Investment Prop. Cross Roads: Sell, Rent, or Cash Out Refinance?

6 Replies

Hi - first time poster to Bigger Pockets.  In 2007 I began construction of a new home, but with the financial crisis of 08/09, my existing home value fell by over 40% and I was unable to sell.  My wife and I turned our existing house into a rental property and moved into the new house.  For the past 11 years we've held on to the rental house.  Original purchase price in 2002 was $292,000, and existing value today is $400,000.  Down payment in 2002 was $75,000.  Over the last 11 years, we've been fortunate to have 3 renters, and only 1 month of vacancy during that time.   Current rent is $2,800 per month / $33,600 annually.  In 2015, I refinanced the house into a 15 year loan, with final payment due on June 1, 2029. Today's balance is $120k.  P&I payments are $1,355 per month, making bi-weekly payments.  I pay $1,500 for annual insurance, $6,500 for taxes, and $4,200 for annual maintenance.    

I am 49 years old, and plan on working another 15 years. I like the idea of having good rental income in retirement, thought current rental income isn't really needed due to current income. I am seeking to maximize long-term wealth accumulation, and if I keep the rental, to become a better real estate investor. I found a good SFH Rental Spreadsheet on bigger pockets and have populated it with my information.

Three options I am considering:

1.  Sell to my long-term tenant for $400,000, and invest proceeds in stock market, while avoiding new roof expense in a year or two and taking a gamble on new tenant when current one leaves if I don't sell him the house.

2. Keep as rental, and keep paying down mortgage, with final payoff in 10 years: Current Cash ROI of 4.60% and Total ROI of 23.54%

3. Keep as rental, do a cash out refinance (maybe buy more rental property): With new 30 year mortgage, Cash ROI would jump to 15.58% and Total ROI of 18.61% and just existing rental, not inclusive of other rentals I could buy. I believe I can extract about $180,000 of equity in a cash out refinance, allowing me to buy another $533,000 of real estate.

Any suggestions on how to evaluate these options?  Thank you for reading through this post.

If you were going to sell if on the open market I would probably say don’t sell. But if you can sell to the curent tenant without a realtor you’ll net about $24k extra. That’s probably a year or two of appreciation and you avoid turnover and roof cap-ex if they are truly due soon. 

You’ll probably have about $15k in capital gains tax if you declared the $282k value when you started renting, more if you declared a lower value at the time you started renting it out.(you mentioned it fell 40% and if that was before you started renting it out you might have used the current value instead of the purchased value.) you’ll also have about $25k in depreciation recapture due. 

So you will net about $40k less due to taxes. 

Something you have to look at as well is your return on equity.  That’s about 1.84% for you right now.  That means you need to take action!  

I think you should look at either option 1 or 3.  If you sell though, instead of investing in the stock market you could 1031 exchange the property.  That will put off your capital gains tax.  

You could definitely keep the property and continue to rent out.  I feel like the rent probably isn’t high enough relative to the value to make it a great rental.  You could probably get a better cash on cash return in a different area if your current rent is where the market is.  On the other hand, if you can expect solid appreciation that can definitely justify keeping it, appreciation can generate much more wealth for you than cash flow.  You would need to look at the expectations for your area to estimate this.

In either case, you need to use the equity you have to work for you.  Again your ROE is currently ~1.84%, it’s like a fat slob sitting on the couch.  Let’s whip it into shape!

@Tom Carlson ,  Well done on the long game.   There's not a lot of investors around who've actually weathered the last crash and held on like you did.  That speaks volumes.  You like rental income as a concept.  And it's been good to you.  But I think you've rightfully identified that this may not be the right property to hold on to.  As @Bill Brandt said your ROE is very minimal and if you've got a looming large cap ex bill . you'll be better off selling and getting out of it now.  A refi will only compound cash flow issues.

But you need to examine the impacts of selling and leaving the real estate sector now.  You've got a gain and depreciation capture exposure of over $200K and looking at a tax bill of around $50K if you sell and move into stock.  That's a lot to leave on the table if you want to end up being a real estate investor on going anyway.  So I'd vote with Bill and say it's time to 1031 into better cash flow, lowered capital expense exposure, and maybe more favorable management options.

i think it would be wise to keep the rental, get a cash out refinance and buy more rental properties. I am in a similar situation and all my research leads to this conclusion. 

I appreciate the comments so far. @Wes Ripley, how are you calculating ROE - total annual cash flow / current equity, and what ROE should I aim for? What are your thoughts on the ROI which includes annual mortgage paydown? That is in the 23% range. David and Bill - your thoughts are in line with what my wife is thinking, though I am looking at the total ROI (based on my original 75,000 downpayment) and find that attractive. To determine total ROI, do I use net cash flow plus annual mortgage paydown amount / my original $75,000?