patrick.net

Sell it?

It's the same house as it was when you bought it for 1M. From your question, it seems like it was worth paying a 1M mortgage to live in it in 2009. OTOH, you now have two new options: sell it for 1.75M or rent it out and rent a smaller unit.
Option 1: Stay in house - no new capital/revenue.
Option 2: Rent out house and rent a smaller unit. Presumably, your out of pocket expenses go down, by a fixed amount, but you have less space.
Option 3: Sell house, and buy / rent smaller unit.

Option 1 & 2 are easy to compare. Just look at the reduction in monthly living expenses and decide accordingly.
Option 3 is harder to compare, as this is an investment decision. If you think that housing is getting overvalued again and want to protect your 'gains' against a potential downturn, then sell it. Otherwise, pick from options 1 & 2. The risk in selling is that if housing prices continue to go up, you are stuck paying whatever rent the market bears.

If you are young and like the area, the conservative option is #2. You always need to live in a house, and assuming no depression style deflation event, you are better off owning one house.

If you are old and want to retire elsewhere, selling and downsizing is the conservative option.

Is your assessment about how much you'll be ahead accurate? A good number of properties seem priced above what rental income would cover. And can you cover two payments if the property sits vacant?

It depends on how you have invested in the house. If it's 20%, then you've basically got a $200K bond paying $1K/month or $12K/year. That is 6%/year. Which isn't horrible if that was guaranteed passive income, but in this case it's not. There is risk of not being rented, risk of repairs, etc. I'd sell and invest the proceeds--you'll make about the same profit without some of the risk.

Sell it. Pay $500,000 cash for the town home. Blow the rest on hookers and coke.

Run the NY Times rent vs buy calculator with your numbers:

https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

Just putting in the price of $1.75M and not modifying any other of their defaults:

If you can rent a similar home for less than ...
$5,600 PER MONTH
... then renting is better.

If you can rent the equivalent house for less than $5,600/mo, it looks like you'd better off selling and renting. Especially since you don't seem to mind moving to a smaller place.

Personally, I'd put the profit from the sale in low-overhead index funds like Vanguard's.

alpo says

I bought the house for $1M in 2009 in san mateo county. Now it is worth $1.75M. If I rent out the house I will get around $ 1,000 per month

It would take you 750 months or 62.5 years to make as much money from rent as from selling it. $750k getting an after tax return of just 5%, easy to do in the stock market, is $37.5k/yr and grows exponentially. And it's easy to sell stocks when you need to. And you can sell how much you need. You can't sell 10% of a house.

alpo says

I figure this will build wealth quickly as the rent money will pay for mortgage, property tax, etc while allowing me to accumulate an extra $1000 per month.

any thoughts suggestions.

Keep the house. It will be worth 50%more in less than 5 years.

joeyjojojunior says

If it's 20%, then you've basically got a $200K bond paying $1K/month or $12K/year. That is 6%/year.

No. You have to use his current equity to calculate his true returns, because the equity is now his true investment. And you have to factor in appreciation.

Strategist says

No. You have to use his current equity to calculate his true returns, because the equity is now his true investment. And you have to factor in appreciation.

It was a simple approximation. Really, you should account for principle paydown, property tax increases, house appreciation, rent increases, etc. And yes, I think you're right that he should approximate his present equity rather than just his down payment. After doing that, it will certainly be better to sell.

joeyjojojunior says

Strategist says

No. You have to use his current equity to calculate his true returns, because the equity is now his true investment. And you have to factor in appreciation.

It was a simple approximation. Really, you should account for principle paydown, property tax increases, house appreciation, rent increases, etc. And yes, I think you're right that he should approximate his present equity rather than just his down payment. After doing that, it will certainly be better to sell.

Only if you use little or no appreciation. Remember, if he used your calculations he would not have purchased in 2009, and would have lost out big time.

Normally people pay the biggest chunk of their income for housing. If, with cash you get from selling this house, you could buy something smaller for around what you get out of it, you'd reduce this amount drastically. That's perhaps two or three thousand per month in savings, vs. the one thousand you spoke of. Plus you are a homeowner able to make your own decisions with the new place and able to still make money on a rising market. Seems like an easy decision to me.

