing, the amount of income you are losing monthly based on the dead equity alone is more than enough reason to sell and the property can not cash flow with leverage. At this point in time you can not in all honesty call yourself a true investor.

Your 200K in dead equity invested in a income fund could easily produce a 10% annual return long term. Best option is to put your money to work for you as a minimum DP on a better property or multiple properties. Stop fixating on paying off the mortgage on a rental property. That is a home owner mentality. Make your money earn it's keep, put it to work for you......Sell.

Luca Mastrangelo · Answer

Yea agreed. I think a refi might not be the worst idea. Gives me a lot of options. Don't know much about them though.

Luca Mastrangelo · Answer

My original question is sell, hold or refi.  I am particularly interested in the refi option as that appear to give me flexibility to use the equity for something else or invest it and still generate a decent return.  I'm looking for constructive feedback and what variables to consider in my analysis,in particular tax considerations which might sway the decision one way or the other.

I did my high level analysis this morning and it suggests holding the property is the best move, not "SELL!!!!!". if my analysis is missing something or doesn't check out please let me know. I'm not a real estate professional.

Thomas S. · Answer

You state you would like to get out of the property but refuse to accept any advice in that direction. The fact is you do not want out of the property at all even though that is the most logical option. Since you posted with no intention of taking advice, especially in regards to selling, why not just tell us what it is you want to hear from us that meets your conservative approach to investing. Obviously you have a idea as to what you want us to say to reinforce your decision.

If you truly are undecided  flip a coin and choose between #2 and #3. It really makes no difference as long as you are ok with the choice.

Joe P. · Answer

Apologies, $200 per door, or $4800 per year. That's not terrible...and someone is building your equity.

Luca Mastrangelo · Answer

Cash flow isn't $400/door but primarily because I have a higher loan payment on a 15 year loan.  After PITI and maintenamce expenses  I cash flow about $400 /month combined between both units.

Joe P. · Answer

Missed something here, everyone is saying sell but it looks like his cash flow is $400 per month, per door? Couldn't he cash out refinance, keep this property, and invest the proceeds somewhere else? Or even HELOC? Asking sincerely.

Luca Mastrangelo · Answer

@Thomas S.   10% annual return investment fund return claims are pretty optimistic.  6-7% is a more realistic # to use.  Future gains expected to be less.    While I agree this investment isn't optimal , it's been good to me.  Ive been steadily raising rents to get closer to the 1% rule and am not far off at this point, will be $2500 starting July 1 which is pretty close to the value of the property.  What scenario do you think I would get burned in?   I've taken very good care of the property and done a lot of maintenance, there will be more in the future, but the property runs well.  I dont see a lot of downside risk ahead with this property. It wont double in value but im certainly not in a high foreclosure depressed part of the country.  Its more opportunity cost.

@Jaysen Medhurst - agreed,  my cash isn't working as hard as it could.  This coming year rents will be $2500/month which would support a $250k sale price at a minimum, not horrible but also not amazing.  i just laid out expected profits over a 10 year time frame and it looks like holding the property and having my tenants pay down the loan and then generate profits for me is the best scenario.  If i sell today i would clear about $150k, if i invest that into the market and earn 6%, id be at $284k in 2030.  If i just keep doing what i am doing, I will have liquid capital of ~$137k plus the asset of the house it self which i assumed woudl appreciate at 2%/year and be worth $323k in 2030.

So while selling will give me the most available capital now, it doesnt look like i will get a better return than leaving it where it is now.  What am i missing?  Yes i know i could use the proceeds into a multi family elsewhere in the country that could yield 10% but im not motivated enough to move in that direction at this time.   Can you share with me some of the types of properties you might consider in this situation?

I dont like Groton or New london for rentals. There's a huge transient population with a large supply of rentals so finding good long term tenants will be a challenge.  You can def make it work but you'll have a lot of turnover, wear and tear and upkeep on the properties.  The reason i picked Waterford is because its next to New london and has a very tight supply of multi families, i wanted easy long term tenants.  I would consider other towns in that area like Mystic, North Stonington, Pawkatuck , Easy Lyme and Niantic if you can find properties that support your model.  Feel free to DM me any specific questions about the area, i was there for 8 years.

Jaysen Medhurst · Answer

@Luca Mastrangelo, the reason I don't like holding the property or doing a refi in your situation is that your Return on Equity (ROE) is terrible. The rents are just too low compared to the value of the property. Sure the rents are covering the expenses, but with little to no cash flow and mediocre appreciation, your money just isn't working hard enough for you.

I understand the challenges of the Cape. Family members recently sold a commericial property in Provincetown and 1031 exchanged into an MFR in Louisville. They've been very happy with the deal.

I don't know the Worcester market, but there is plenty of MFR stock there. I've been looking in New London / Groton, CT. The Cap Rates are great and property prices are very accessible.

Have you considered investing in a syndication (assuming you're an accredited investor) or REIT. That's truly passive. Although, I don't think you can 1031 into them.

Maximize gains - cash out refi? sell outright? continue to rent?

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