Rent or Sell our current home?

Question

Quick background: We purchased our first home in 10/2010 as a newly married couple with a FHA loan and as little down as possible.  We paid $93,000 and financed $91,764 for the home.  The home is a 4/2 with two kitchens, in essence a 2/1 with a kitchen on each floor.  However, we do not use it as an in law suite or a rental, it has never been an official rental, nor has it been metered for two units.  Within a year or two, my wife and I are looking to move. Currently, we owe approximately $85,000 and if we sold right now, minus selling costs, I estimate we would be pretty close to breaking even with the potential to lose $1,000-$2,000.

I've considered keeping the home as my first rental property given the initial buying costs, guarantee of selling costs, and potential to lose money on the sale.  However, the numbers do not look very promising.  The only "give" I see within the numbers is I did included 10% for management and $500 for lawn care.  In truth, I would manage the property myself and mow the small lawn.  I also calculated the rent at $1,100 a month based on a quick comparison search on Craigslist.  If any Rochester folks care to comment on this estimate I'd appreciate it, the home is located at 115 Renouf Drive, Rochester, NY 14624 (In Gates).  Onto the ugly numbers!

Please note, this is my first time setting up a Property Cash Flow Analyzer, so if I'm off please tell me.

What would you do?  Keep it with the negative cash flow or sell it off at a very slight loss just to be done with it?

Thanks

Mark Updegraff · Answer

93,000 acquisition

monthly rent 1100

gross yearly rent less 35% (10% PM, 10% Vacancy, 10% Capital reserve, 5% repair) = 8580

minus operating costs

-3850 taxes

-750 insurance

(make the tenant mow the lawn & shovel!)

= 3980 cash flow yearly

cash on all cash = 4.27%

if your financing rate is higher than that it will make your return go down.

here you have 4.75% with 91764 balance = 4358.79 interest

= Negative cash flow! -378.7 per year...

unless you can get more than 1100 rent (which you probably can if you have 4 bedrooms) you should ditch this puppy.

Cheers

Mark Updegraff · Answer

Not a problem!

I would adjust the interest amount to include what it is currently (on 85K) and yes add the PMI.

With those two adjustments (4037.50 interest and 457PMI)

negative cash flow = -$514

The only way to help this would be to have higher rents.

If you could push to 1200 in rent cash flow would be $266

If you're only out of pocket 3k your ROI is 8.8%

typically when I help investors use a FHA product for their first investment property they end up getting well over 30% ROI due to the nature of the little $ out of pocket.  Multi's will perform the best.

Talk soon!

Mark

Simon Campbell · Answer

Since you have two separate entrances and two separate kitchens, it looks to me as if this is already designed as a two unit rental. Does the zoning allow it? When was the work done? Could it have been grandfathered in? You would have a harder time with the city if you were converting, but the conversion was already done by the owner.

On the part about the utilities. Tenants have a nasty habit of running up utility bills when they are not paying them. Why turn off the A/C when they go shopping. Oh just leave the water running while we are washing dishes, etc. If possible, I would definitely look into the cost for separate meters - at least for the electric. Which should be easy since it is most likely that each floor will be on their own circuits.

Doug Shapiro · Answer

Hey Greg,

Another option you may consider would be to charge $1,500+ per month for rent to include utilities, garbage, snow removal, yard maintenance, etc. Or increase rent to be whatever all those additional expenses would add up to.  I think this is a good selling point.  Tenants may appreciate this all inclusive rent and some may be willing to pay more so they don't have to worry about utilities every month.

As long as you can break even every month with rent received being equal to or greater than all your monthly costs, then I think you should keep the property.  However, if you are losing several hundred each month, then perhaps sell.  Looks like you have 27.5 years left on your mortgage, so take a look at your amortization schedule to see how much interest and principal you are paying each month.

Again, this is a tough call, but if I were you I would try my best to hold on to the property if you can manage to break even each month.  Selling properties is costly because you will pay 6% of the sale price to the listing agent and buyers agent, and you have closing costs.  Definitely talk with a real estate agent in your area because it may turn out that you will lose several thousand dollars if you sell right now.  Also check with a real estate agent to find out what your place can realistically rent for.  Tell them you are thinking about renting out your place or selling it, and if they can help take a look to see what the place can rent for.  Remember, renting in the middle of winter typically has the lowest monthly rent because fewer people are looking for a place now.  The best months are May-October, since this is best for school year schedules and is when most people are signing lease agreements.  In other words, ask what your place can rent for now, as well as what it can rent for during the best months to rent.