Strategist says

Only if you use little or no appreciation. Remember, if he used your calculations he would not have purchased in 2009, and would have lost out big time.

I don't think you can assume 10% appreciation/year forever.

joeyjojojunior says

Strategist says

Only if you use little or no appreciation. Remember, if he used your calculations he would not have purchased in 2009, and would have lost out big time.

I don't think you can assume 10% appreciation/year forever.

You can assume a long term appreciation of 6% to 7% in desirable California cities. Even 4% would tilt the outcome of your formula to a "buy"

Strategist says

You can assume a long term appreciation of 6% to 7% in desirable California cities. Even 4% would tilt the outcome of your formula to a "buy"

That's assuming a house in san mateo county, is desirable. To some maybe, to me ... well, there again I don't want any part of any place in CA.

I make that after expenses on 200K houses I buy out of state and rent out. Basically new houses as well. (few years old)

Strategist says

You can assume a long term appreciation of 6% to 7% in desirable California cities. Even 4% would tilt the outcome of your formula to a "buy"

Not if you use his equity instead of his down payment. And if you're going to include appreciation, you must also include rent appreciation as well.

It's going to be a strong sell.

Option 1: Stay in house - no new capital/revenue.

Option 2: Rent out house and rent a smaller unit. Presumably, your out of pocket expenses go down, by a fixed amount, but you have less space.

Option 3: Sell house, and buy / rent smaller unit.

If I rent out this house and move into a smaller 2x2 apartment, I would save approx $1,750 per month without loosing the ownership of the house. In next five years, I should be able to save enough to buy a 2x2 condo or a townhouse. Basically, this is the best I can come up with to increase my net worth.

The house will probably sell for more in this market, if I spend some money remodeling it. Also, if I add 1000sqft of second floor to the house (approx $200,000), or remodel the attic into living space (probably 100K), the house will probably sell for $2.5M easily, i.e there is potential money to be made here, so selling the house in this condition seems like throwing away money on the table.

But for now, I am a bit constrained for cash, so the only way I can think up of increasing my cash reserves is by renting out the house and moving to a 2x2 apartment. At the same time, the renter will continue to pay down my mortgage indirectly, so I don't loose ownership of the house. Once my cash reserves are up after saving for five years or so, I may buy a 2x2 condo or townhouse in same area and continue to rent out the original house for some extra income or maybe in future, I remodel the house and sell it for more. Obviously, I wouldn't be moving out if I had loads of money.

The way I look at it is that the $570K loan on the house is "leverage" that can be paid down with rent to increase my net worth. I am not comfortable investing in stock market etc as in my view they are too volatile and I don't have much faith in financial instruments such as stock etc.

Wondering if my plan makes financial sense?

Quigley says

Normally people pay the biggest chunk of their income for housing. If, with cash you get from selling this house, you could buy something smaller for around what you get out of it, you'd reduce this amount drastically. That's perhaps two or three thousand per month in savings, vs. the one thousand you spoke of. Plus you are a homeowner able to make your own decisions with the new place and able to still make money on a rising market. Seems like an easy decision to me.

Selling the house doesn't make sense to me. My lifestyle doesn't require me to have a load of cash, so I have no attraction for the cash that i will get by selling the house. Beyond that, if I buy a 2x2 townhouse in the same area as the house, it will cost me around $1M (the same price as I originally paid for the house) so my property taxes will remain the same, but I will have a smaller house. I don't have much faith in sock market (or my ability to invest cash in stock market or funds to make money and increase my net worth). Also, HOA won't allow me to add a second floor to a townhouse. My current house is a single floor house and if I spend around $200K adding a second floor or remodeling the attic it will sell for way more. So by selling the house, it seems like I am leaving money on the table.

