Poll: Should This Guy Sell His Rental House?

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A friend of mine is having a dilemma about what to do with one of his rental properties. He asked me for advice, and I thought I should float the question to all of you.

Here’s his situation:

In 2001, he purchased a single-family residence in a middle-class suburb of Denver for $180,000, with a $40,000 down payment. He refinanced the property one year later, locking in a fixed 30-year interest rate of 6.25 percent. The mortgage (PITI) comes to roughly $1,000 per month, and he collects rent of $1,200 per month.

As most of you can already see, this is not a good investment. He’s aware of that, too. He’s learned a lot since 2001.

He’s received two independent opinions of the value of his home from respected people involved in the real estate industry within that specific neighborhood. Both of them believe that the house is worth roughly the same amount that he paid for it. In other words, he probably wouldn’t make any (or much) capital gains by selling the house, but he probably wouldn’t take a loss, either. (He may or may not take a loss due to commissions and fees — after all, there has to be some margin of error). For the sake of this example, let’s assume he’ll “break even.”

The house is in good condition and does not have deferred maintenance issues. He has a long-term tenant in the house, but he’s not sure how much longer that tenant will stay.

Alternate Uses for That Money

His risk profile is conservative. He absolutely WON’T buy another rental house (or do any other type of real estate investing) for at least the next three years. He doesn’t mind holding this house, but he does not want to accumulate any more.

He says that if he could liquefy his $40,000 down payment, plus pull out whatever other limited equity he has in the house (if any), he would ideally like to use that money to accelerate the mortgage pay-down on his primary residence, which is currently in its earliest years of amortization.

So … should he sell the house or not?

Benefits of Selling:

#1: Although he probably wouldn’t make any gains, he would have access to his down payment money of around $40,000. (He does not want to borrow against his equity to pull the cash out).

#2: He would not have to deal with any management or maintenance issues on the house. While he has not had to deal with many issues, he’d prefer to deal with zero, particularly because he now understands that this house is a marginal rental deal.

#3: The only reason that this house is supposedly “cash-flow positive” is because he manages the property himself (and does not pay himself for his time), and his occupancy rate has been 100 percent for the past several years. A series of misfortunes could “turn the cash flow tides,” as it were. Perhaps he should unload the property before that happens.

Related: Don’t Sell Your Real Estate Holdings Just Yet…

Benefits of Holding for 1-3 More Years:

#1: There’s a chance that if he holds the property for another 1-3 years, home values in Denver will rise, and he will be able to make gains on this property. This is his strongest reason for holding onto the property, thinking that perhaps he might sell it in 2014 or 2015 instead. (On the other hand, of course, no one knows what the future holds).

#2: He’s not motivated to sell because the pain of holding the house is not yet uncomfortable enough. There are no tenant issues, no major maintenance issues. So why should he bother?

#3: He’s already held the property through the first 10 years of ammortization, when most of his payments have gone towards interest. Now a greater percentage of his mortgage payments are going towards principal pay-down. Is there an argument to be made for holding the property for a few more years and building greater equity before selling?

So …. that’s the situation. What do you think he should do? Sound off in the comments!

Photo: maryfrancesmain

About Author

Paula Pant

Paula Pant quit her 9-to-5 job, invested in 7 rental units, and traveled to 32 countries. Her blog, Afford Anything, shares how to shatter limits, build wealth and maximize life. (At AffordAnything.com, she shares EXACT numbers from all her rental investments -- costs, cash flow, cap rate; it's all published for the world to read.) Afford Anything is a gathering spot for a tribe dedicated to ditching the cubicle. Read her blog, and join the revolution.

50 Comments

  1. If I were him I would sell now. The fed’s recent meeting signaled slowing of asset purchases and as the market showed wed/thurs, anyone who thought that all this easing wasn’t creating an asset bubble is in for a world of hurt. As rates begin to tick up his hopes of appreciation in the near term are probably not going to materialize. Unless he can rent the place for $2,000+/month on a net lease or better, this investment is not worth his time. Better to pay down his mortgage.

