Should I sell for loss, or Refinance rental

45 Replies

I purchase a new property in 2007 for $186,000 to be used as a rental property from day 1.  The property was initial rented for $1300.  Hindsight is 20/20 and not  good investment, but I'm trying to figure best way to exit this poor decision.  Here are the numbers:

Market Value = $165,000

Current Loan Balance = $176,000

Current Rent = $1100

Tax/Ins = $3200 / yr

Property Mgmt = 10%

Yearly NOI = ~ $8500 (Rent - prop mgmt - tax - ins)

Current Mort Pay (PI)= $1050

Yearly Net = - $4,000 (negative cash flow per year)

OPTION 1 - Get a HARP refi at 4.378% (PI $900), and reduce yearly net to -$2500 ($1500 improvement, but still a loss)

OPTION 2 - Put on market and hopefully sell at market value = $165,000 (minus commission and mortgage, and closing costs).  Negative -$20,000

Yes, market could improve, rents could go up, but both could go down as well.

Anybody see an Option 3?

Hey @Jeff Blankenship  - I hate to be the bearer of bad news, but that $20K+ hit is looking like your best option right now.  Unless you have a very strong reason to believe values and rents will be going up quite a bit, this doesn't sound like a good property to hold on to.  I'd say cut your losses now and do more work on the front end next time you buy a rental to make sure it will cash flow from day 1.

Hopefully this doesn't discourage you from further investment...rentals can be quite profitable if you know what you're doing and even the best investors hit some nasty bumps along the way!

Nope, not discouraged.  I've got/had lots of winners in past 7-8 years.  This was just a dud.  Market was hot when I purchased, but 2 major corporations pulled out, so employment status in the area changed.  It was speculation on my part at best, and lessoned learned.  

Thanks for your opinion.  Looking forward to what others have to say.

Just brain storming here and you would definitely have to speak with an attorney regarding my suggestion. You could try doing an owner finance deal or option to purchase. Charge 50-100 more then what it costs you monthly as a lease to own scenario. You have people that have the means to pay a higher MP but don't have the discipline to save up 5-10% for a DP or the credit to qualify. 

Keep it.  Your annual net after HARP is -2500.  At that rate, it will take eight more years to sink another $20,000 into the property, whereas a short sale would be $20,000 immediately.  Over that eight years, you will pay down $27,809 in principle, too.  What you consider an annual loss is actually increasing equity at a faster rate than it is incurring a loss.  It's not ideal, but a $20,000 "loss" offset by a $27,809 "gain" is a lot better IMO than jumping off the cliff.  Oh, and you skip a payment (or two) during the refinance, so cash flow will be "better" this calendar year.  Rates are getting better each day (for now), so ask how much rates need to improve before you get 4.25%.  That would obviously be even better to the tune of a couple hundred bucks a year.

Okay, so 1 vote for option 1, 1 for option 2, and a suggested option 3.  

Thanks guys!  You are giving me several things to consider in my decision.

Punt...or in this case, option #1.  This is a case of taking one step back to move forward.  If you hang onto the property , you are losing money every year...this couldn't even be considered treading water, since when you tread water, you are still on the surface.  You are throwing good money after bad by hanging onto it...and losing precious time while you "hope" you can break even.  Hope is not a plan.

Punt.  If you were playing poker, and you had a bad hand, would you keep throwing money in the pot with the hope that your cards would change, or would you fold, stay in the game, and move on.  Just like poker, the object is to stay in the game.  That $20k isn't lost...it's just in a different property down the road (just like in a different pile on the table after you lose a hand).  If you run out of chips, you're out of the game.  If you run out of cash hoping for a change in income from this house, you will lose more than $20k...and be out of the game.

You can always get your money back...you can never get your time back.

Punt.

Originally posted by @Joe Villeneuve :

Punt...or in this case, option #1.  This is a case of taking one step back to move forward.  If you hang onto the property , you are losing money every year...this couldn't even be considered treading water, since when you tread water, you are still on the surface.  You are throwing good money after bad by hanging onto it...and losing precious time while you "hope" you can break even.  Hope is not a plan.

Punt.  If you were playing poker, and you had a bad hand, would you keep throwing money in the pot with the hope that your cards would change, or would you fold, stay in the game, and move on.  Just like poker, the object is to stay in the game.  That $20k isn't lost...it's just in a different property down the road (just like in a different pile on the table after you lose a hand).  If you run out of chips, you're out of the game.  If you run out of cash hoping for a change in income from this house, you will lose more than $20k...and be out of the game.

You can always get your money back...you can never get your time back.

Punt.

Joe, do you not see merit in reducing the principle loan balance while "treading water"?

If he leaves, he is guaranteed to lose $20,000.  At the present rate of burn, he is losing $2500 per year.  I am having trouble reconciling how losing $20,000 at once is better than "losing" $2500 per year for eight years while lowering his principle loan balance by $27,000.  The eight years also creates the opportunity for the property to recoup its value or for rents to increase (which would also increase the value).

