Assumptions and calculations for selling vs. renting out

[Mike J.]

Warning: the below is a lengthy, generalized hypothetical. The questions are about calculations of average (yes, "average" is a very dangerous word because most years are far from average) returns on rental properties, considering both costs and typical rents.

It is the year 20XX. Jane Doe owns a nondescript single-family home in Townsville, USA, with a value of $100,000.

Jane is about to leave for another part of the country for work. Or whoever knows why. It is the year 20XX, after all. She is considering two options: (1) selling the property and (2) keeping it and renting it out. Jane has no need of liquidity and the roughly $100k that would be available after an eventual sale. In other words, for the long term, what are the prospects?

The financial gain from (1) is the sale price minus transactions costs and frictions, as well as any renovations or staging done to achieve such a sale. I think we can call this roughly in the range of $100k, probably lower to some degree. Let's assume a neutral housing market, where the $100k is a fair long-term value: not a hot sell at a cyclical peak nor a stinker at the lows.

How much could Jane expect to earn in the long term by keeping the property as a rental in option (2)?

Data over the decades suggests that real estate appreciates roughly with inflation over the long run (less than 1% over inflation), but this is only a historical national average and not applicable directly for any particular market. For now, assume Townsville just about follows the average or slightly worse and properties only follow inflation over the long run.

Likewise, I assume rents appreciate roughly with inflation as well, for some of the same reasons. Let's just say Townsville isn't the next hotspot in the country and rents are flat with inflation.

Jane is moving far away and is unable to keep tabs on the property or screen tenants, so she would need to hire a property manager, say for 10% of the rent, so as to not risk it to a shady fly-by-night operation. She also risks vacancies and the occasional eviction and associated cost, which in the long run let's say takes another 10% chunk out. This property management service is earning its keep, keeping vacancies to a minimum. Is that a lowball estimate?

Other recurring costs for Jane would include property tax (say 1%) as well as any and all maintenance and improvements (1.5% of home value, with some years much more than others), and insurance (0.5%). If a home falls apart, it is not going to keep tenants or keep up in value with inflation, to be sure. Have I missed some other expenses for Jane? (HOA dues, I suppose, potentially) Do these numbers look about right?

So Jane needs 80% of a year's rent (9.6 times a month's rent) to cover 3% of the home's cost to break even, with the rest being profit. How much does a $100k property rent for in Townsville? Any idea of some kind of average or range to expect? $700/month? That would imply a profit of $3,700 / year, or 3.7%, with the principal value and profit both adjusting for inflation. Recall that $100k is the long-run fair value of the property in 20XX dollars, not what an enterprising real estate investor could buy an undervalued house for in a down market.

That looks somewhat in the ballpark of the 50% rule of thumb to me, but maybe I'm misunderstanding what goes into that calculation.

To be sure, real estate is illiquid and risky to some degree, so we would expect a positive return. I'm just not sure by how much. Ideas? In case you're wondering, no, I'm not in Jane's position, just wrapping my head around realistic expectations so I can advise myself and others in future circumstances. Individual markets and circumstances would affect all of the numbers.

Whew, if anybody read even half that, I would be impressed.