    • carrying costs will eat that up fast if his tenant leaves. factor in his broker’s fee and hes negative. she stated that it was appraised roughly the same as his purchase price…if hes had it for so long and no appreciation, why would it appreciate 10% in 6 months when rates are rising? not following your logic here…dump the house

  2. Paula, obviously this property violates the 50% rule. The question now … to which you alluded … is “what are the chances for a hefty appreciation versus the likelihood of a larger expense (major repair or extended vacancy) in the near future?”

    I’d bet on that the expenses would likely go up and this landlord will incur a real loss (expenses greater than income) in the next 3 years.

    A buyer who buys this as a rental property will also see that the expenses are more than 50% of the total income so would likely want a ‘haircut’ on the selling price. My first step, if this would my friend asking for advice, would be to get some comps on both the selling price and rents on comparable properties.

    The real ‘uncomfortable moment’ will come when it has been vacant for two months or needs a new roof. If the landlord tries to sell then, the ‘haircut’ will increase.

    Good luck

    • If he sells the house to an owner-occupant (rather than an investor), he might not accept a reduced price for the house (since the buyer won’t be looking at his P&L sheets). Unless, of course, he just panics and dumps the house in order to get rid of it — but it sounds like inventory is tight in Denver and houses are selling quickly.

      Needing a new roof, though, will definitely cause an uncomfortable moment. 🙂

  3. I have two condo’s as rental properties. I love the buy and hold method. I now have total cash flow as my tenants paid off the mortgages. Don’t sell unless you have too. Raise the rent a bit each year to keep good tenants.

  4. I have two condo’s as rental properties. I love the buy and hold method. I now have total cash flow as my tenants paid off the mortgages. Don’t sell unless you have too. Raise the rent a bit each year to keep good tenants.

  5. I have two condo’s as rental properties. I love the buy and hold method. I now have total cash flow as my tenants paid off the mortgages. Don’t sell unless you have too. Raise the rent a bit each year to keep good tenants.

  6. Another option is to look at the possibility of a refi. He’s making payments on a note that was amortized for 140k at 6.25%. He’s paid 10 years down on that, so would have somewhere around 118k balance. If he were able to refi at, say, 4% for 30yrs, That would drop his (min) payment by about 300 a month. He could keep paying the same as he is now for an accellerated payoff, but have the 300 buffer if he needed it. Sure that is going to kick the can down the road further, but since it hadn’t been mentioned yet I figured I’d toss it out for discussion.

    • I’ve asked him why he doesn’t refi … he says there are two reasons:

      1) He’s already 10 years into his ammortization schedule; he doesn’t want to re-start that clock. He’d rather devote payments to principal rather than interest.

      2) After the closing costs and other various fees associated with a refinance, there will be a matter of months or years before he reaches the “break even” point. Is he committed to holding the house for that long? He’s not sure.

      What are your thoughts about those? (He’s reading all these comments, by the way, and LOVING these opinions! Keep ’em coming!)

      • Here are my thoughts – until he crunches the numbers on what the closing costs will be vis-a-vis the 1% interest over time is, it’s pointless to speculate. It’s a numbers game.

        When I ran the numbers the other day, I found this:
        140,000 note @6.25% – payments are ~$862 (PI only)
        At the 10 year mark, balance is abour 118k, and about $246 of the payment is going toward principal, $615 toward interest.

        If he refinanced at this point to 4% (let’s say he gets that rate) he ends up with a PI payment of ~$563 a month. Of that, 170 is going to principal, 393 to interest (at month 1)

        If he wanted to keep paying the amount he is paying (i.e., adding the 300 difference each month) his breakdown would be ~863 a month (about the same as now) with 470 going to principal and 393 going to interest. If you just look at those numbers alone, he is saving $222 the first month alone in interest ($615-$393), with that amount going to principal.

