Rental property help: sell or keep?

Question

Hello! I need help from smart people on this forum to decide whether my rental property should be sold or kept. It is a condominium with 3 bedrooms/2 baths, 1200 sq ft, built in 1997. It was bought in 2011 at a price of $110k in cash. Monthly rent $1,175 during the last year. HOA $255 monthly (covers water, outside landscaping and roof repairs). Property management fee $75 monthly. Plus rental insurance and home warranty. Current market price is about $220k. Good location. Net return on investment according to my calculations is about 4.2%. Should I sell given the 100% market appreciation or continue renting it out? Thinking to sell as I prefer single family homes with no HOA as rental properties (would do a 1031 exchange). However, might be challenging to find a great deal now. Thank you for your thoughts!

Clayton Mobley · Answer

@Amy Thompson I am going to (surprise surprise) second the opinion of @Dave Foster - while you're getting a nice rent rate here and the appreciation you've already seen is great, those HOA fees are dragging down your ROI. I think selling and using the 1031 process to leapfrog into a few solid SFR rentals would be your best bet. No HOA fees will make a huge difference.

I can only speak for Birmingham, but with $220k in capital (debt and equity, not sure your split here) you could get a couple wonderful B/B+ properties that get about $950 per month each. Now, I assume most of that $220k is equity, given the appreciation. So if you have like $80k in debt and $140k in equity, you can use the equity to put down payments on two ~$100k props and even buy a third outright if you'd prefer not to be completely leveraged (you'd still end up with more debt than you currently have, maybe $160k instead of my $80k assumption). If you're comfortable with debt and can qualify for this much financing, that $140k could give you several down payments.

The point is you're in a position with a lot of options, and most of them will result in greater cash flow, fewer fees, and much better diversification. If your current prop is vacant for a month, that's your entire cash flow gone. If you own 3 SFR rentals and one is vacant for a month, you still have $1900 in gross rents from the other two (using Birmingham numbers, of course).

Congrats on that sweet sweet appreciation! I recommend that you use the tools available to you to leapfrog it into a nice little starter portfolio with fewer fees.

Good luck!

Clayton

Dave Foster · Answer

@Amy Thompson I think you’ve already got this figured out.   There's always bargains to be had.  And you've got a lot of equity drying up.   But real estate has become very commoditized within regions and sectors.  You can always buy  what your selling.  That's your worst case.  And there's always bargains to be had if you look.

In your case there's an even greater incentive to sell and 1031.  By moving back into SF with no HOA you're upping NOI a significant amount.  Now you've got to remember that you won't get to keep all of that monthly fee because undoubtedly some covers insurance and some maintenance.  But still simply exchanging into a property with identical cash flow and all would net you more each month.

The key of course is that you do it without triggering a recognition of gain.

Amy Thompson · Answer

@Jason Cory and @Dave Foster many thanks. Would like to avoid paying hefty taxes by doing a 1031 if possible. Would a title company be able to take care of it or still need a qualified intermediary?

Dave Foster · Answer

@Amy Thompson, I think I see what @Jason Cory is referring to.  You're on the right trail.  You can use your 1031 with mortgages as you were anticipating to buy whatever assets in whatever quantities you want to complete your 1031 and boost your ROI.

Jason is referring to the old way of 1031 exchanging where two parties had to actually trade properties.  He's absolutely right.  Back then you didn't want to get stuck with cash because you then paid tax on it.

In the regular form of the 1031 now you simply sell and as long as you reinvest all the cash proceeds you get from the sale and purchase at least as much as you sold you will not incur tax.  So you can follow Jason's recommendation to sell nicer properties and purchase more cheaper properties that provide better cash flow.

Of course in the modern 1031 a qualified intermediary is required to facilitate and document the process of you selling and buying.

Jason Cory · Answer

You never want to be the one with cash in an exchange. You're always fighting appraised value to avoid gains since you're always exchanging, like kind. Both assets have to match in value or one side has to contribute so it's like kind value. It's a headache I don't think you want. I used to appraise.

As far as cash flow, you find a market with low entry & cost of living, as this will reflect lower renovation cost. Take your downpayments & start purchasing in areas where Section 8 or assistance is common place. Your rent would be guaranteed for a year by the housing authority. It's renewed on an annual basis not monthly. Lower income can't afford to move often nor can they move if they have an outstanding balance with a utility company or the landlord. They are essentially locked in place. You aren't chasing rent or dependent on the economy or a job. It's a direct deposit on time every month.

