We are moving out of our primary SFH (bought 6 years ago) in the Campbell area, and are deciding between selling it or letting it out for rent (fully managed by a third party ~ 7% fee). Given that the we have had double digit appreciation the past few years, I thnk it is very unlikely that this will continue. Putting some numbers into the rental calculator, it seems that almost all of the IRR is from the expected property appreciation:
I will not be cash flow positive till the property is sold. If I compare the Schiller SFBayArea median home price vs S&P500/NASDAQ, the percentage increase since 2000 seems to be about the same. This makes it even more confusing on how to proceed.
I am a newbie, and would really appreciate some pointers here if I am missing anything.
Updated almost 3 years ago
Edit 1: For tax purposes, the rental income (~40k) can only be offset by about 25k of depreciation. So I will need to pay around 50% of (40k-25k) in additional taxes, which would lower the IRR further.
Your management cost seems a bit too high you can probably find someone to do it for around 5% in the Bay Area, your repairs budget is decent as a percentage but comes out high as a dollar value, Vacancy of 5% is also a tad high for the bay area. Also 1% appreciation is extremely low even in no growth markets most people use 3% (inflation average) for calculations. You could refinance to make it cash flow positive. In addition I have no idea what "other cost" is in this scenario.
Aaron, many thanks for the input.
- In my mind, the home appreciation should be about the same as the S&P. So I am trying to compare renting the home, vs. selling and moving the money into an index fund. So I am considering a 0% appreciation in the calculation below.
- Other costs are the maintenance costs (we have a 10k lot and lot of yard maintenance) - $100 a month, so $1200 a year.
- Since the rental income cannot be offset by the home depreciation, I will need to add an additional 7k to the "Other costs" (have not done this below)
- As you suggested, I did make changes to the management costs in the calculator.
Updated changes below, the rental income itself is generating about 0.5%:
I have to be missing something here, please help!
@Samuel Gardener If you invest in an index fund you will have dividends that will be taxed with no depreciation offset (Also management fees). Also would you be willing to borrow to invest in the stock market? My suspicion is no. The yard care should be made the responsibility of the tenant and in a quick search on Zillow your $3,400 rent number may even be a bit low. Where did you get it? The cheapest 3 bedroom home is listed for $3,500 there are others that are pushing the mid to high $4,000s. Even so with my calculations the cap rate should be closer to 1.75% without adjusting the rent.
CA returns on rental properties are very low compared to many/most other states. Personally, since Bay Area RE prices are high right now, I'd sell it and take advantage of your homeowner cap gains exclusion--- and then reinvest capital elsewhere. Could be index fund as you say (although the stock market is pretty frothy right now) or out of state real estate so you can get better returns and take advantage of all of the tax breaks RE has to offer. For some it can be a little scary going out of state but I've been doing it for 15 years and have had few problems --- all about finding the right property manager!
You said, "I will not be cash flow positive till the property is sold." That says it all right there. I would sell. Campbell has had a tremendous run-up in price along with every home in the South Bay. You can sell cash out and reevaluate what your next plans will be. I don't believe in holding a rental property than loses money each month. I especially don't like holding a property this high in value. It is such a large risk having this much equity and risk in 1 rental property.
Some investors will argue and say CA appreciates over time and values always go up. Yes, those are all valid arguments. Prices in CA have also gone down and stayed flat. No one really knows what values will be in the short term. What we do know is that keeping this property will not be cash flow positive. I think when you look at this deal from the outside it becomes more clear. What I mean by that is would you buy this house at $1.4m today as an investment? Pretty clear answer.
Hope this helps.
You’re not looking at future appreciation correctly. Yes we’re at a market high now. Yes appreciation isn’t predictable. BUT no calculator can help you analyze it. Basically Bay Area appreciation moves in cycles where it can be flat or down a bit, but when it turns around it goes up a lot in a few years. You want to hold during those times. That’s when you make the big bucks. This graph should help:
Also your cash flow should be better than expected, if you adjust as suggested elsewhere. Keep in mind you’re holding a prime asset- good quality tenants, always in demand, fixed prop 13 protected tax base. In a few years rents will be higher and you’ll be making money on a safe easy to manage asset, with a very low interest mortgage that will disappear in several years.
I bet you that this home will end up being a better retirement asset than your 401k plan (etc.).
Most people who sold in the Bay Area ended up regretting it in the future.
@Samuel Gardener I'm surprised you're only getting $3,400 for a rental in Campbell. Is it a 2bedroom? In East Oakland, we're renting 3bedrooms for $3,000/month, and those are D class areas. In my neighborhood, 3bedroom houses are renting for $4,500, and this is Oakland.
I thought Silicon Valley was much, much more desirable. Like @Amit M. says above....you will want to keep your prime Bay Area assets
Account Closed, thanks for your replies and feedback.
Just some additional info - we bought the home 7-8 years ago. The calculator shows the numbers based on the current Zillow estimate, and the downpayment is based on my remaining mortgage. Based on a very cursory online search, our Campbell/WestSanJose area has 3-bed/2-bath rentals for around $3500-$3600. However, given we are already at the end of summer when schools have already started, I assumed I would be ~ $200 cheaper. However, I will be cash flow negative regardless even if I get $3700.
Another comparison I checked out is the Case-Schiller SF Home price index vs the S&P over a the longest period I could find, the comparison is shown below:
This is why I am concerned about letting it for rent.