        On this accellerated payment schedule, he isn’t really “resetting the clock,” as the extra payment amount will end up paying off the note in about the same time anyway. Maybe even earlier – this is the same as making about 4 extra PITI payments a year!

        The more I look at this, the more I would refi if I chose not to sell.

        *(disclaimer – I made a few assumptions, to include that closing costs would not be rolled in, but on a 118k note, they shouldn’t be much more than a couple K only adding a small amount to the payment.)

        • That is an excellent, excellent breakdown — I just emailed him and told him to take a long, hard look at your comment, and then work a spreadsheet testing those numbers. I think you’re right … there’s a very strong case for refinancing that mortgage.

          If he chooses to do that (or whatever he chooses), I will definitely keep you (and everyone at BiggerPockets!) informed. He has a lot to think about this weekend …

        • Agreed! His interest rate is terrible. Although I don’t think he will get 4% either. Maybe he can do a 5-year adjustable and sell at that time if he chooses.

          Not sure if anyone mentioned this but the cost of selling will cost him as well if he doesn’t have any appreciation. (It’s worth what he paid.)

          Personally, I would keep the property and probably keep it forever. Rents will go up and so will appreciation. What can he do with $40k now?? Can he really find a replacement property with great cash flow in Denver? (You can’t around my area.) I don’t know if that’s the actual property in the photo but it looks in good shape and expenses probably aren’t that high so the tenant is actually paying for the house anyway and as owner you’ve got a nice tax deduction.

      • David Toelkes on

        Paula,

        Remind your friend that the term of the refinance does not have to “reset” the clock. I recently refinanced a loan that I took out six years ago and asked for a 24 year amortization on the refinance. That way, I did not restart the clock, just lowered the interest rate for the remainder of the time left on the original clock.

  7. Denver also has a very tight rental market. Has he raised rents at all?

    The market in Denver is appreciating, but whether it’s another bubble or not, will continue appreciating or not, is anyone’s guess. You stated he was risk-averse and doesn’t want to be a landlord, the tenant may leave and he’s not paying himself so is basically losing money as a result, so he could sell quite easily in that market (in some cases a matter of days since inventory is so low) and be done with it.

  8. Scott Kelley on

    I’m new to all of this and have a property that’s in a similar situation, I don’t meet the 50% rule (I know more now!) but I have a consistent renter in Colorado. I’ve also managed to save the management fees.

    If he’s comfortable with the house and doesn’t want to reinvest, I would refinance and get the lower interest rate.

    I think, if he can’t get to the lower interest rate, I’d sell, considering the current market in his area.

  9. john milliken on

    seems like he wants out.
    sell. might be his last chance to break even in this “mini-bubble”

    anyone who was a real buy-n-hold guy doesn’t have this dilemma.

  10. Your friend is going to lose part of his $40k no matter what the RE agent says, I know how that goes.

    There is an easy way to get more rent or to outright sell the place over time.
    I would sell the place to this tenant or another tenant on an installment sale basis, much like a car is sold. The deed transfers on the last payment, where this is different then a owner financing; the payment is set at an equal amount for a set number of payments. Just like a car the buyer is responsible for all costs of ownership, although the taxes should be factored into the payment.

    I would also try to raise the payment to a higher amount say $1500, so 120 payments latter the tenant owns the place free and clear, you friend makes $500 a month or $60k plus regains the equity he has locked up in the house.

    If at anytime the tenant decides to move, it’s a clean break as they never had a ownership interest in the home, just like the repo man takes away your car, and if not reclaimed all monies paid are forfeited. The deal is structured solely as rent paid each month not a lease option.

    Not a bad deal for the tenant 10 years to ownership of a house, no money down, no interest.
    Good deal for the owner, no Realtor sales commission.

    If however you think this a bad deal because he loses the upside of appreciation, taxes could go up, or he is not getting interest on his money. Well first of all the only money he should get interest on is the $40k and in his present situation he is not going to get a dime of interest. If one simply adds a few more months to the mix the problems are solved taxes may be a issue as CO is out west where folks feel ok getting hosed for RE taxes.