Memphis, Indy, St Louis, & Birmingham seem to be the markets it works best in. I'll use Birmingham as the example since it's where I'm located.

Taxes & Insurance are typically around $600 a year for each here with these properties. Management is 10%. 3 bedroom houses rent for $750 at minimum if done right. Loan payment would be between $100-200 a month for each property so you would net $300 or more depending on the rent for each.

Let's say your average renovated purchase price or all in price renovated & purchase is $35k. That gives you 28 houses with 10% down. That would net you originally $8,400 a month with $300 as the cash flow being used. Now you use this cash flow as downpayments to buy one or 2 a month or pay off the loans. Once a loan is paid of you increase your net per property by ever how much the payment was so now you cash flow maybe $500 a month for that property. If you don't want to buy more you can pay off a property every 6-7 months saving $5,000 of the  $8,400.

If you keep buying with the cash flow you get to the point where you can pay off a loan each month with the cash flow. If you rent for more than $750 cash flow is higher. 28 houses paid for with a minimum rent of $750 & netting $500 is $14,000 a month.

You're basically creating your own closed end fund that all of the Wall Street funds use to buy so many houses with their investor's money.

The lender that finances the houses I sell does 3 or 5 year interest only loan, which increases the return only making interest payments.

You could do some damage in Birmingham & the other markets I mentioned where the entry & cost of living is lower using this model.

Stone Jin · Answer

@Amy Thompson Well I didn't say Arizona :).  I'm buying out of state in the midwest.  Buying in A- neighborhoods.

Last year I did 6 1031 exchanges and bought all in Phoenix area.  The rent to purchase prices ratios weren't great, however I was able to preserve my cashflow and buy into a bigger better asset with more equity.

For example.  I had a condo that we bought for 55K and sold for 155K ish, with that I bought 2 SFH in East Mesa at 180K each (picking up some debt), I had to fix them up a little but they are now worth 220-240 each.  My cashflow from the 2 houses combined is maybe a little more than the 1 condo, but the upside is much greater.

I hope this make sense.

Dave Foster · Answer

@Amy Thompson, The qualified Intermediary is an extra piece that has to be in place in addition to the regular title company or attorney closing the property.  Any QI with a national presence can help you out.  And I did send you a pm :)

Amy Thompson · Answer

@Jason Cory Thanks Jason - would you please expand on how $100k can create $15k in cash flow? I am ok to get some mortgages/debt and was thinking to buy 1-2 SFH. Wouldn’t it be a 1031 exchange? what do you mean by tying up your profit in 1031 by selling?

Jason Cory · Answer

4.2% net return vs 100% return on the investment?

Which is the highest & best use of the property and/or return on your investment?

If you are purchasing Real Estate to cash flow you shouldn't buy based on the 1% rule. The areas B/C do not pass the 4 tests of the highest & best use for cash flow. Your example shows that facts. You make more money in B/C areas by flipping for lack of a better word as your example shows.

If your goal is cash flow it's always better to invest in areas where entry is low & rent is what drives demand.

For example, you pay $100k for a property to rent for $1,000. That's a 10% gross return and/or 1% rule. Or

You pay $100k for 2 properties that rent for $1,500 combined. This is an 18% gross return so can actually net a 10%+ return on your investment.

Comps for a B/C areas will be retail sales from owner occupants. That's not what you are using the property for so the value stated is wrong in the event you needed to sell as occupied.

Comps for predominantly rental areas are driven by the income it generates & market sales reflect the proper usage of the property, vacant or occupied.

I'm not sure why you would tie up your profit in a 1031 by selling. In my opinion, use the profit as a downpayment to buy multiple properties that cash flow properly in predominantly rental areas. With $100k to use as a downpayment you could easily cash flow $15,000 or more a month by purchasing properties in predominantly rental areas.

If you continue to purchase for appreciation your money becomes stagnant with no guarantee the economy will allow for this type of appreciation in the future.

If you purchase for rent in the predominantly rental areas the appreciation is slower but the rent is always stable given that's what is driving demand for that area.

Sell the property, drop the downpayment, turn & burn & increase your return/monthly income.

Amy Thompson · Answer

Thanks so much for your responses!

Yes, HOA has been increasing over the years and eating more of my cash flow. While we have not had big issues yet, it can also be restrictive and you are not your own boss so to say.

I guess what has been holding me from selling is not knowing if higher net returns can be found now.

@Stone Jin, wow you acan find 10% returns? Would appreciate your advice on exactly how and where in Arizona!

Rental property help: sell or keep?

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