On the other hand, by moving to a 2x2 apartment, I can save approximately $1,750 extra per month and in five years time that should allow me to buy a 2x2 townhouse. Ultimately, I should be able to retire my living in the townhouse and living off the rental income of the first house. I like the leverage that comes out of taking a mortgage home loan. In this case, the renter will indirectly be paying my mortgage and all other expenses for the house that will allow me to accumulate equity.

mmmarvel says

That's assuming a house in san mateo county, is desirable.

lol if u only knew what Peninsula real estate is like

Where are you going to find a rental in that area now that'll give you an extra 1k compared to your payments on your 570k loan?

Rashomon says

Where are you going to find a rental in that area now that'll give you an extra 1k compared to your payments on your 570k loan?

I am renting out a larger house with likely rent of $5000 and moving to a smaller 2x2 apartment that I will rent for around $3200. My expenses related to electricity, water, gas, garbage bills will also go down once I move to 2x2 apartment.

I don't really follow. Why not just stay at your (presumably) much nicer property and pay the 2.5k on your loan rather than throwing away money on your smaller 3.2k rental?

Rashomon says

I don't really follow. Why not just stay at your (presumably) much nicer property and pay the 2.5k on your loan rather than throwing away money on your smaller 3.2k rental?

If I move out into an apartment, I will be saving $1750 per month, that is $105,000 over next five years. That will go a long way in downpayment for a 2x2 condo or townhouse (if I can afford it) five years down the road. I don't have enough cash for downpayment for a 2x2 townhouse or condo right now. My total expenses for staying in a 2x2 apartment (rent and bills) are lower than my total expenses (mortgage, property tax, insurance, bills, maintenance) for continuing to stay in the house. By moving out, the renter will be indirectly paying all house expenses while I still continue to maintain ownership. My expenses will decrease and I will save an extra $1750 per month. I will also continue to increase my equity in the house at the rate of around $800 per month while the house is rented out

I thought you said the loan was 570k. The payment for that isn't 5k...

No, the house will rent for 5K. loan is 570K.

So you currently pay less for the mortgage than you'll pay in rent...

yes, but there is property tax, insurance, and bills also. My total expenses for staying in the house is around $4100. If I move to apartment my total expenses for staying in the apartment will be around 3400, plus I will make around $1000 by renting the house as the house will easily rent for $5000

Are you actually spending anything on maintenance? You'll have to foot the bills in the rental. That 3.2k is now. What will it be next year or the year after? Your proposed 5k is just that. You haven't rented it yet. You don't know how long it'll rent for or what you'll get - how many months might it sit vacant? Doesn't have to be many to take a big bite out of your calculations. If money is tight, then why not just realise the appreciation? You're taking a bit of a risk renting out a multi-million pound house if you don't have that much cash on hand. What happens if a major problem arises and you have to foot the bill for repairs whilst also carrying rent (and no rental income)?

maintenance expenses on the house are minimal and I am pretty handy at fixing things around the house. If the apartment rent goes up, then house rent will go up as well. Houses in this area are not known to sit empty. They either sell or get rented out quickly. If apartment rent goes up, house rent will also go up. Plus in the very worse case if for some remote reason the house sits empty, I can always break apartment lease and move back into the house - I just stop saving $1750K per month in that case.

This is a ~2000sqft house, not a palace :-)

>
> If money is tight, then why not just realise the appreciation
>

because if I remodel the attic or add a second floor for $200K, the house will sell for more, so selling the house now will mean leaving money on the table. Also, money is tight, but not that tight. If I can rent out the house for two years, money will be fine after that. My liquid assets will get back to more comfortable level. If I can rent out the house for five years, I should be able to have enough money for a downpayment on a 2x2 condo or townhouse.

i would rent it out.

alpo says

If the apartment rent goes up, then house rent will go up as well.

There's no guarantee that increases will be uniform across the market - the real pressure in your market is the lower end, isn't it?
alpo says

Plus in the very worse case if for some remote reason the house sits empty, I can always break apartment lease and move back into the house

And presumably lose the deposit and incur moving expenses...
alpo says

because if I remodel the attic or add a second floor for $200K, the house will sell for more, so selling the house now will mean leaving money on the table

That rather sounds like pie in the sky. You said you don't have that money and from what you're saying won't have it for a very long time (if ever). Who's to say what the market will look like many years down the line.
alpo says

If I can rent out the house for two years, money will be fine after that. My liquid assets will get back to more comfortable level.