@Sam Elder  You're missing the big picture.  It isn't that he's only losing $2500/year over 8 years.  He's wasting 8 years....while he's spending over $17,000/per year.  The comparison isn't between losing $20,000 at once, or a slow bleed of $2500/year.  The comparison is between a one time cost of $20,000 in year one vs. $17,000 in year one, and 2, and 3, etc...

That $20k loss represents one step back, which then frees up $17,000 every year after that to recoup and grow.

That bleed of $17,000 means $17,000/year less to invest for all those years he is "only losing $2500/year". 

Originally posted by @Sam Elder :

Keep it.  Your annual net after HARP is -2500.  At that rate, it will take eight more years to sink another $20,000 into the property, whereas a short sale would be $20,000 immediately.  Over that eight years, you will pay down $27,809 in principle, too.  What you consider an annual loss is actually increasing equity at a faster rate than it is incurring a loss.  It's not ideal, but a $20,000 "loss" offset by a $27,809 "gain" is a lot better IMO than jumping off the cliff.  Oh, and you skip a payment (or two) during the refinance, so cash flow will be "better" this calendar year.  Rates are getting better each day (for now), so ask how much rates need to improve before you get 4.25%.  That would obviously be even better to the tune of a couple hundred bucks a year.

This plan assumes there are no major capital expenses coming due and that the value of the property doesn't continue to deteriorate (sounds like this is a real possibility).  The $20K is already lost.  Selling the property or keeping it won't change that.  You're suggesting he lose another $20K in hopes of waiting long enough to recoup the $20K already lost, plus another $20K to cover 8 more years of losses.  Doesn't sound like a good idea in my opinion.

That $20K over 8 years could be invested on a property that isn't, as the OP comments, "a dud"

@Michael Seeker  100% correct.  The same point I was trying to make.  Here is the choice.  He can either:

a - Spend $17,000 in the next year, and another 17k in the next, and so on, or...

b - Lose $20k in the next year, and invest 17k in all the following years.

He only loses money in the first year.  He invests money in the rest.  Like I said above,...

Punt

Originally posted by @Joe Villeneuve:

a - Spend $17,000 in the next year, and another 17k in the next, and so on, or...

b - Lose $20k in the next year, and invest 17k in all the following years.

He only loses money in the first year.  He invests money in the rest.  Like I said above,...

Punt

 I'm not sure where you're getting the 17k from. That's the amount of expenses each year but there is rent to offset most of it. The net loss is less.

Jeff, I notice your numbers don't seem to include any repairs/capital expenses. They will come up if you keep the property so should be part of the conversation.

@Jeff Blankenship  thanks for putting this out for discussion.  I think ultimately, the move you make should directly correspond to what you need. All possibilities that members are providers seem viable (so far :)) but they are solutions to different needs. So if you can identify what your need is, that may help point you to the solution that works best for you.

Personally, I am on board with @Ryan Dossey  here. 

I would HARP Refi and then lease option the property out or sell to a creative buyer buy wrapping the current mortgage. A $900 payment, 4.378% fixed rate loan, and market rents >/= to PITI is an attractive option for some investors. Especially considering your current loan balance isn't even 10% higher than market value. This option would save you from losing any more monthly money (once the refi is complete and tenant-buyer/buyer are identified) and would allow you to sell without bringing any additional capital to the table.

Best of luck!

@Adam Moehn  Yes...those are the expenses.  Let's take this one step at a time.

Option 1 - year 1 he spends 17,000 (and loses 2,500 of it).  Regardless of how much he loses, he is spending new money every year to lose money...at 17k/year.  So every year he is losing money, and every year he is adding 17k into a losing investment.

Option 2 - He loses 20k.  Now the loses are gone.  Any money he was adding to the loss, is now adding to positive investments.

I would rather lose once, and follow up with wins, than lose a little every year...slowly bleeding to death.

Know when to fold em

Like Kenny Rogers

@Brian Gibbons That's funny you mention that. When I'm teaching this, much to the regrets of my audience, I start by singing that song...only I change the words for REI. My group also invented a game called "Know when to fold 'em", which is based on multiple entrance and exit strategies, and putting them together for real deals.

Where is the $17K spend a year coming from? Couldn't trace to it in the thread.

I agree with Sam on this one (although if someone could clarify the $17K I may change my mind haha). Why lock in a $20K loss right now? This assumes you feel good about not having troubles keeping it rented. Yes a big expense could come up and make that worse, but that is going to be a risk for any property so I don't think you should factor that in.

Sorry, reread the thread and realized the $17K is total expenses. Again, you can't think about it this way because he is going to have expenses like this on any house he buys. He has cash flow coming in to offset most of that amount.

