Should I Stay or Should I Go Now...?
Hi all! Still kind of new to all of this, so bear with me...
My husband and I have a duplex (he had it built in '96) and it's nearly paid off ($38k left). Thing is, we're not seeing much (if any) return. Never have. Total income is $1350 per month, and expenses run around $1300 (pmt+tax+ins=$875, $275/mo for repairs/CapEx, $150 for prop mgmt). We have to use a property management company (we're not local) and refinanced for a shorter term when we put in both our names four years ago (shaved a few years off, got lower interest, and the payment was STILL less than it was prior to refinancing).
I'm torn. I don't know if we should sell and use the equity (maybe $70k) for a new venture, or if we should hold and let ourselves pay it off so we'll start seeing that $1350 "free and clear." (Yes, I know there will still be expenses, but the largest one - the mortgage - will be gone.)
So, in the infamous words of The Clash, should we stay or should we go? And why?
Cut bait, get educated and try again.
You can do much better than that. even with a motgage you can be cashflowing.
welcome @Laura H.
What is the condition of your duplex and do you see any major expenses coming up by the time you pay off the loan? I know you have budgeted for CAPEX. But you may come out ahead if you sell soon, or you may actually lose money if you need to fix something major (more than what you have budgeted for)
Do you think your area may appreciate in the near future? if no, maybe it's better to sell it if you can. And invest that money somewhere else.
But some investors prefer free and clear properties, so it's ultimately up to both of your investing strategies.
#2 General Landlording & Rental Properties Contributor
Your largest expense is in fact not the mortgage it is the value of the equity you have lying dead in the property.
Based on the fact that you are not seeing any cash flow and do not seem to understand that equity you have in the property is reducing your return even farther I would advise selling immediately.
Every $10,000 in equity you have in a rental property reduces your monthly income return by an additional $83/month. If you have $70K in equity you are about $530/month negative cash flow.
These guys aren't wrong - you could do better. But I get you - you've come this far!! And maybe you're not all about the return - you're more about being passive. What are your goals? Do you have good tenants? Can you up the rent?? If you want to invest more you could cash out refi and invest elsewhere but that resets the clock. Not sure how close you are to retirement or if that's what this was for or not.
If you're not interested in being a professional investor and you're not going to do something super useful with that $70k, i would keep it and enjoy the cash flow. You've held on to this property for a long time and it's given you no love. Let the property pay you now. Selling it and buying something else is costing you transaction costs and a lot of effort - people like me and the others on this thread get a high from that - maybe you don't (or you would have done it sooner). Selling it and not buying real estate again gives you cash - are you going to put that in the stock market? I don't think so - you won't get income from that - just appreciation and it's risky.
Let the property pay you and enjoy the extra money. It's not the savviest move but it might be the right one for you.
Greg S., can you please explain how equity loses income? Specifically the 10k vs $83/month. That concept is new to me.
That cash flow is terrible. You can take the 70k in equity and buy true cash flow rentals by using leverage of hard money lending/ or conventional lending. You can do cash out refi to get money out after seasoning title for 6 months to a year and buy more.
No one wants to comment on the 11+% management? Seems like you could save there. Also I think it would be a sell for me but no one else has mentioned you have to be paying down principal at around $500/month. Meakes it not as bad as it looks. So you have work that into your thinking and goals. So another alternative is refi it, cash out maybe extend it out, get more affordable management and make cashflow. That is assuming you want to grow.
@Laura H. You didnt give enough numbers but a couple things stand out. you are not using leverage correctly as @Thomas S. has indicated. you financed the property way wrong to begin with. a short term note increases equity and lowers interest. trouble is you cant utilize equity to make more money. and you got the benefit of the interest savings?? your tenants did!! they pay the interest not you. have you looked at doing a 30 year cash out re-fi? im betting if that property was financed correctly and you are getting close to market rent it would cash flow. plug it into the rental property analyzer found here on BP and try different scenerios to see what would make things work the best. I would be looking to re-finance at a longer term (30 yr) and take out some (Maybe not all) equity and buy another after doing some research on this website. Land lording is not always easy and investing in real estate is not always easy. My cardinal rule is "if you don't like the results, you have to change what your doing" Sometimes you have to fix your mistakes. I just re-financed my last 15 year note. I thought the same as you I need to get these rentals paid for. that's wrong, wrong, wrong. it took me several years to correct my first errors, 2 of them being 15year notes. the property I just refinanced went from costing me $20.00 a month on a good month to a $200 a month cash flow. just with a refi. the other mistake I made was to buy a property not well located for a rental. I had to put extra cash in that one to get cash flow (bought it at the high point in the market too) its finally almost back to what I paid for it. as soon as I can I will sell it. it almost bankrupted me though and has taken 4-5years and some cash input to hang on . but it didn't bankrupt me. I had to get creative to save my credit though. it cash flows $199 a month now, but i own around 50% equity (around $60 Thousand dollars) that's 25-30 thousand dollars sitting there. that is almost enough to buy another house. That was one of my 15 Year notes as well Hope this helps RR
I would sell. Consider the opportunity cost. You have $70K in equity locked up that's not earning anything. I'm sure you can use that money elsewhere to make some money.
