We're planning on upgrading in the near future(kids, more space, etc.) and I'm debating whether to sell the house and roll the equity over or sell some equities to fund the down payment. The house is 2,385 sqft in a north Dallas suburb. We bought it for $320k five years ago, put about $60k into it, and we're being told it would likely sell for $400-420k in the current market.

On the rental front, we're being told by neighbors who have rentals in the neighborhood that we can likely get 2,600-3,000 per month if we rented it. I've never evaluated a residential rental investment before but my conclusion is that the math looks OK if we get the top of that range and that we're negative cash flow at the bottom.

This assumes we use a management company @9% flat rate.
No management company, and a minimal fee for listing, lease, and rent payment services, and we're cash flow positive anywhere in the range.
The other expense is HOA and I inflated the taxes a bit due to losing the homestead exemption. The made some guesses on the expenses but financing, insurance, etc. is pretty accurate. Depreciation I took the dwelling value on the appraisal district over 27.5. It's also worth noting that the only two foreseeable cap ex items are HVAC(16 yrs old) and our insurance deductible if it hails.

My math is below and I'd like some feedback on whether my expense allocations look reasonable or not and if you agree with my conclusion. Also, I have a few questions...

-Would you use a management company if you lived 1-5 miles away? I'm very handy and comfortable with non major repairs.
-Would you lease it anyway if cash flow negative? Why/why not?
-What else should I be thinking about as we make this decision?

Great job on thinking this through from all angles. I see renting as a favorable decision in most cases, unless the neighborhood becomes overrun with rentals, which could then result in a decrease in home value. My one rental has done incredibly well over the 10 years we've rented it. I've always used a management company as I don't have the time or know-how to fix stuff on urgent notice. Over the past 10 years it's only been vacant for 1 month. Unless you have concerns about an unforeseeable real estate market correction, rent it for a year and see how you like it. You can always put it on the market next year.

But there are some really strong rental property owners on this board who could give you better advice.

Edit: regarding negative cash flow, I never saw it as a big deal. The $100/month loss was less than the $300/month in increased equity. Over time, the rental rates have increased to where I now have a $100/month surplus plus the increase in equity.

Thanks for the feedback so far. Good call on the Insurance and we already have an umbrella.

birdman said:

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I went through it very quickly. It appears you laid out two scenarios.

On the best scenario, do you net about $k per year?

No way would I hang onto that house for that amount of money. You are taking on a bunch of risk and work for very little money.

I'm not sure what you would get out of house sale, but selling ought to be a better financial decision.

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It's probably overly cautious, but this has always been my concern - a few thousand a year seems like it could be eaten away quickly by a vacant month, an increased tax assessment, a busted pipe, broken washer/stove/oven/ac, etc. I'm guessing if you're in a situation where you have a paid off or very nice mortgage vs the rental rates and/or where you are managing things yourself, it would make sense, but it feels like such a roll of the dice if those aren't the case. Especially given that your renters aren't going to necessarily take care of things the way you would as the home owner.

Ditch the management company as it's going to sink any "one off" deal. Not that much work if you're in the general area.

Also, maybe you explained this somewhere but why are you pencilling in principal paydown in the proforma? That might be part of your strategy but I wouldn't include it in my assumptions.

That's a fair comment. We've been paying down extra on the mortgage monthly and the plan was to hold it until the end of the year as a buffer to the vacancy/maintenance reserves. We'd make the extra payment if all was kosher and use it for whatever came up if we needed to.

right. That can certainly be something you do with your cash flow, but I wouldn't burden your proforma with it, considering it's a pretty arbitrary number.

It's an expected outflow either way so that's why I included it. One way just happens to be deductible and the other doesn't. Is your thought to exclude it to simplify the calculation or is there another reason?

I'm just saying that number doesn't tell you if this is a "good" deal or not.

If you were paying down $1,000 in principal, it would be totally underwater, but that has nothing to do with the
rental value of this property.

That makes sense, thanks for clarifying.

JDCAG (NOT Colin) said:

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birdman said:

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I went through it very quickly. It appears you laid out two scenarios.

On the best scenario, do you net about $k per year?

No way would I hang onto that house for that amount of money. You are taking on a bunch of risk and work for very little money.

I'm not sure what you would get out of house sale, but selling ought to be a better financial decision.

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It's probably overly cautious, but this has always been my concern - a few thousand a year seems like it could be eaten away quickly by a vacant month, an increased tax assessment, a busted pipe, broken washer/stove/oven/ac, etc. I'm guessing if you're in a situation where you have a paid off or very nice mortgage vs the rental rates and/or where you are managing things yourself, it would make sense, but it feels like such a roll of the dice if those aren't the case. Especially given that your renters aren't going to necessarily take care of things the way you would as the home owner.

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IMHO it makes less sense if it's paid off. Real estate gains won't be able to out pace market gains long term in most situations. Where real estate shines is you can leverage your credit and roll $100k into a 500k property at a low intest rate, whereas you can't get a favorable loans like that to invest in stocks.