I would definitely refi and hold. If you can increase rent down the road $100/month you wipe out half your annual loss, and $200/all of it (the rent used to be $200 higher, presumably it can get back there down the road).

@Joe Villeneuve  - I'm trying to wrap my brain around the $17,000 expense you are referring to.  For clarity, this is:

mortgage payments + taxes + insurance + property management = $17,000 per yr

So, this is a true expense (plus any capital expense to property which have been minimal ~ ($500/yr as it is a fairly new brick house on slab).  However, these expenses would not exist if I did not own the property, which currently produces $13,200 in income every year.  So, I'm not clear on why the property has a $17,000 yearly expense instead of a $3800 expense?  (and if I refi a $2500 expense)

You mentioned that in option 2, I take the $17,000 and invest it each year, instead of spending it on the property. But I'm not understanding this - if I don't own the property, I don't have $17,000 to invest.

What if I owned the property free and clear?  I would have a $4,500 annual expense (17,000 minus mortgage payment).  Would you say - why have a $4500 annual expense, instead sell and invest that $4500 each year?  (again, I would not have have the $4500 expense without the $13,200 income, so this would not be possible).

I know you guys are way smarter and more experienced that I am, and I'm just taking a while to wrap my head around this.  I'm certainly not trying to be argumentative, or difficult, just want to understand.

Nicholas J. This property has a very small chance of recovering based on the author's own words and description. I'm not banking my REI money on hope. "Hope" isn't a plan, it's a rationalization for a bad deal, and is the most expensive word in the REI vocabulary.

This is a cut and run...fight another day.  Losing money on a deal isn't near as bad as trying to "hold out" for the future, all the while bleeding money that could be invested positively elsewhere.

Just like in Poker, you have to know when to fold 'em...and it's time to fold this hand, get new cards, and win that lost money (pot), back with another deal.  You can't throw more money in the pot of a bad hand and expect the cards to change.

@Michael Seeker   - good point about capital expenses.  they have been minimal so far, as I purchase the house new (2007), and had excellent young professional tenants.  It is a 2000 sq ft brick home on a slab.  So far the repairs have been minor (garage door, minor a/c repair, etc..).  I would not anticipate any "major" repairs ($1,000+) for another 3-5 years.

ANOTHER TWIST - so, this little neighborhood of about 30 homes is a little odd. All of the homes sold new in 2007-2009 for ~$180,000. The house across from mine sold in April of 2013 for $179,000. HOWEVER, 2 houses in the neighborhood sold in past 6 months as short sales for $120,000. Those are the last 3 comps. The market value of $165,000 is based on a 1 mile radius of same sq footage, age, build quality, style, etc...

My RE agent knows the agent who brokered those �$120k deals, and he was helping an investor purchase these properties.  Bottom line, can I sell my property for $165k or $120k?  I'm going to talk this over with my agent and see if she thinks we can justify a listing of $165 or not.  

I'm not exactly an expert at this, but it seems like he has a choice of losing $2500 per year with a possibility of the loss increasing/recouping the losses or losing $20,000 right now with no possibility of recouping the loss, but with a firm cap on the potential losses.

Could you possibly manage it yourself?  That'd save you $1320 a year.  Have you looked into whether you can get a cheaper insurance policy?

@Joe - As Sam showed the math earlier (which I haven't double checked), in 8 years he's paid down $27K of principal but perhaps only burned $20K in cash ($2500/year losses x 8).  At that point he's ahead, so why lock in a $20K payment now?  In addition, depending on his tax situation, he can use the annual losses, in addition to depreciation, to reduce the effective loss of $2500/year even further.  

As the previous poster just stated, you are spending over $1K on management fees.  Can you handle yourself?

Jeff - I'm guessing you have time to do other deals since you have a management company, and I'm guessing you also have economic capacity to do additional deals if you can afford to write a $20K check right now to exit the property.   If these statements are correct, I would personally do the refi and go out and look for another cash flowing deal with that $20K. 

Just my two cents based on the facts I've read, but I'm making any glaring mistakes in my assumptions, please feel free to point them out.  :)

@Jackie Chiles  - Great thoughts.  

Insurance - I spoke with existing insurance company and they can reduce by $100/yr.  I'm going to get some more quotes.  

Management - interesting thought.  possibly, but I think i would first talk to mgmt company and see if they would take 7%-8% instead of 10.  I live out of state, so have an in town reputable mgmt company makes sense.  I'll look for opportunity to reduce this cost.

RE Taxes - the property is valued by Tax Assessor at $179,000.  So, if it is really $120k, as these last 2 short sales, I may be able to get my taxes down.  Not sure how successful that will be.  On one hand I'm trying to justify a $165k value for selling, and $120k for taxes...seems like a conflict;)

Nicholas J. - yes, I have good cash reserves, and my other rental properties are doing well.  Lots of equity, positive cash flow, etc...

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