Rental Properties in Boulder, CO?

Question

We own two rental properties near Boulder, CO (Gunbarrel). Market value is about $550,000 (total, before taxes). We paid $108,000 for our first one (15 years ago) and $135,000 for the second one almost ten years ago. Just paid them both off, so we are no longer paying mortgages.

Combined net income is around $14400 per year (except unexpected repairs). We have cash savings to cover unexpected repairs, etc. I have been reluctant to raise rent too much b/c I have reliable long term renters, but I could definitely get a bit more for them.

I realize we are not making much money from them, but ... I've kept them over the years thinking they diversify our retirement portfolio, pretty easy passive income (I manage them myself), etc.

We are still working but hoping to move to at least part time work in the next few years. I had planned to use the rental income to help cover health insurance costs until we reach Medicare age (5 years for wife, 10 years for me). BUT taxes and HOA fees are really eating in to our income in the last few years. Wondering maybe if it's time to sell ...

Any insights on this situation? Thanks in advance!

Dave Foster · Answer

@Kim Bunning, Great thoughts by @Steve K. and @Matthew McNeil.  As you near retirement there are a few transitions that need deliberate purporseful attention.  One is the transition from active to passive ownership.  If these properties run themselves or can then great.  But it's no fun having time to enjoy retirement but being stuck close to home to manage assets.

Another important transition is from regular income to passive income.  Here too it just may be like Steve says and the properties are under leased.  But right now your return on asset before you pay repairs is about 2.6%.  Inflation is expected to be 2.1-2.3% in 2020.  So this year you will just about break even with inflation and have enough left over for an over priced cup of coffee or a dog from Mustards last Stand!  If you want to depend on income from that asset in retirement you've got to do better than that.

The third (and most important in my mind) is the transition from appreciation based investing to cash flow investing.  This is a very hard pill for most investors to swallow.  We're ingrained to find the deal and buy low and sell high.  But this type of investing becomes geometrically more risky as you near the end of your career.  You start to lose your runway for recovery from correction.  But cash flow smooths out many a bump in the road.

So where does that leave you - Well Boulder has been an incredible appreciation market.  Will that continue?  Who knows.  It is not a great cash flow market as evidenced by your NOI.  Your assets are paid off.  That's awesome and gives you lots of flesibility to take on a little debt or stay with cash investing or do a hybrid and buy some assets for cash to protect yourself.  And buy some assets with leverage to take advantage the interest arbitrage.

And it's also a good time to be exploring the fractional passive markets where you can still 1031 and keep tax deferred but you can also go completely passive and get the arbitrage of interest on loans that are non-recourse to you.

And there's three letters that tell me you need to run not walk away from these as you near retirement - HOA!!!  Nothing can kill a retirement like an HOA gone rogue.  I've seen bad assessments and management destroy peoples lives in retirement because they have no control and can't absorb the impact of bad HOA management.

So I guess my vote would be to sell and look for higher NOI, passivity, and protection against any kind of market correction.  The 1031 is obviously a good way to do that and not have to pay tax on gain and recapture depreciation.

Matthew McNeil · Answer

Hi Kim. You’ve asked a great question for your initial post here on BP. It seems evident that you’re an overly conservative investor, which is great! You’re probably going to get several different comments offering you good advice. However, I think you may feel much more comfortable maintaining your current position regardless of whatever feedback you get here.

You would probably be best served by letting someone like @Steve K. (above) to personally walk you through options where you can increase the return on equity he mentioned. Then reach out to @Dave Foster to help you manage a 1031 Exchange. These two people will help you position yourself for a healthier retirement. Both of these gentlemen post often and they have really good comments and advice. You will be in good hands with both of them.

Steve K. · Answer

Hi Kim,  First of all, since it's your first post, welcome to BP!

You have a good problem here: you're equity has gotten so high that your return on equity is very low. You picked a great time to invest in Gunbarrel. Coincidentally that's also where I began (Twin Lakes) back in 2005 when I first moved to Boulder. I exited that property a few years ago to invest in multifamily buildings in Longmont. I would consider selling if I were you, as your return on equity (in my opinion the best metric to determine whether or not to sell) is only 2.6%.

Although, from looking at your net operating income, it seems these properties are rented way below current market rate, so you could also easily improve your ROE by raising rents. The rate of increase of your expenses has likely outpaced your rent increases, contributing to your low ROE. Nobody likes to raise rent on good tenants, but if you're not raising rent by at least 3% per year, you're not even keeping up with inflation and most tenants can understand that. I'm sure your tenants are well aware that they have the cheapest rent in Boulder, and I think that if you are going to hold these units you should think about raising rent closer to market rates in order to serve the purpose of paying for your health insurance costs until you qualify for medicaid.

If one were in a different phase of their investing career, they might also use leverage to unlock some of the trapped equity, but seeing as you're getting ready to retire and just paid them off, that probably doesn't make sense in your situation.

Depreciation tax benefits are something to consider as well, as having held these properties as long as you have, and considering the purchase price, you may not be getting much tax benefit from them as they are probably mostly depreciated by now on a tax basis. You could reset the tax depreciation benefits simply by selling and buying a different property, just something to consider.

It's an extremely hot market right now: right out of the gate 2020 is shaping up to be the best seller's market we've seen since 2015. We're seeing properties going under contract immediately with multiple offers above asking price, and inventory is at historic lows especially in the under $800k price range. If you held another five years and raised rents during that time you'll probably also be in a great position, but if you're thinking of selling, you could do so extremely easily given the current market conditions. I'd be happy to chat further if you'd like to discuss! Best, Steve

Kim Bunning · Answer

Thank you Steve and Matthew. I appreciate the local real estate perspective!

Rental Properties in Boulder, CO?

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