    I almost sold a house this way in Philly the tenant paid a rent 1/3rd more then market rent for 8 years and just 3 years shy of owning the place moved in the middle of the night. The place was pretty worn out and is still to this day (near 2 years later) vacant. I paid $12,800 and rented for $950 a month normal rent in this area was $600 8 years ago, today the rent is $900-$1000.

    I tell my wife the place is on the 2 year plan.

    So the transaction was $12,800 and I received $91,200 over 8 years, no repairs, and no management issues. The place will need about $15k to put back on the rental market, where I will try for $1200 for 120 months once more.

    The taxes on this house were $237 a year, recently the City has near tripled them to $645 which are being appealed.

  11. I guess I am of the mindset that positive cash flow is better than no cash flow. I would hold it for a few more years. He may be able to strike up a lease purchase deal with the right tenant.

  12. Bobby Houston on

    Sell, simply not worth any risk for that kind of gain. I would be greatful walking away with a small loss and a big lesson learned, especially in this economy. I think we all need to be very careful with mortgaged investment’s right now. Dennis has the only other plan I would consider right now. Just my personal opinion though..

    • Sharon —

      Thanks for your input! Out of curiosity — how long is “awhile”? One or two years?

      His biggest concern is that an extended vacancy, major repair, etc., might take cash out of his pocket. But, that said, it is a pretty nice property in a desirable area, and home values are rising. Which is why he’s not sure what to do …

  13. HOLD! The tenant is buying him a house!!! even if it breaks even for the duration of the mortgage at the end he has a house he hasn’t paid a dime for. The smart money is getting fixedrate long term financing on as many properties as possible right now.

  14. 1) any product is always cheaper if purchased last year. You bought it for less than you will ever sell it for.

    2) refi to a 15 year note. 3.2% interest, lower pmt, faster payoff than the remaining 20 on current loan.

    3) in 15 years when the house is paid off and runs have doubled you’ll be glad you did this!

      • A house bought in 2006 was cheaper than the same house in 2009? Any product is always cheaper if purchased last year? I just don’t know how you can make this generalization. Ever heard of deflation? You feel certain that his home price will continue to appreciate while interest rates begin to rise from historic lows? I don’t care what market he is in. More probable scenario: Home value stays stagnant for years while rates rise, renter loses job or moves out at some point, home needs major upgrade, HVAC replacement, roof replacement etc., property taxes rise, and his capital is tied up in an investment that is making a very slim return that could be erased by one major repair etc. or a couple months of vacancy. Better to get his capital out and invest somewhere that he actually gets a return instead of a constant headache…

  15. Has he asked the tenant if he would be interested in buying the house? I structure some of my lease options with 5% option payment, can be paid over a year as extra rent, tenant/buyer is responsible for first $1000 of repairs, takes care of most small stuff, and make sure you have a good home warranty with $1000 deductible or less (this helps mitigate larger expenses above $1000) and good insurance including rent replacement. The tenant abides by the lease, set it for 1 to 2 years, if lease is broken then owner has the option to remove lease option purchase agreement. The 5% option payment is non-refundable, I would set aside about two months worth of payments if he doesn’t have a decent reserve/emergency fund, this gives him time to fix and rerent, sell, whatever he chooses but at least the tenant has skin in the game and will take some of the burden off the owner. Possibly even refinancing the agreement is signed and using some of the lease option money to reduce the monthly payment so that more of the rents are applied towards the principle. In the mean time, if it appreciates, at the very least pays the principle down, if the renter decides not to exercise option the owner is sitting better in the property. If the renter does exercise, the price would probably already been agreed upon and it’s one the owner can live with.
    It’s not the only answer, depends on what works for him and what he’s willing to do. But glad you put it on here so we can all see the different approaches!