So much great information - thank you all for the replies!
Our goal for years was to get the duplex paid off so we could see more of the rental income in our pocket. We thought that by refinancing and paying it off sooner, we'd start seeing the benefits sooner, too. From what I'm reading here (and all over BP) is that's not necessarily the way to go.
I think the biggest mental hurdle for both of us is that cash flow is better than equity - especially when we're so close to paying it off. My husband is especially uninterested in making payments on this property until we're 80, and hasn't quite caught up to my realization that, even if we are paying $100 in interest every month forever, we get more money out of it that we can "snowball" invest elsewhere.
But you all are exactly right - if we haven't been making money all this time (even before the refi), and the property hasn't appreciated by leaps and bounds, we're just losing money AND the opportunity to invest elsewhere. The point isn't to own the property outright (i.e., paid in full), it's to have more money coming in than going out. And that's backwards from what we've always thought. It's like finding out the world isn't flat.
@Chris T. - You have a good point on major repairs. The property will be due for a new roof and possibly new furnaces in the next 5-10 years. Appreciation has not been our friend, either. The build went over budget in '96, so I doubt we'll get what my husband originally put into the property. Still, as everyone else has commented on, that equity isn't doing anything for us right now.
@Sara Abernethy - I'm 35 and the hubs is 43. Still a ways out from retirement, but my goal is to have rental income supplement (maybe eventually replace) the income from my job. This property has been on auto-pilot for awhile, and now I'm looking at it in a new way. I'm not liking what I'm seeing, so I feel like something needs to change.
@Matt H.- That property management cost is pretty typical for the area (or at least it was at the time when we were shopping around a few years ago). It's $10 per side + 10% of the rent. We only pay the rent portion *if* it's rented. We liked this because it gave the manager incentive to get it rented out as quickly as possible. What are your thoughts on this?
@Ralph R. - What other numbers can I provide? Thank you for providing your story - it's takes away some of the sting knowing that we're not the only ones who've made this mistake.
Thanks again, everyone! So happy to have this community.
@Matt H.
Laura H. Based on one of your follow up comments, it sounds like you and your husband need to get aligned on goals and investing mindset. This is critical! You both need to be in complete agreement with your long-term goals and what actions you plan to take to achieve those goals.
Next, I would try approaching your duplex with a new mindset, like that of an investor that is analyzing the property as a potential purchase. If your duplex is marketable to another investor that can create a way to make it cash flow, you have to ask yourself what is they can do that you have not.
If it were my property, I would lay out my income statement and challenge every line item. The "challenge" is to identify changes that can increase rents and decrease operating expenses, which will increase cash flow.
Aside from operational expenses, you have an opportunity to affect cash flow through how you have your property leveraged. You mentioned refinancing a few years ago to shorten the term, etc. If you were to do another refinance in the near future with a longer-term note at a great rate, that simple action should lead to a substantial cash flow increase from the duplex. It may be a stretch, not knowing all your numbers, but you may even be able to do a cash-out refinance that increases cash flow from this duplex and liquidates some of your equity to use on another investment.
If it were my property, I would hesitate in selling just to harvest the equity. I would shift my paradigm and look at opportunities to further leverage a successful investment I had held for 20 years. If a year of trying tons of ways to increase cash flow does not yield any results, then I would reconsider selling the property. The thing you would need to avoid is selling the property only to reinvest in another property that puts you in a similar situation.
I wish you the best of luck!