And in the mean time? What happens to you if an earthquake causes say 20k of damage? 50k..? 100k...? Earthquake insurance (if you have it) has some pretty staggering deductibles. I know that's a pretty out there prospect, but what about say a sewage line problem etc?

Just pointing out that your scenario may be more optimistic than you realise. There's a lot to be said for cashing in the kind of appreciation you've made. Hassle free cash to do with as you like.

Never leave your primary house and rent a smaller house. Most people end up regretting it. There are so many reasons against it.

1) Rent --- Your exempt capital gain becomes taxable --- disaster for 1K bucks a month (and trade in 250K in taxes?) (33% of 750K gain)
2) Sell - Selling your only primary home is never a good idea. Now you are gambling on market direction.

Hope that helps.

SFace says

Never leave your primary house and rent a smaller house. Most people end up regretting it. There are so many reasons against it.

I am looking for sound financial reasons to stay in the house, but not finding any. My expenses will go down by around $750 per month if I move into an apartment. Beyond that I will make $1,000 a month extra by rending out the house. So in total I will gain $1750 every month by moving out. That $1750 per month will add up to $105000 in five years time and after five years, I should have enough savings to make a downpayment for a $1M townhouse. So after five years or so, I am hoping to live in the townhouse and continue renting out the house for income. At some point, the house should be fully paid off courtesy of the renters renting the house or maybe I rent out both the house and the townhouse and go on an year long world tour. The way I see it my opportunity cost for continuing to stay in the house is $1750 per month. I am not able to justify that cost.

1) Rent --- Your exempt capital gain becomes taxable --- disaster for 1K bucks a month (and trade in 250K in taxes?) (33% of 750K gain)

By renting, I get can depreciate a lot of things too in tax return and if I need to sell it, I can move back in for two years to get the 250K capital gains benefit.

2) Sell - Selling your only primary home is never a good idea. Now you are gambling on market direction.

Thats not in my plans either. I will still need a place to stay in silicon valley long term even after I sell the house and having been through several economic boom and bust cycles, the only reason that will make me sell the house is if I desperately need the money or if the long term future of silicon vally is in jeopardy.

Hope that helps.

Not an easy decision.

alpo says

I am looking for sound financial reasons to stay in the house, but not finding any. My expenses will go down by around $750 per month if I move into an apartment. Beyond that I will make $1,000 a month extra by rending out the house. So in total I will gain $1750 every month by moving out.

You really need to talk to a good tax guy before you do anything. There are many tax considerations. The entire $5000 a month rent is taxable income to start. You lose your 250k (500k if married) capital gains exemption if you do sell the house. . etc, etc, etc.

You need to maintain the property. There will be down time There will be tenants that stop paying and you have to go to court to get them out, some states that can take months. There will be tenants that do thousands in damages beyond the security deposit and disappear. You will almost certainly have to pay someone to manage the accounting and tax filings. All of this is going to nibble away at your theoretical 1750 every month.

There are plenty of rental markets out there paying 1% gross with strong nets. A 100,000 house rents for 1000 a month a 200,000 rents for 2000 a month. Once you get over 300k in most markets you start to lose ground. A 1.75 million house should, but never will, rent for 17,500 a month. You will be getting 1/3 of the rental income that you would get selling the property and buying in other markets using a professional property manager. Even with paying capital gains on 500k the numbers are still way against you renting out a 1.75m house.

A house is a big wooden box. Period. Use your boxes to make the most money you can. If the numbers fall then move on to better opportunity cost. Selling a house isn't very hard in most markets. Don't give any thought to appreciation. Only look at cash flow. You will never be disappointed that way.

bob2356 says

You need to maintain the property. There will be down time There will be tenants that stop paying and you have to go to court to get them out, some states that can take months. There will be tenants that do thousands in damages beyond the security deposit and disappear. You will almost certainly have to pay someone to manage the accounting and tax filings. All of this is going to nibble away at your theoretical 1750 every month.

