Sell an overpriced house that is finally cash flowing?

Question

My nightmare entry into REI: I bought a personal house in a St Louis suburb with a friend (never ever do this btw) at the housing peak and then couldn't sell it when I had to relocate due to a military PCS. I bought this SFR for $203k in 2006 and in 2008 it was worth $150k. I was pretty unbearably upside down.

My co-owner wanted to sell for a loss but I couldn't because I didn't have the cash to close it clean, so he sold me his half (by paying me to take it) and I began renting the place out.

I began renting this place in 2009 after 9 months on the market but was still losing cash. I needed to refinance it in order to get my old co-owner off of the mortgage, so I started making double payments on the mortgage to get it to qualify for a refinance.

The numbers today: This house is worth $175k, rents for $1335/month, and I have paid the mortgage down to $135k. After management fees, repairs, taxes, and insurance I break even or toss ~$50 in my capex acct, but have been gaining approximately $400/month in equity. I have learned a great deal about this process in the past 7 years and I would like to add additional properties to my portfolio and make it a more meaningful part of my wealth acquisition strategy. Separately from this - I have a job that pays me a very respectible salary and I have saved up approximately $125k and I would like to increase my exposure to REI. I travel a lot with my job and work ~70 hours a week so my preferred method will be hands-off turn key.

My choices (looking for some advice from the BP community):

A. Pay off the remaining balance on my existing property to improve the cash flow situation

B. Leave that property as-is because it's finally cash flow positive (even though I sunk so much into this in the past that it was historically a bad investment)

C. Sell this property and use the equity to start fresh with a property that makes more sense as an investment on day 1, even though this means a pretty big capital loss from my original purchase price of 203k (for some reason I feel like you'll tell me this may be the smartest choice by the numbers, but the hardest to swallow because it'll mean permanently realizing the loss of property value, as well as may be costly to lose on the rental income for the time it takes to sell this property)

Thanks in advance for your advice.

Adilah Curry · Answer

@Austin Murphy Just my 2 cents, I would retain the rental property, continue with a positive cash flow (paying out $135k & having no liquid capital to invest elsewhere...if it were me, I would definitely not go that route). I'd continue to let the property appreciate. You also have the option of doing a 1031 Exchange if you just want to be done with the property - The 1031 would allow you to avoid paying taxes on capital gains. I would leverage the savings and invest in other properties. I hope this helps :) Best of luck!

Chris Colley · Answer

Hey @Austin Murphy, sounds like you had a pretty tough break on your first dip into investing, but don't let it discourage you from furthering yourself into the market. It seems like you're ready to step out of your depreciated property and ride the 1031 deferral into a new, sounder investment. As with what @Brian Harris had to say; your potential gains are crucial to outweighing your current losses and I'm confident in your ability to get a running, educated start on a new investment in the real estate market.I'm interested in offering you a more detailed breakdown on the fundamentals of real estate investing should you wish to further verse yourself in its anatomy. If you'd like to learn more about what the 1031 tax deferral method entails or how you can make a potential short term large gain investment to balance out your P and L then you are more than welcome to imbibe in my and my colleagues knowledge and contact me.Always here to help.

Brian Harris · Answer

Peter only mentioned it briefly at the end, but it's an incredibly important point. If you sell this property, you won't be able to realize the $40k loss. Hold it, buy a 2nd property. If that other property appreciates, you can sell them both and offset that gain with this loss.

Peter MacKercher · Answer

@Austin Murphy I'd nix out A immediately, as paying off your mortgage, while it would have a direct impact on your cash flow, also ties up your working capital and makes it stagnant. Leverage is a hugely powerful thing in REI, so choosing to not take advantage of it when you're young, have a good income and can take more risk will severely limit how quickly you can grow. Since you're looking to grow I'd say take advantage of what's in your favor.B/C: Imagine you took a pile of money and put it in a square you drew on the ground. When you leave the money there sometimes more money appears outside the square and you pick it up and take it away. Sometimes you have to add money to the pile, sometimes the pile gets smaller (namely in 2008). Now imagine there were other squares you could move your pile to that would, potentially, produce more money that you could pick up and take away. Would you leave it in the original square?I'm obviously trying to get you to remove the emotions you've attached to this particular property for these two decisions. St. Louis is a great cash flow city, and if that's what you're after then there might very well be better options for the ~$40k you'd clear from selling. Tie that together with the additional funds you have and you could do very well, almost certainly better than $50/mo towards capex and $400 in equity. The time value of money should be a critical part of your decision process here -- can you wait years longer to simply recoup losses while that capital isn't performing and is losing value?I'd consider the possibility of refinancing the property if you're inclined to invest in the same area to boost your working capital (if it makes sense on a cash flow basis), but realizing the property as a loss also comes with tax benefits, so keep that in mind.Happy to talk with you further about this if you'd like more advice or if you'd like to talk about the St. Louis market and feel out other options, so feel free to reach out!Cheers

Austin Murphy · Answer

Thanks for the reply and encouragement @Adilah Curry. To be clear, if I chose to sell this property, I would expect to net ~40k minus costs, so I would have capital to invest elsewhere. I'm still inclined to keep it and move on, but wanted to get a sanity check on if 40k to invest elsewhere would be a better option than to keep a home that's finally flowing a bit of cash today.