Sell, refinance, or hold?

Question

Hi all,

I would appreciate any input or advice on our current situation.

We live in Hawaii and purchased a single family “forever” home last year, and decided to rent out the townhome we were previously living in.  We refinanced the townhome to a 15 year note in 2021 to pay down the mortgage faster because we thought we would be there another 5-6 years.  We have a good interest rate (2.85%) and about 13 years left, but have a significant negative cash flow of around $1100/month, largely due to maintenance/association fees.  Currently, the principal balance is getting paid down about $1700/month.  Our loan balance is roughly 300K and comparables are going for about 600K so we have a bit of equity.

My initial reaction is to sell the townhome when interest rates somewhat stabilize and before we have to pay capital gains tax in 2025 (townhome rented in 2022, lived there 2 out of the last 5 years).  The concern is that it will be difficult to deploy the capital into real estate out of state due to competitiveness, interest rates, and logistical difficulty travelling from Hawaii to scope out other markets.  The other concern is our high DTI ratio and would likely need a DSCR loan for any future real estate deals.

I don’t like the negative cash flow even though we can technically afford it.  The other thought was to continue paying down the principal and refinance back to a 30 year note to break even, though this may take another 3-4 years depending on rates.  The way things are going, the annual increase in maintenance/HOA fees will negate or exceed any rent increases, so we wouldn’t see any cash flow until the property is paid off.  The caveat is that Hawaii is typically a high appreciation market, if we do hold it for longer.  We are in our mid 30’s, love our jobs, and don’t plan on retiring for another 20+ years.   If we do hold, I am worried about the opportunity cost of the negative cash flow and tied up equity.

Should we sell, refinance, or hold?  Am I missing other things to consider?

Thank you for any input,

Sean

Bonnie Low · Answer

This sounds like a great opportunity to apply the Shred Method to accelerate mortgage paydown since you do have available disposable income (just based on the amount you're coming out of pocket every month). I highly, highly recommend you look into Adam Carroll's Shred Method. We use it for paying off our primary mortgage and other debt paydown acceleration and it's been an incredible tool. If you can put a HELOC on your townhome which has a lot of available equity, you would basically be using arbitrage to capture the difference between simple (HELOC) and compounded (mortgage) interest in order to pay off your debt more quickly. Check out shredmymortgage.com We work with Nick Der at Shred and he is incredibly helpful. (Disclaimer: I get nothing out of this - I just wholeheartedly believe in financial independence and find most investors do, too.) This might help in your situation. At the very least it's a great option to consider before you make your decision. Good luck!

Bryan Vukelich · Answer

Hi @Sean Field-Eaton, that is a difficult decision but that is fortunate that you have equity in the property and can afford to feed it   As you know, 2.85% is a great interest rate and 13 years left to be mortgage free is really not that long.  How well maintained is your community?  Do you expect any special assessments or large increases in the association dues?  Also, although it is area specific, over the past 30 years, townhomes/condos on O'ahu on average appreciate about 4.68% annually.  I'm long term bullish Hawaii real estate and with current rate of inflation, you could do quite well if you held it long term - though I know feeding a property is not ideal.

If you sold and wanted to stay invested in Hawaii real estate, have you considered a vacation rental?

Ultimately - only you can decided what is best for yourself.  But if you want to do more investment deals sooner than later and keeping this property will prevent you due to high DTI, it seems best to sell and reinvest in a cash flow positive property.

If you have any other questions, I'm happy to answer them.

Evan Polaski · Answer

@Sean Field-Eaton, while not an ideal scenario, at least you have options.

First, I would consider what you think the appreciation in Hawaii will be.  Work from home is slowly coming to an end: not universally, but the heyday is over. This could limit demand for Hawaii homes.  Secondly, you are in, what I would assume, is a high rate of second home area.  When times get tough, which they certainly could get tougher, second homes tend to be where people cut.

The flip side is: the affluent tend to be less impacted by recessions.

Personally, without running numbers: it sounds like refi'ing is off the table.  A) because your HOA is not going to be resolved, and b) presumably, you are going to more than double your interest rate on a refi, negating any extended amortization savings you would achieve.

So it comes down to "how much appreciation" are you anticipating, if you hold on longer.  Will your $600k townhome become a $1.2mm townhome in 10-15 years?  Right now, you seem to be building about $600/mo in equity, $7200/yr.  That is only 2.4% return on equity.  If you home is appreciating roughly 5% per year, that is actually another 10% ROE, given your current debt to value ratio.  So you are earning 12.4% right now, roughly.  That isn't a bad overall return.

Finally, if you do sell, why would it have to go back into real estate?  I get it if you are looking to make real estate a career, but investing is investing.  Investing should be agnostic and based on maximizing your overall return relative to the perceived risks.  I am not saying you shouldn't stay in real estate, if you think that hits the concept above, but there are many ways you can make a return on your money.

Henry Clark · Answer

What is your rental rate?  Are you doing LTR, MTR or STR?  What is special about this property?