Should I hold,sell or refi?

Question

Hi Guys,
      I'd like to give you my current situation and see if you can provide some feedback. I have a 1 bedroom condo in NY, which is now worth about $300K. There is no mortgage on it, just RE taxes and CC = $250 per month. I've been pretty lucky with the tenants and have not had vacancies longer than 3 weeks. I collect $1250 per month in rent, which adds up to $15K per year or 5%. Please give me your 2 cents on some of my options.

1.) Sell and put the money in a CD at 4.5 for 3 years. Same ROI no headaches.

2.) Sell and put the money in a house that we're planning to buy in the near future. Does it make sense? If I buy a house for $500K and instead of putting 20% down I will put $300K it'll save me more money in a long run than I would have ever made on this apt. (I like this option the best)

3.) Refi? and use the cash to invest more? Not even sure if it's an option.

4.) Hold and rent until I retire... don't really like that option.

Thank you,
   Paul.

Jon Holdman · Answer

If you sell that rental for $300K, you'll net somewhere around $225-250K after sales costs and taxes.  You'll have to pay a combination of depreciation recapture and capital gains on the sale.

On the residence, you can use the Section 121 exclusion to avoid all the taxes.  You'll still have the costs, though.  So, if you have a $400K house with a $200K loan, you'll net about $160K after costs and paying off the loan.  I'm assuming 2% for seller concessions.  Maybe none are required, but a recent poster mentioned doing a 6% concession.

If you move that money directly into a new investment property, you could use a 1031 exchange to defer the taxes.  You might want to consider that.  Use the gains from the house to finance the new residence, and roll the returns from the sale of the rental into new (and much better) investments.  I think that will be a more profitable strategy than paying the taxes on this money, using as a down payment, then taking it back with a HELOC.  You will have to use it for a like kind investments, probably rentals, but I'm no expert on 1031's.  I do know you can't, for example, put it into stocks.

If you want to invest in rentals, do some reading in the landlord forums.  No matter where you come out on the whole expense discussion, or how you deal with financing, there's no way to get a decent return with $1250 in rent on a $300K investment.  Paying $80K for $1250 would probably ensure a good return.  Even with very optimistic expenses and a 20% down payment, you can't pay more than about $100K for that amount of rent and still get a good return.

Paul Kogan · Answer

Hi Jon,
   thank you very much for your input. I do consider investing in a multifamily as mentioned in my option 3. It's just that the steady income from the property makes me not want to sell, but I see you points. The ROI on this 300K property is really low.

We currently own a house but need more space. We found a bigger house that we like for 800K.I know the numbers are really high but we live in NY and you don't get much for 800K.
So, we're planning to sell our current residence that has $200K equity and the rental property mentioned above with $300K equity and use most of this money for a downpayment. Also, the new house has an apt. that will produce $1100 in monthly rent. My long term goal is to take out HELOC on the new house and use it for investments.
Please let me know what you think.
Thank you,
   Paul

Jon Holdman · Answer

As a rental, a house worth $300K that collects only $1250 in rent is a horrible investment.  Its not really nearly a 5% return.  I'm sure you have taxes, insurance, and HOA fees at the very least that all come out of that $1250.  Don't know if you mean three weeks vacancy total or per year.  Three weeks a year would be about $60 a month in lost revenue.

I'd sell this in a heartbeat.  You'll have some taxes, but should still have a nice return.  Better would be to move in for two years, then sell, taking advantage of the $250K exclusion (check with a CPA, though.)

As to what to do with the money, that's a different question.  Do you own your residence now?  If so, why do you want to move.  If you rent, why not move into this condo?

You're really asking if you should invest it (in CDs) or, well, blow it on a residence.  I don't consider residences as investments.  They're rarely evaluated as investments but based on what you want.  Purely as investments, most of the residences we buy wouldn't make the cut.  They may generate some cash, if you plan to stay a long time.  You have the forced savings from the mortgage paydown.  You have the slow, but usually steady over the long term appreciation.  Combine those and you have some cash when you sell in the future.  On the other hand, you're paying out massive interest.  If you add up the total of your payments, and compare it to the cash invested at the start and what you get when you sell, your return will likely be very low or even negative.

But, you gotta have a place to live, so if you can afford the house you really want, go for it.  Just realize its an expense to your personal budget, not an investment.

CD's look pretty attractive, right now.  But, I'd invest elsewhere.  Real estate is one alternative.  I don't see that in your list of alternatives, though.