Separately, pver the weekend, I spoke to a few realtors and it seems like the market has been pretty sluggish, and most buyers are making offers at/below the asking price, or with contingencies. Most realtors I spoke to suggested that I wait till early spring next year to sell.
This decision is too confusing :(
@Samuel Gardener I was in similar situation as you about 2 years ago. I had a 1br condo on Winchester Blvd and was contemplating the same. I did the following:
1. Refi to minimize loan constant (i.e. 60% LTV Interest only from local bank), this made it cash flow even from day 1.
2. Take a vacancy hit (I took ~1mo to find tenant), and find the best quality tenant and current market rent.
3. Open a HELOC to access remaining equity (80% LTV), and re-invest on other assets (out of state properties, private lending, etc)
In the end, you have an asset like other people mentioned above, that will continue to appreciate in the long run, and you have access to the equity to reinvest and make more profit.
In the end, I have ~20% equity locked in the property. But consider the rate of appreciation over time. Let's say being super conservative and value goes up 4% every year on average, And you have 1:5 leverage, cannot beat this return. And you can adjust financing like I did to make it cash flow.
My plan is I am never ever letting go this golden goose in my life!
@Samuel Gardener I would refi and rent it out for at least 2 years and do a 1031
From my view, it's pretty clear. Keeping it makes zero sense to me. Based on your calculations you are losing -$1,241 a month. That is not a performing asset. This is a liability. I don't care what the future may or may not hold as in value. If this was 2010 and the market is recovering from the crash I would say keep it. We are on the tail end of one of the most bullish real estate cycles.
Right now the market is in a transition period and slowing down. The crazy overbidding on homes in the South Bay is slowing down. Only the lower price homes are seeing it. Could the market pick up again? Yes, it could or it can stay flat or turn over. No one knows. Banking on appreciation is like gambling. Would a bank lend on an apartment building with negative cash flow? Exactly.
If you decide to sell don't worry about it. Whats done is done, can't worry about the future and have FOMO. You were lucky to buy the home 7-8yrs ago and rode this wave. Be happy and congratulations!
Hope this helps.
that chart comparison is useless. 1- you’re not accounting for leverage in the home, which amplifies returns by 3-4x depending on loan percent of asset value. 2- Schiller home price index is a generality, it doesn’t reflect your home in your neighborhood.
Your rent estimate sounds quite low. Did you look at comps on Craigslist? I’m not an expert on your area but I’d guess closer to $4000-4500. Don’t rely on Zillow or other BS estimators. Search directly on Craigslist for similar homes (compare via the photos too) in your area and see what the range is.
Lastly, be cautious what realtors suggest...it’s always a good time to buy....or sell. Transactions matter most to them.
Bottom line, if you can rent it for at least close to cost, you’ll benefit significantly from future equity, as well as future rent increases. No brained IMO. See how many people you can find who in the past had the option to hold a home in Silicon Valley as a rental, sold it, and did not regret it. Crickets....crickets.
@Samuel Gardener I agree with @Keong Kam and @Amit M. - if you can, keep the home. I would do a bit more research on the rental price ($3,400 does seem low for a SFH in the Campbell) or try to refi/pull equity out.
I'd be wary of hiring a property manager. From my experience, most of property managers in the Bay Area are pretty useless & do a completely subpar job - especially for managing a SFH. Get a great tenant in, manage it yourself, and save yourself the 7%. If you decide to rent it out, I'd be happy to help you market it as a rental for free.
And as Amit mentioned, most realtors will tell you to sell now. Don't listen to that advice - that is in a realtor's best interest. The market is always a bit quiet right all of August (right before Labor Day), and between Thanksgiving-New Year's. In this case, I'd would personally be inclined to keep the home as a long-term play. There's barely any new inventory or construction in Silicon Valley. There will almost certainly be future appreciation. If you do sell though, avoid Nov-Dec, and wait for the Spring market.
I’ll 2nd what @Houston Garcia says wrt property management. For one SFH it's best to do it yourself.
Rent: I think you might be able to get slightly higher rent than entered. About 2.5 years ago people stopped coming to Silicon Valley for jobs. At least they are not hiring or able to fill in the openings in high tech field. Near San Tomas Aquino it took me 3 months not able to fill a brand new 3/2 with a Saratoga address. The owner was losing money as a renter. Same with a purchased home this year wanting $4K rent. In Willow Glen a high techie is losing 40% of his PITI after 2 months on his home bought this spring. The double digit appreciation rate can not sustain as home prices have stabilized last couple months. See PM
I'm a complete newbie here and to RE. Just started reading today and following this discussion with interest. If the Bay Area is beginning to soften, what are all the local RE pros doing for current investments? Going out of state? I did some very preliminary research on whats for sale vs currents rents on condos/townhomes/SFR but all were cash flow negative bigly!
Like most othere here, I'm trying to figure out a way to use about 500k in cash/home equity to start generating some passive income.
Another question - when housing goes down, does commercial follow the same pattern?
Another thread had mentioned buying 25 100k rentals OOS with 750k investment. If housing weakens in Bay area/CA, don't other states follow directionally?
[quote]If housing weakens in Bay area/CA, don't other states follow directionally? [/quote]
Real Estate is local. What happens here may not happen there. In fact the opposite may happen there.
I would lean to cashing in my chips on the high bucks home. But that's me.