Father wants to retire soon and move out of house, cash-out refi and rent or sell?

Question

My father is close to retirement and plans to move to buy a home in Florida soon. Over the years, his current SFH in Maryland has appreciated through renovations and with time.

He is trying to decide if he should sell the house and take the equity or rent long term. He does not need the cash to purchase the new home in Florida, but could put it in other investment vehicles. I should mention he has no experience in real estate investing.

After talking, he got interested in the idea of cash-out refinancing the home to pull some equity out, going with a longer-term mortgage, and renting the house out to cash flow every month. He is attracted to this idea because it essentially guarantees cash flow into the future, and also allows for more appreciation and the potential to leave the home in his children's name to start to build generational wealth.

I am helping him with this, and frankly I think the cash-out refi then rent makes a lot of sense. Here are the rough numbers:

State: MD

5 years into a 15 year, 3.5 % loan, $1500/mo mortgage payment

Still owe $200,000

Appraisal will likely be around $420,000

Considering refinancing to a 30 year, $300,000 loan

This frees up about $100k of equity to put into retirement accounts and other investments

Based an estimated 6.5% rate, the mortgage would be somewhere around $1900/mo, and the house would almost certainly rent for $2600+/mo.

What are we missing here? Is this sensible? Our family has not had much generational wealth and this would allow the house to continue to appreciate while cash flowing. This is our first venture into REI and I would love any feedback/suggestions to help us out. Thanks!

Steve Milford · Answer

I would say leave it alone, and get a HELOC if really needed. Nobody foresees that we are going back to 3.5% mortgages, so keep it, you can't get cheaper cash. If anything push for rent higher than $2,600 to get max cash flow. It sounds like you are local, so you can handle the issues come up. Screening future tenants is #1. Forget PM, they are just a middle-man sucking money away, until you have more rentals. Read the tenant landlord code in your area, know the rules. They spell out what you can and cannot do. Have a good contract,  and keep good records so if you have to goto court or evict you can. Use an online platform to collect rent. Plus now is a horrible time to sell. You can always sell later.

My father had same scenario a few months ago. Everyone he talked with suggested he sell, refi. I suggested he do nothing and rent. He first wanted to sell, then got turned on by easy rent, wanted rent of $1,400 per month and thought it was "fair". I told him, forget "fair", be aggressive. It took a little bit of convincing him but we got it rented for $1,800 per month. Easy cash flow is the best thing in the world. Once it gets going, you/he might find it takes very little time at all. I check in with my tenant every 3 months asking about maintenance issues and annually when we have the "raise the rent" conversation and when I hire a home inspector to do an inspection. All communication by text or email as much as possible.

Ozzy Sirimsi · Answer

@Kristofer Marsh

Cause I rather not to have mortgage but have HELOC on a house so I can have access to capital by just writing a check if nothing comes up collect 20k a year.

But again that's my preference based on where I am in life :)

Kristofer Marsh · Answer

@Joe Norman thank you for you honest suggestion. By no means do we think this will be passive, although we were planning to hire a property manager. This property is not in Baltimore but a popular suburb. Would $400 dollars make a difference? Some, but the way I’m seeing it he could cash out $100k and keep the house as an asset for his children to inherit while still taking in some cash flow every month. He can cover months where it’s vacant but this is in a family friendly neighborhood near good schools and not far from the water, I think renting will be easy.

Also, I plan on helping him with this. He doesn’t want to worry about it and I want to learn about REI, so I would manager the property manager and essentially have POA to make decisions.@Steve Vaughan thanks for your reply! What do you mean if he doesn’t sell within three years the gain won’t be tax free?

@Ozzy Sirimsi this is an interesting option we didn’t think about yet. The current house in an attractive neighborhood with good schools in a Baltimore suburb. Why lock up the $200k capital in a single home like that? I’d almost prefer to rent the place out now with the current mortgage which would be paid off by someone else in about 10 years. Another option would be to sell and use some of the profit to put a down payment on another rental property. Or, partner with his son (me) to private finance a BRRR type deal over and over for the coveted “infinite return”.

A better way to frame what I need help with is given his situation, knowing that he wants to both make some cash now and also set his children up to help get the generation wealth train moving, what would be the best way to do this? He’s thinking if he keep the house in the family but takes out equity now that both gives him some immediate cash and also leaves an asset to continue to appreciate. What would you do?

Ozzy Sirimsi · Answer

To be honest, I would sell the place, buy a 200K townhouse in Baltimore ( or in FL) free and clear with the proceeds, rent that and if you have any problem at least you dont have a mortgage.

Bonnie Griffin Kaake · Answer

@Kristofer Marsh Here are a couple more options to consider.

1. He could keep the house and do what needs to be done to update it for a tenant and maximize the rental value of the home. Then, he can list it for rent, get an estimate (at no cost) for a cost segregation study. He will have some significant tax benefits, about 6-8% of what he purchased the home for plus renovations in after-tax cash-flow. And, if he wills the property to his heirs, he NEVER has to pay that tax benefit from cost segregation back. When the heirs inherit the property, they inherit it at current market value and can do a cost segregation study again. Everybody wins and dad has some spending money that he would normally be paying the IRS.

2. Another option is that he could do a 1031 exchange into a more expensive property or multi-family anywhere, upgrade, rent it, and do a cost segregation study on the new property and leverage the tax benefits or use as he would like. Again, when the property passes to his heirs, there will be no "recapture"...he will not have to pay back any of the benefits of cost segregation. And, his heirs inherit this property at full market value and can do a cost segregation study on their full new market value.

If you need more clarification or an estimate, let me know.

Steve Vaughan · Answer

The gains on a primary when we sell are tax free if we lived in for at least 2 of the past 5 years.   If he decides to sell 37 months+ after renting it out, he will be taxed on all gains and depreciation.

Kristofer Marsh · Answer

Ah, I see! So you essentially use the property as a bank to fund deals. Seeing as we are new to REI, would a HELOC still be possible if not owner occupied? I’m assuming yes but possibly with higher fees/more paperwork until we build trust/credit with the lender.

Steve Vaughan · Answer

Honestly,  I don't think it's sensible as a first choice.

Unless he sells within 3 years, the gain won't be tax-free.

One tenant selection mistake will be a long, long nightmare.   Out of state while trying to chillax but zero LL experience? Rents and cash-flow are hardly 'guaranteed '.

I would try to sell regular.  If/ when that doesn't go as planned, at least lease option it.  No regular landlording or signing up with some mediocre to horrible PM either.

Only a fortunate seasoned local pro gets to retire and have rentals at the same time. Rookie landlords from several states away get character building experience.

Joe Norman · Answer

If you think that this plan "essentially guarantees cash flow every month" they you need to take off those rose colored glasses. REI can be a great way to build wealth and cashflow, but it's by no means guaranteed or passive (at least not at this scale).

Can your father comfortably cover the $1900 mortgage payment during the months when the property is vacant or the tenants aren't paying? If not then I would sell. If he can then you can absolutely consider refi-and-rent, but is $400/month (after paying a PM, maintenance, vacancy, etc) going to make that much of a difference in your fathers retirement?

Father wants to retire soon and move out of house, cash-out refi and rent or sell?

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