Is there such a thing as too expensive a house to make a rental?

Question

I appreciate any and all opinions and insights into my situation.

I currently own a townhome free and clear. Technically the townhome is classified a condominium, so I'm unable to do anything with it financially other than sell it or keep collecting the cash flow.

I have an idea to 1031 exchange into a property that eventually I can live in for a few years and avoid all the capital gains taxes. But in the meantime, I'm a little concerned that doing the 1031 into a more expensive property will put me in the very narrow end of the rental market because I will be renting this out for the foreseeable future.

I'll give some number examples. Current worth of the townhome $300k, looking to 1031 into a $450k-$500k. Current rent for townhome is $1800, expected rent for the new home would be $2700-$3000. I could even go into a more expensive property with higher rent, but concerned about the number of people that are looking for a $3000 monthly rent. The median home price for my area according to Zillow is $378k. So at $500k, I'm not at the very top of the home prices. I've looked at the highest rents in my area on Zillow, and most of them have been listed for several weeks.

I considered trying to market it as a corporate rental, however, I don't really want to have a furnish a huge house. I also don't really know anything about that part of the rental market.

So my question boils down to, how do you know when you're buying too expensive of a house to try and rent reliably?

Marcus Auerbach · Answer

There is a market for what I call executive rentals. In Milwaukee the biggest volume is between 1000 and 1500, followed by over 2000. Over 2500 the air gets very thin - but there are properties that rent between 3000 and 6000.

The issues: longer vacancies between tenants, because of the smaller market. And when you have to rehab it get's expensive. Even painting a 5000sf home with tall ceilings is quickly over 10k, all new carpet/flooring: over 20k. That eats up a lot of cash flow!

Thats why we keep it below 2500 in monthly rent.

Adam Martin · Answer

In my area there is a sweet spot on home price that makes it a good rental.  Too cheap and you are getting into lower quality areas that may attract lower quality tenants plus the houses are older and more prone to maintenance issues.  Other end of the spectrum as you get too expensive your COC diminishes as the home prices keep rising but rent doesn’t proportionately.  This sweet spot has risen over the years but the neighborhoods stay the same.  There are a few rentals in my area that just don’t make sense as rentals and should be sold.  There are houses worth 4-500k renting for 2300 when it could be sold and buy a 325k that would rent for 2100.  The neighborhoods and schools would be similar just different streets at different price points.  With that much equity have you thought about a 1031 into 2 or more properties putting 20% down to grow faster or is your main goal to fund your future home while deferring capital gains.

Conner Olsen · Answer

@Michael H. I've had a lot of success with furnished monthly rentals. I have found there's a ton of demand and much higher rents than LTR.

Nathan Gesner · Answer

I don't have all the answers, but I know things are getting more expensive and people will have to tighten their belts. When that happens, people will downgrade from a $2,000 rental to a $1,500 rental. People in the $3,000 rental may downgrade to a $2,000 rental.

In my experience, the people that tend to move up/down the least are the blue collar families. They get into a home with good schools and community and they'll sit tight through difficult times because they want a good home for their family and they're smart enough to know that the bad times won't last forever. If they do decide to downgrade, there should be plenty of higher-income earners looking to downgrade that will now find your lower-quality, smaller rental attractive.

Bjorn Ahlblad · Answer

Many properties you buy today may not make great rentals from a CF point of view. So it depends on your goals. Appreciation can be very lucrative. In your example the 300k house is no better/worse than the 450k house. Be careful moving into the 1031 house it takes about two years to break the curse.

We had a couple of rentals in Ca for 30 years that never made money as rentals; but they were paid for and we had no intent to sell. We retired a few years ago and made serious lottery ticket money on the sale. One of them was a 1031 which we replaced with other rentals in a different state. Today we only invest for cash flow and that covers our retirement lifestyle.

Jared Hottle · Answer

I agree with Nathan needing the high rents to make it work expose you to recessions even though rents keep going up. However I will also say if you would still break even at a lower amount it makes your property recession proof as yours will be the first one rented if you can slash prices signficantly during a recession or budget tightening.

Billy Smith · Answer

I like the rentals that are $1000 to $2000 in a desirable area they will pay extra money for the location. If they ask what the rent is high, I tell them the truth you are partly paying for the  location the other is size and shape of rental.

Jordan Moorhead · Answer

@Michael H. I don't think there is a home too expensive, as long as the numbers work. I know people that buy in San Fran and make it happen.

Michael H. · Answer

@Bjorn Ahlblad

I get what you're saying, but if I 1031 into a breakeven property, I'll actually be losing about $2000 CF because that is what I make currently.

Is there such a thing as too expensive a house to make a rental?

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