Jay

Dave Savage · Answer

@Greg Baker your last post made a lot of good points about the negatives of changing it to a double.   I am not sure about Gates, but the City of Rochester would be very unlikely to allow you to change it to a double, and I suspect Gates would be similar.  The neighbors would fight it for sure.

The numbers are tough on this one, although I like you got into it with nothing down, renting a $93k house for $1100-1200(max for Gates) is a tough proposition.   The only thing to consider is you will be gaining equity every month, but the high taxes, and PMI make it a tough deal long term.

I would rather see you sell it, and start saving $300-500/mo until you can put a downpayment on a $50-55k double in Maplewood with separate utilities that you get $1300 a month for.

Greg Baker · Answer

@Jay Shapiro  @Simon Campbell @Mark Updegraff

Thank you for the additional points of view.  The house would be very easy to rent as 2 individual units, there is a "common entrance" side door, after which you can enter the basement to the right which provides access to the electric panel, go through a door to the first unit on the left, or walk up the stairs and through another door for the second unit. The good news is the mortgage is also only in my wife's name.

Here's my only concern which I would love advice on a work around.  The home is not metered for two units.  Gas/Electric for my wife and I is $209 a month but would expect more for multiple families, garbage is $30 a month, water is $17 a month, so say $260 at least more per month in utilities if I cannot pass them on. If I was able to collect $1300 a month rather than $1100, I'm -$60 unless I can somehow pass those costs onto the tenants.

Additionally, I know I can tell a single family home renter to mow the lawn and shovel snow, but can you tell tenants who share a property this?  If not, that's me on the weekends for mowing, and $250 a winter for plowing.

Last, but not least, does it require any additional inspections or certifications from the town/village before it is approved as a multi rental as compared to a single family rental?

Thank you for your time and expertise!

Doug Shapiro · Answer

Hi Greg,

I would definitely look into the possibility of splitting the house into 2/1.  Each "unit" should have its own entrance and essentially be separate from one another.  As Simon Campbell said, this should increase what you can rent the property for.

Another possibility would be to remodel the 4/2 so that you can again charge more for rent.  If you remodel and increase the value of your property a lot, then your lender may remove the PMI after an appraisal.

Considering how little equity you have in the home, selling is almost silly.  If you can make your net income positive, then definitely keep the home.  You paid only a few grand to own a $93,000 home.  I mean, even if you just hold on to the home until your loan is paid off in 27.5 years, that return is amazing...in theory you invest maybe $5,000 (down payment + closing costs) to purchase, and assuming that there is no appreciation and you can keep the place rented so that all costs are covered, then your initial investment will increase just over 18 times.

If you purchased the house with both you and your partner on the loan, then you should look into refinancing under just one of your names.  Couples should always try to keep loans separate because then the non-loan holder can still buy with a new loan.

Also, you may want to speak with a real estate tax specialist about this, but remember that if you change a primary residence into a rental, then you can count the net income as an addition to your salary and the loan is not counted against your credit.

I looked at your spreadsheet and noticed that you may be able to cut costs by looking into different insurance companies with lower rates, but equal coverage, and also by appealing your property taxes.  Do a search for "How to appeal your property value NYC" to find out information about this.

Hope that helps.

Jay

Simon Campbell · Answer

Two kitchens, definitely should split this one. Lets say you can get $650 per unit. Gross monthly income of $1,300. Less 50% expense rule (does not include mortgage or PMI). Less mortgage payment of $518 +/- including PMI. NOI before tax is $134 per month or $1,604 per year. Meaning you make your down payment back annually.

Cap rate is 8.4% - not bad.

But your cash on cash return is 129.8%!

Greg Baker · Answer

Mark, as always, thank you for the feedback.  I created a little spreadsheet based on your formula, but I have two questions.  My CURRENT balance on the home is approximately $85,000.  Do you always use the original amount I financed because that's how amortization of interest is set, or can I use my CURRENT balance?

Secondly, the loan has PMI ($457 a year), should that be an additional line item?

Rent or Sell our current home?

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