That's the worst case scenario from hell.

Most of the time if you consider about 10% vacancy you'll be accurate. I hear in Bay Area there are waiting lists for rentals, so you might not even have that problem. Not saying you won't have issues, there is always a learning curve to everything, just giving you the average for LA which is a good comparison for a big city.

Your income = (MonthlyRent * 12) * 0.9 - maintenance(~2%) - taxes - loan.
0.9 in there is assuming 10% vacancy rate over a long period of time, reasonable standard for big cities.

Hope this helps.

most importantly ask yourself, will you feel comfortable with whatever you are doing if downturn hits? it'll happen eventually, boom and bust cycles happen periodically.

bob2356 says

You need to maintain the property. There will be down time There will be tenants that stop paying

Agree with SF Ace and Bob. From what I hear it's now difficult to find credit worthy long term renters in San Mateo county. Putting 500K capital gain tax free at risk is not a good idea.

Do you have a family? If yes, I would just keep the place. If not, sell it , and put your money into NAC or something with shorter duration. What's your approximate wage income?

FortWayne says

That's the worst case scenario from hell.

How many properties do you rent out right now? Rent out long enough or often enough then sooner or later you get screwed by a tenant big time. My worst deadbeat was a cardiologist. It looks like it would take 90 days to evict a non payer in CA, then probably another month to get someone in. Carrying a 570k mortgage plus taxes, utilities, etc. for 4 months would be a big hit on that 1750 a month in savings.

FortWayne says

Most of the time if you consider about 10% vacancy you'll be accurate.

and every time you turn over there will be touch ups, key changes, advertising costs, etc., etc.. All of this comes out of the projected savings. Maybe someone will move in and stay 10 years, maybe the house turns over every year. You never know.

Personally I would take the cash out and invest in houses in markets that have the highest ROI. Find a really good property manager and let them do their job. This would require lots of homework. I wouldn't go crazy with leverage, but with interest rates so low putting 50% down and taking a 15 year or 10 year would be a good compromise. Cash flow would be reduced, but equity would build quickly. There are markets where 500k cash plus 500k in mortgage could get you close to double the gross income you are projecting while leaving you a large amount of cash (1.75-570k mortgage -500k investment is a lot of cash) Nets would be somewhat lower with a property manager, but still much higher than your current projections.

If you can rent a 1m apartment for 3k a month then why would you even consider buying it? That's .3%. Arbitrage the 1% in income in another area against your .3% locally and smile.

bob2356 says

Personally I would take the cash out and invest in houses in markets that have the highest ROI.

The highest rents are in places where the appreciation is rates are the lowest. I would go with the appreciation.

bob2356 says

If you can rent a 1m apartment for 3k a month then why would you even consider buying it?

Definitely not worth buying as an investment, but it's a whole different formula when you will be living in your own home. The satisfaction of owning your own home has a lot of value.

bob2356 says

Personally I would take the cash out and invest in houses in markets that have the highest ROI. Find a really good property manager and let them do their job. This would require lots of homework. I wouldn't go crazy with leverage, but with interest rates so low putting 50% down and taking a 15 year or 10 year would be a good compromise. Cash flow would be reduced, but equity would build quickly. There are markets where 500k cash plus 500k in mortgage could get you close to double the gross income you are projecting while leaving you a large amount of cash (1.75-570k mortgage -500k investment is a lot of cash) Nets would be somewhat lower with a property manager, but still much higher than your current projections.

yeah it's one of the reasons I don't invest into rental properties. I invest into stock market, over years it beats real estate. Has it's risks and up and downs, but it's better overall, and there are enough strategies to cover yourself. Plus I feel better about myself, I don't feel that it is morally right to buy houses to rent them out, rather leave that housing to families who want to buy and live there.

FortWayne says

Plus I feel better about myself, I don't feel that it is morally right to buy houses to rent them out, rather leave that housing to families who want to buy and live there.

You need to rethink your morals. A third of the population would be homeless. Students would not be able to attend college. Young people would find it impossible to start families. Society would sink in the chaos.