If the house was paid off you should sell it, take the tax free gains and invest in two rental properties if you want to get into the real estate game.

Good point on market vs real estate growth.

I guess my question is, if you used $100k to buy a $500k house, it seems like your rent would be such a narrow margin that any typical "house" thing would potentially blow a year or mores worth of earnings. In that case, it seems you'd be looking at somewhere close to or north of $3k/month between the note, insurance & taxes. Would that house rent for substantially more than $3k? If it went for $3,500 a month, that'd net you $6k per year, but 1 vacant month cuts that in half. And that's if there is no overhead at all.

Very good chance some of my estimates are off which makes the math more workable, but it's always seemed to me like it would be a very low margin situation unless you had a mortgage that was substantially less than the going rental rates. Would love to hear from some folks that make it work and get an idea of what they look for, why type of returns they have, how much margin they have for things like vacancies, repairs, etc.

I suppose another consideration is that you are gaining equity with each month, so it isn't like cashflow is your only long term value here.

If you choose to sell - I'd look at Red Pear Realty for listing and maybe buying. They would save you a lot of money on the listing and if you buy with them too, you'd get 2% of the purchase rebated back to you as well. They have some great reviews too about their service.

Other thing to consider is when moving out of the primary residence is you are giving up the tax free growth in house value (up to a cap). If you bought a house for $200k and it's now worth $300k you can cash out and likely not pay capital gains tax on that 100k. If you rent it for 5 years and sell it for $350k you will be in the hook for the full $150k in appreciation, so that is an opportunity cost to consider.

sell it. I've culled some rentals the past year.

If you had $100k equity and a mortgage of $1800 on a 500k house, in a crazy year like this one if your monthly cash flow was -1000 but you see a 10% increase in value on the house, you would have essentially paid $1000 a month to turn 100k equity into 157k equity (50k home value increase $7k principle reduction). That's over a 30% return on your money!

If you owned the house outright in the same scenario that you would net $800 a month instead of losing $1000 since you don't have a mortgage so you have made $9600 cash and 50k equity so you turning $500k in value to $560k which is around 11% return... So an insane real estate year amounts to a slightly above average stock market year when you aren't leveraged.

We would have roughly $180k in equity if we sold today at 400-410k. FWIW.

Rate on the current mortgage is 2.8%

Nothing to add, but where are you getting insurance that cheap?

Mercury Insurance. Liere is my agent.

Anything with a useful life >1 yr is technically under cap ex but I'm sort of making this up as I go.

Does your answer change if we change the equation to renting to sell within the next 3 years? In an effort to avoid cap gains tax.

In my head, the "right decision" hinges on whether I think the equity market is more likely to correct/dollar hit rapid devaluation or is it more likely for the RE market in my area to stall or crash. If I'm thinking the former is more likely to happen than the latter, then I might make sense to rent regardless. Am I over simplifying this?

In other words, if I think the equity markets are as likely to return 10% as they are to return -10% annually over the next three years, and I expect annual asset appreciation of 5% plus positive net income from renting, then renting sounds like a less risky endeavor and may be a good way to diversify. Its worth noting that the equity in this house, plus a small amount of physical gold and crypto, are the only assets I have that are not in stocks, bonds, or cash.

NTXAg10 said:

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Does your answer change if we change the equation to renting to sell within the next 3 years? In an effort to avoid cap gains tax.

In my head, the "right decision" hinges on whether I think the equity market is more likely to correct/dollar hit rapid devaluation or is it more likely for the RE market in my area to stall or crash. If I'm thinking the former is more likely to happen than the latter, then I might make sense to rent regardless. Am I over simplifying this?

In other words, if I think the equity markets are as likely to return 10% as they are to return -10% annually over the next three years, and I expect annual asset appreciation of 5% plus positive net income from renting, then renting sounds like a less risky endeavor and may be a good way to diversify. Its worth noting that the equity in this house, plus a small amount of physical gold and crypto, are the only assets I have that are not in stocks, bonds, or cash.

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If it is your primary residence and you've been there five years, you can sell it now and avoid all the cap gains tax. It's just highly unlikely that just by chance your best investment option is your old house.

Right. My understanding is that as long as it was my primary residence for 2 of the 5 years prior to the sale then I can avoid cap gains. My post was suggesting that I rent it for however many months/years allows me to meet this criteria.

NTXAg10 said:

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Right. My understanding is that as long as it was my primary residence for 2 of the 5 years prior to the sale then I can avoid cap gains. My post was suggesting that I rent it for however many months/years allows me to meet this criteria.

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It is definitely a big enough amount that you should talk to a CPA......do not risk that. This IRS web page would indicate you are okay:


https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/property-basis-sale-of-home-etc/property-basis-sale-of-home-etc-5

Management company is only worth if you have 5 or more properties

Rent it out and keep on building equity and hopefully some monthly cash flow.

This is something I've been thinking a lot about lately. I'm not sure if I'd be able to handle driving by and seeing the lawn not being cared for the way I think it needs to be, or having someone destroy our floors due to a pet, etc.

I'm leaning towards selling as of now.