Should I Sell the My Rental?

Question

I have a single family home that used to be my primary residence and about 3 years ago, I moved out and have been renting it out ever since. I've learned a lot about real estate investing since then and am now questioning whether or not it is worthing keeping.

It appraised at $119,000 and I was able to purchase it for $114,000. I own it free and clear and it's been renting for $975 a month ever since. I do have a property manager that charges me 50% of the tenants' first month rent as well as 10% of monthly rent. When I attempt to calculate my cap rate, I'm coming up with a really low number, and since I tend to be overly conservative with my projections, I'm wondering what other landlords think of this property.

Thanks in advance for thoughts and opinions! I'm open to any and all feedback.

P.S. The address of the property in question is 3070 S Overhill Ct, Springfield, MO 65807

Jaysen Medhurst · Answer

@Aaron Lancaster, this is right on the bubble. We really need all the numbers to really offer a constructive opinion. That said, @Joel Gulstrom's points are pretty spot on. If your taxes and insurance are low, you may be okay not hitting the 1% rule. Cap Rates don't really matter when it comes to residential properties (other than for your own internal comparisons) Where I would disagree respectively disagree with Joel is:

• That most people on BP "leverage to the hilt." The posts I read (and you can see that I'm pretty active here) strongly come down on the side of responsible leverage. 75-80% LTV.
• "Dave Ramsey would say you're doing it right." If you are here, concerned about returns and sophisticated enough to properly analyze investment properties, you're beyond Ramsey. He's great for the uneducated masses who don't know what interest is, let alone how it works, and are thousands in debt. For those with a solid base of financial literacy, his blanket advice quickly loses value and becomes counter productive.

Your real concern here, Aaron, is Return on Equity (ROE). My guess is that you're cash flowing ~$525/month after all expenses. That's ~5% ROE on your $119k of equity, which is pretty terrible. Unless you're expecting to see some amazing appreciation (and that is certainly not guaranteed), I would recommend selling and redeploying your capital.

You could take out a mortgage and use that cash for further investments. That would probably drop your cash flow to ~$100/month, but would actually drop your ROE to ~4%, so probably not the best plan.

If there's an opportunity to raise rents and get yourself closer to (or above!) the 1% rule, it may be worth rerunning the numbers to see what's what. I don't know the first thing about your market, but on Zillow I see 3/2 houses in your general area for rent $1100-2700/month. That's a really wide range, which tells me there are a lot of market intricacies.

Dave Foster · Answer

@Joel Gulstrom since your property is owned without debt the cap rate and ROE are going to be the same number.  Cap is a commercial metric that eliminates debt from influencing performance.   I'd ask 2 questions:

1.  Why has it appreciated only $5000 in all these years?  That's not even keeping up with inflation unless you mean that it appraised at 119 when you bought it.  In that case what is it worth now?

2. What kinds of cap ex can you expect in the next few years?  You're probably netting what 5 or 600 a month after taxes insurance, management, etc?  That means that one AC replacement is a years net revenue.  One roof not covered by insurance sets you back 2-3 years.  When you couple that with a negatively appreciating asset that's something to ponder.

If you actually lived in it for 2 years before moving out and it hasn't been a full three years since you moved out then you would qualify for all profit (except depreciation recapture) to be tax free.  A 1031 exchange would save you a bit more but not too much.

My biggest fears with properties like these are making allowances for big ticket expenses when cash flow is good but small.

Joel Gulstrom · Answer

Residential real estate (1-4 units) is valued based on comps. i.e. what are comparable properties selling for.

Commercial (5+ units) are valued on cap rate. Most folks don't look at cap rates for SFR (Single Family Rentals)

Your numbers aren't bad and with it being paid off you will cash flow ok.

However most folks here would say you could do better in a couple ways.

1) It doesn't meet the %1 rule which says monthly rents ought to be %1 of the purchase price. (Your not far off, and you may not be at market rent) This is a rule of thumb for purchasing only.

2) Most folks on here want to Leverage to the hilt which would make your cash on cash returns much higher. However Dave Ramsey would say your doing it right.

To answer your question on should you sell your going to get alot of "depends". It all comes down to what you want. Paid off like it is you should get your $5k spread in cash flow every year.

Current portfolio is my house only. (Also owned outright).

Account Closed · Answer

I agree with Jaysen above about the rent. It sounds like you haven't raised it in years, and looking at similar properties online in Springfield, I think you could raise the rent at least $100. I know nothing about Springfield though, so take that with a grain of salt. Other than that, totally depends on your tax situation, goals, risk tolerance, feelings about debt...etc.

Dominique Pradel-Lewis · Answer

After reading everyone. I vote for calling it a day and redeploying your cash somewhere else with focus on value add. Just my 2cents. And do the lived in it 2/5 yrs strategy.

Joe P. · Answer

Yep, it depends. Renting free and clear @ $975 a month is nothing to scoff at. What are your other expenses like? What's your cash flow?

Why not use the equity of this home to HELOC another purchase for another cash flowing home? You could always sell, but you could BRRRR from the equity of the home and pay back the HELOC after financing another one, and possibly still cash flow on this property. Leverage is everything -- if you want to expand, make more cash per month, you have to utilize what you have. Selling this for ~100k in profit will lead to...what? What's the plan?

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