Sell your house at a loss or make it a rental?

Question

I have a young friend, lets call him "Matt" who owns a 4 BR 2.5 BA in a northern VA city just outside Washington, DC.

Matt listed the house with an agent asking $439,000 and hopes to sell it at $430,000. He is upside down on the property owing $427,000, and is also carrying a note with his credit union for $60,000 in improvements he made on the property in the last year and a half. If he sells, he takes a total loss of $78,000. He has a rock star 3.25% 30 yr VA loan. The house is in great shape in a good neighborhood.

He is moving into one of his in-law's nearby rentals, rent free, There is no pressure to sell other than he wants to get it sold, take the "hit" while interest rates are good, thinking doing so will "clear" him to invest in FL real estate (his dream) sooner. He figures its better to absorb the loss because he and his spouse clear about $10,000 a month (combined) from their jobs and figure they can pay off the debt in 2 to 3 years.

I suggested turning the property into a rental. My thinking is he can get depreciation and some favorable tax treatment by turning it into an investment/rental against all of that earned income, and learn about being a landlord (a goal of his) as well.

I think he can get rents close to the mortgage amount ($2500), he thinks more like $2000, but my point to him is even if he sustains a loss of $500 a month, he could do that for about 12.5 years (150 months) before he will have sustained that $78,000 loss - and in the meantime he will have (most likely) had appreciation on the house, and depreciation and business loss against earned income for all that time, So I think he comes out way ahead.

Thoughts? Am I steering him wrong to hold it and make it a rental?

Brian G. · Answer

Hi @Thomas Dorwin

Interesting situation. I personally would not sell. The guys above are right. Depreciation, deductions and expenses will help decreasing any losses. This is a clear example of the need to double down by aquiring another rental to further offset any losses. Also, if the property is in great shape, repairs should be minimal. All the best

Lacey Russell · Answer

I'm an agent and I've worked with investors and rentals in the northern Virginia area. It can be pretty risky depending on the rental rates in various neighborhoods. If you'd like, send me the subdivision and I can run rental comps to help you guys figure out your best option. I can also give you info about the specific area.

I have an investor friend that I work with that bought a property around 625k in NoVA in 2006 (owner occupied), values went down, they had to move, they decided to rent it and it nets them a pretty penny. So it can be done in the right area.

Let me know if I can help you out with the numbers so you guys can make a more educated decision.

Rob Beland · Answer

I think you're right on @Thomas Dorwin. He should do whatever he can to avoid a short sale which will hurt his credit and it will hurt his chances at future investing. I went through a similar situation about 10 years ago. I still own the house I couldnt sell at the time and its been rented ever since. Im not into selling real estate these days. Im into buying it.

Jesse T. · Answer

Is the 60K loan secured by the property?

If only the VA loan is secured by the property, then moving on now without damage to his credit may be possible - although he would still have the 60K loan.

How long ago did he buy the house or what was the original loan balance? Does the 2500/month include payments on the 60K loan?

A couple things about depreciation and taxes if he goes the rental route. He will have to use the current value vs. the purchase price for figuring depreciation. Also if his income increases by about 15% he may not be able to use the passive income deduction.

To maintain his credit I see these options:

1. sell house and pay off 60K loan separately

2. sell house and refinance to personal loans(if it is a secured loan). Even at 10% interest the loan(s) should be paid in just over 2 years with just the 2500/month applied towards the loan

3. rent out house - I would pay rent payments towards the 60K loan

I think the amount of principal that is currently being paid off makes a big difference. If rent ends up paying off taxes and interest and not much else - he is probably better off just having the 60K loan to pay down.

One marketing strategy for selling might be mentioning the possibility of assuming the VA loan.

Rob Beland · Answer

@Steve B. The short sale assumption is based on the selling for $430K and likely paying an approximately $25K commission plus other closing costs and owing $427K. There is also the $60K note that may or may not be tied directly to this property.

Steve B. · Answer

I'm confused as to some of the assumptions you are making. First @Rob Beland said "to avoid a short sale", is this a short sale? I didn't see that anywhere in your post. I'm assuming whether he sells or not he isn't working a short sale with the bank or in danger of foreclosure.

Also you seem to be making a fundamental error in tax calculations. You cant write off active (career) income against passive (real estate) losses, so the fact that Matt and his wife make $10, $10,00, or $1,000,000 of earned income a month is largely irrelevant to this situation. Normally it's always good to pay off non-producing debt as fast as you can I don't know why this would change whether you sell or not other than to say you can afford to support a bad investment. Also taking that depreciation from passive income is advisable but it's still going to be recaptured on the sale.

Finally if all he is making of rent is enough to cover his mortgage ($2,000-$2,500) then he is losing money when you account for property tax, insurance, vacancy, and maintenance. On a $450,000 house even if he clears your optimistic $2,500 a month your talking about a gross rent multiplier of less then half a percent per month. That's an awful investment. So unless you really speculating on enough appreciation to make up for a negative cash flowing property with a crappy GRM you should sell it.

Nicole Jones · Answer

I'm with everyone. Do not sell. I can't find any way where "moving on" is worth the $78,000

Thomas Dorwin · Answer

Thanks Rob and Zach. Thats very helpful. He is impatient and wants to "be done" and "move on". I tell him to be patient, not lock in the loss.

Sell your house at a loss or make it a rental?

Sell your house at a loss or make it a rental?

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