How to decide if it's worth renting out primary residence?

Question

Hi there!  In about 2-3 years, my family will be buying land and building our own home.  We were going to sell our primary residence (O.C. California) at that time, but my mom keeps telling me that our house is the "perfect rental home".  I understand what she means- it's in a great neighborhood, walking distance from good schools, and we bought it at the bottom of the market (406,000 which is now paid in full, and now the zestimate is 600,000).  We can get at least 2800.00 per month.  I'm thinking in the next 5-10 years it may need a new roof, new shower, and other repairs.  We will be within a few hours driving distance of this home after we move.

Basically, this house wouldn't meet the 1% rule criteria if I were looking at it objectively, so I'm leaning toward selling.   But are there other advantages that come into play when deciding to keep or sell, such as tax considerations, ease of paperwork, etc?  Somewhat passive cash flow is important to me to free us up physcially and mentally to focus on building our new home when the time comes. If we did sell, we would want to invest the money somehow to gain passive income.

I appreciate your input!

Ali Boone · Answer

Well, I'm going to take a different stance on this. Maybe. Instead of just thinking of selling or keeping, I'd be thinking in terms of running the numbers on a cash-out refi and using that money to invest in cash-flowing properties. That way you keep this property (certainly it would have made a bad rental property if that was the original intention but it's already paid off now, so let's not go crazy) and benefit from any additional appreciation that may come of it and whatever else, and you also buy $480,000 worth of cash-flowing properties (the $600k value less 20% down for the refi). If you buy right, that could be a TON of cash flow!

The way you'd want to do it to make sure it financially pans out is to find out from a lender how much your monthly payments on the refi would be. Then look at some cash-flowing rental properties-- find out how many you could buy whether through cash purchases or leveraging (all with that $480k) and how much each would cash flow each month-- and determine if the total cash flow between those properties and this one is greater than the monthly mortgage/refi payment. I can't imagine that it wouldn't be.

I'm usually the last person to advocate keeping a property that is bunk on the cash flow, but in this case that 'bunk on the cash flow' property can actually be used as an insanely useful tool. I mean, you could sell it and use the money to buy cash-flowing properties in the same way, but why not just keep it? It's almost like having a free additional property at that point.

If you want any help running cash flow, reach out anytime, but here's the basic formulas I use-

https://www.biggerpockets.com/renewsblog/2013/01/1...

You could have napkins on both the new properties and with the cash-out refi numbers in order to get a full picture.

Thomas S. · Answer

Minimum DB on numerous cash flow multi plex's will easily produce 10% or better returns. Even your 7% is far better than leaving it sit in the property losing money.

James Wise · Answer

@Kristin Brancaleone If you still had a mortgage on it and could afford to i'd say hang onto it. However you are all cash into the investment and seem to have rode the market well. Now seems like the appropriate exit point.

Kristin Brancaleone · Answer

@greg s.  I appreciate your tinput!  What would you do with the 600k to get a 10% investors value?  I've looked into trust deeds, turnkey, etc and it's looking like 6-7% are the rates I'm seeing most.  I've been resigned to getting these lower rates (assuming it's fairly passive on my part.)

Thomas S. · Answer

Terrible choice for a rental property. You mother knows nothing about investing. With a 10% investors value on the $600K the equity alone is worth $5000/month  meaning that by renting it you would be losing $2200/month plus all the other costs related to maintaining a rental property.  Probably going to lose $3000-$4000/month by keeping this property.

Terrible idea.

Jesse Valencia · Answer

Kristin,

I am siding with @Nathan Miller on this one.  You could do better reinvesting that money elsewhere.  Also, since this is a primary residence that you have been living in, there won't be taxes on the gains once you sell.

By the way, everything you mentioned above regarding why it would be a good rental is also good factors on why it would be a good sale.

Good luck!

Jesse

Nathan Miller · Answer

My super quick analysis based on it's current value and $2800/m rent says that it's not worth it.  It's less than a 6% return not even considering property management fees, repairs, and maintenance.

There are tax benefits to renting (depreciation, passive income, etc), but for these numbers they don't really make sense to me.  I'd sell the 600k house in California, and buy three 200k homes in Oregon and rent the 3 for $4-5k/month instead and have a much much better return.