@Laura H. you say the property has not appreciated are you taking depreciation on your taxes? What's the market value of the property? What's the current rent comps for the area? Are the rents at current rates or have the tenants been there a long time and paying out dated rent? What would the property be worth if you could raise the rent. ( a duplex's valu is partly based on rents) Are there ways to increase case flow? Who pays water lights and trash? Can these expenses be passed on to tenant? Can you put more units on the property? What kind of neighbor hood is it in? What's the tenants turnover rate? It's been my expierence that the property manager can make or break you. ( all my investments are out of state). Are they doing all they can to keep rents up and cost down? Do you get monthly tally sheets from them so you can track what's going on with your money? Do you get a year end report that tells you where all your money went and to help with your taxes?Like we all said the idea isn't to get the property paid for as much as it is to make as much money as you can using some of your own money and a lot of somebody else's ( the banks). The expenses are all the tenants He pays the principal and interest not you. In your case he's putting it all in eguity wich you can't spend. When you sell the place the depreciation buy back is really going to hurt your taxes. If there's Capitol gain you will pay tax on that too. Talk to a CPA before you sell it. A 1031 exchange is probably going to be in order. That means another property and more debt. Payments on a 91k 30 year conventional loan @ 4% are 435 A month, plus the same taxes and insurance you are already paying. (91k = 38k pay off + 3k loan cost +50k to reinvest) would that payment help your cash flow? Plus you would have 50k to reinvest. No taxes no buy back. Nothing like getting a free house. (Actually 50 k comes close to buying 2 $100k houses if your credit is good and you have some cash reserves.or even a 4 plex??) You gotta Make sure it's the right house's so learn to do some due diligence first. Put tenants in it to pay your expenses and get some cash flow now your making money on 2 or 3 places. Rinse and repeat. The property would need to appraise at around 110-120k. To get a 91k loan. These are rough numbers and only suggestions I can see from looking at it from the outside. There are some AWSOME books available on BP as well as the podcasts They are a good place to start CAUTION if real estate gets in your blood it's addictive!! Good luck to you. RR
@Laura H. I don't know all the details surrounding your situation but I would recommend talking to a CPA first. Use the tools and network BP has to offer to research your possibilities! Happy investing:)
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@Laura H. I'm not from anywhere near there location wise so I don't know what's standard. I realize PM rates are higher where the rent is lower since the work can often be the same or more for less rent. Do they charge any other fees or is that inclusive? Still seems high to me given your situation, someone would likely do it for less. Between the management and the buy down that is why it isn't cash flowing. The property may be good or bad but it is impossible to know without comparing apples to apples. There are times when paying down a property with 15 year are appropriate, so I disagree there. That's not my game I tend to agree with what everyone here is saying but they have to also realize everyone's situation isn't the same. But from reading what you are saying yours is the same and so you should either refi into a 30 and get the cash flow up or sell. Paying it down like you are might be a plan for the later stages of your career.
#2 General Landlording & Rental Properties Contributor
Someone may have already covered it but the reality is that money must earn it's keep. It is the opportunity value of having cash to invest. With todays interest rates as low as they are any investor paying off a loan with cash is losing money since cash has a opportunity value in the range of minimum 10%. Paying off a 3% loan is losing 7%.
If you pay cash for a $100,000 property then before you calculate any other numbers you must deduct $833 from the rental income to pay yourself for your cash investment. This same principal applies to any equity you have in a property.
What this means is that every property has two income streams one is created by the equity in the property the other is the property itself. Cash buyers generally place zero value on their cash which is how they can claim high cash flow on their investments but in reality once you pay for the opportunity money (equity) in a property almost all higher priced properties will be cash flow negative.
This doe not make any sense. If cash has a 10% opportunity premium and you use that cash to buy a property and it has ROI of 10% then you just meet the premium. Using your example if you pay cash for a $100k property and it cash flows $1k per month then it's 12% roi. Why would you deduct $833 from the cash flow? How do you calculate "equity income"? Why is it $833? So you are saying the more equity you have the more you are losing equity income? If that is the case then the best way to not lose equity income is to have zero equity in a property right? But then it would be very difficult if not possible to make it cash flow wouldn't it?
@Harrison Liu There are different ways of calculating cash flow. I guess by premium you mean principle. At BP, I think people tend not to include principle/equity accumulation. This is justifiable:
1) This is much simpler, because that is the money you land in your pocket.
2) A deeper reason is that if you want to factor in equity, a more comprehensive way is to calculate the IRR instead of cash on cash ROI, which factors in appreciation, inflation and other elements. Equity complicates things, because it is not just about principle. It is also about a lot of other factors.
#2 General Landlording & Rental Properties Contributor
You deduct the $833 from the income because as you state the "property" has a ROI of 10% but what about the cash you have lying dead in that property, what is it earning. If it's the same 10% why bother with the hassles of having a rental, tenants, repairs etc. Why not put it some where more passive and get similar returns.
Remember every property has two income streams.
If you have a 100% financed property with positive cash flow of $100/month and you pay down the mortgage to a point that you then have $200/month. Where did that increase come from, not from the property, from the cash injected. If you do not attribute the additional $100 to the equity then your money is in reality dead, not earning a cent. Why would you attribute the additional income to the property, that makes no scenes. Investors do not like money that earns nothing.
But along with investors not liking money that does not earn it's keep we also expect it to earn in the 10% or higher range, why, because that is what we can generally invest it for.
So when you have equity it will always be valued higher than prevailing mortgage rates, therefor dollar of equity is reducing your properties cash flow by a minimum of the difference between the prevailing mortgage interest rate and the opportunity value of the cash in the form of equity.
Which is the better investment a 1M dollar property 100% mortgage at 3% with a return of 10% or a 1M dollar property purchased all cash with a 10% return. Why.
@Account Closed's suggestion - cut bait and try again. Now to look into 1031 exchanges...
Thanks again, everyone, for all of the replies. This has been incredibly helpful.