Should I sell my only Investment Property

Question

This is my second post, so forgive me if I don't provide all the necessary useful information for you all to help me make this decision.  I've also been running the numbers the last few days, so errors in my calculations of cap rate, ROI are possible.

I bought a 3 BR 3.5 Bath townhouse in Alexandria, VA (in the DC metro area) for $280,000 in 2009 as my home.  I converted it to a rental in 2012 when I moved to Germany for my job.  I will probably not return to live in the house when I return from Germany in the next 2-3 years, but it is possible.

Gross annual rent: $24,000

Operating expenses: $7,300

NOI: $16,700

Mortgage interest ($250,000 x 15 years @ 3.25%): $7,460

Principal Payments: $13,620

Total Debt Service: $21,080

Cash Flow: $-4,380

Cap Rate: 6%

COC ROI: -15.56%

Original purchase price (2009): $280,000

Approximate current price (2013-2014): $340,000-$370,000

I still haven't figured out how to accurately determine my investment basis (and total ROI) since I'm not starting from year 1.

The property could probably easily sell for $340,000 based on nearby comps.  My real estate agent/property manager says it could sell for as much as $370,000 in the spring, but I'm not counting on that.

Here's the interesting situation.  The two tenants I've had so far are diplomats and they rotate out each year and their replacement has taken it over.  The current tenant has already asked if his replacement can continue renting when he leaves in March 2014.

There are of course extra risks with renting to diplomats because they have diplomatic immunity and can't be taken to court or evicted. However, I haven't heard any stories of diplomats in the area not paying rents, so I took a chance on them. They have paid on time the past two years and have been generally great tenants.  They have told my real estate agent/property manager that it's been difficult for them to find a rental in the past.

Market rents are in the $24,000-$25,200 range, but my thinking is that these diplomats probably don't want to look for another rental unit as that would cost them extra to get an agent and not all landlords want to rent to diplomats because of diplomatic immunity. Also, their embassy pays all costs so the tenants might not care as much about how much the rent is.  So, I think I might be able to charge a higher than market rent to them.

As you can see, I'm currently negative cash flow, but that's partially from using a 15 year mortgage.

Should I sell? Should I continue to rent to the diplomats? If so, should I hike the rent up? How much?

Any and all thoughts would be greatly appreciated.

David Krulac · Answer

@Phillip R.

I'm not a fan of the negative cash flow.  I would not refi out of the low interest rate that you have.  The ready supply of diplomatic tenants, the $2,000 monthly rent and the potential appreciation are reasons to keep the property.

As mentioned by @Elizabeth  C. your intentions on whether you are coming back to DC and maybe even re-occupying the TH  should be factors in your decision.  If you are not coming back to DC, that for me would be another reason to sell.

And as @Ned Carey and @Michael Siekerka point out the ability to use the personal residence exemption is a big deal.  As far as I;m concerned that is one of the top 3 most favorable tax laws for real estate investors.  If you can use the tax law in your favor, and sell the property with no capital gains taxes due, that would be another point on the side of selling.

On the keeping side:

1. ready supply of tenants

2. $2,000 monthly rent

3. future appreciation potential

4. low interest rate on existing financing

On the selling side:

1.  negative cash flow

2.  out of the country

3.  maybe never coming back to DC

4.  Favorable tax treatment for selling personal residence (IRS Code Section 121) not to be confused with Section 1031 which does not apply to personal residences.

Tie score automatic OT

Elizabeth Colegrove · Answer

@Taylor Massive

At least  you can carry over the lost until your income allows you to take it.

Ryan Shuchman · Answer

Losing money in real estate only lowers adjusted gross income if you are below a certain threshold. If his wife is working and he is on an expat package he probably is exempt.

Elizabeth Colegrove · Answer

@Phillip R.

My understanding is it is 2 complete years or nothing. Definitely talk to a CPA because your overseas circumstances could change the rules. If you are not going to move back in the house than you might be best of to sell it.If you think you are going to just want to buy another house in D.C I would keep it as a place holder.

I would definitely check the market. If you could increase the rent by $200 that would cut you negative cash flow in half.

Are you using a CPA? Since you are having negative Cash Flow AND Depreciation +Expenses, this should be assisting you on your taxes.

Arjun K. · Answer

Or contracting with the NSA to remove their bugs before the CIA arrives.

Donald Hendricks · Answer

perhaps you could make up the shortfall by contracting with the CIA to plant bugs in the house so they know what Boris & Natasha are up to.

Jay Sebastian · Answer

I still haven't heard back from the guy who was renting to diplomats, but he had a really good business plan around it.

Arjun K. · Answer

Since you don't care about negative cash flow, then it seems to me you are asking whether the total return of holding the property is worth holding the property.  In my mind, the tax exception, your forward assumption of any HPA, and then opportunity cost to invest that capital elsewhere -- are the main issues to focus on?

Phillip R. · Answer

How come only one of the names I replied to highlighted?

Phillip R. · Answer

@Arjun K.  if I refinanced into 4.375% over 30 years, my total debt service would be $13,500 for a positive cash flow of $3,200.  That sounds much better to me and makes me happier with this rental; however, I wouldn't consider refinancing yet again.  Cash flow is important, but I have a good job and can easily cover the outlays.

@Rick Baggenstoss you made some great points that were in my head but you crystallized them.  If I were to sell, I'd just put the money into mutual fund in a taxable investment account. I would not invest more real estate while I'm still in Germany, and I do plan on becoming a long time real estate investor and holding onto this rental will only increase my knowledge and experience.

@Elizabeth  C. my operating expenses are: $2000 for PM, $3000 for property taxes, and the remaining is for insurance, HOA dues, and maintenance. I am not prepared to fire my PM as I see my first real estate investment as much an opportunity to gain knowledge/experience as it is to gain wealth.  I like to bounce ideas of my PM and see how she handles issues with tenants.

We may consider moving back into the property if we move back to DC and if I can talk myself and my wife into it.  If we did move back there, that would allow us more time to sell the property using the capital gains exclusion rule that @Ned Carey  and @Michael Siekerka referred to.  I have one question on that rule...February 2015 is the very last date we could sell it and still say we lived there in 2 of the last 5 years.  However, the lease would likely end in March 2015, so let's say I happened to sell it in April 2015 (and therefore had it approximately 1.8 years of the last 5).  Would that sale allow me to exclude most of the gains from the capital gains rate on a prorated basis?

Should I sell my only Investment Property

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