  16. Interesting question. The first thing that comes to my mind – and I apologize if I missed this info – is what sort of lease does he have with the tenant? My assumption is that it has gone month-to-month; if that’s not the case, it may make his position more complicated….

    • @Ben — It’s a 12-month lease that they keep renewing annually. The tenant has been there for several years, but every summer, he worries about whether they’re going to renew for another year or not ….

      • Tenant is on a 12-month lease and has stayed several years and the owner is ALWAYS worried they won’t renew??? I don’t think he’s cut out to be a landlord. From my perspective this is a dream tenant–they don’t get much better than this. I had originally recommended that he hold the property because he won’t find anything better to buy. However now I’m changing my recommendation and I think he should sell and whatever money is left to put it into something other than real estate.

  17. If I were in his shoes, this would be my approach. He seems to be able to manage the property well enough but does not want to have more properties. He is not looking for some killer deal or some outrageous return just something managable and stable. I think the Denver market will remain stable and growing. I think the main problem right now is he might be getting a lot of opinions based on a mentality of a growing real estate investor. So with that said I would refinance the current balance, even rolling in closing costs if wanted, down to a 15 year mortgage at today’s still low rates. This will be more than possible as I would imagine he has enough equity from the numbers given and has owned the property long enough. By dropping it down to a 15 year note his payment should stay roughly the same but the amortization will be much more in line with his goals. I make this recommendation with the assumption that he is in a financial position to cover a vacancy and make neccessary repairs. If this is the case I believe this path would be the win win for him. He keeps his capital working for him and maximises his returns in line with a methodology that fits his comfort level and goals. The beauty of a 15 year note is that it provides many options. 5 years down the road, 25% of the balance is paid down whsreas on a 30 it is maybe 5% – 8%. This make it a lot more advantageous. He does have a lot to think about but I believe once he looks at his goals 5 – 10 years out the answer will become clear. Good luck!!!

  18. David Driscoll on

    Think about this, sell the house he’s living in and move into the rental refi the rental as a owner occupied to lower the interest rate. The current rate is too high. His purchase price is too high for a rental base on the rental income. Repairs, property tax and insurance comes out of the $14.400K per year income. Just in mortgage payments, he has $12,000 a year in expense and only $2,400 a year gross income. He’s one plumbing, roof leak or heating problem away from a negative cash flow. One other thought is to rent the house he’s living in and move the rental, put both of them in an LLC

    • That’s a great idea, but unfortunately, he definitely doesn’t want to move into the rental. It’s too far away from his job and would be massively inconvenient. Plus, he likes his current home and wants to stay there.

  19. He can not base his decision on what may or may not happen in the future, that’s speculating not real estate investing. If that tenant moves out he’s going to feel some real pain real fast! Even if he only has to suffer through some minor repairs and a short term of the property being vacant, that will hurt. He’s also speculating that if the the tenant moves, the next tenant will be just as good and reliable.

    I assume he bought this place to make a profit which he’s barely getting. And he’s probably one big repair from taking a hit. He should sale ASAP, cut bait, abandon ship, get what he has coming back and use that towards more beneficial endeavors.
    As others have said refinancing to a 15 year mortgage is also a pretty good idea. Since he would pay off the house a little sooner and have more of a cushion.

    Good luck my friend and keep us posted, and don’t become inflicted with analysis paralysis!

    • “Don’t be affected by analysis paralysis” — great, great point! Maybe he should set a decision-making deadline (I’ve found that a self-imposed deadline is one of the best ways to avoid analysis paralysis … )

  20. Land speculation is pure gambling. Rental real estate is a business of positive cash flow. Unless you know something about the Denver market that nobody else knows, I wouldn’t assume that real estate prices will rise and use that as the basis for a business plan.

  21. I am in a similar situation. I own a 2003 house in middle Georgia and paid $140k. It has remaining balance of $118k. My renter has been in the house for 6 years and is leaving next month. My interest rate is also 6.3% and I tried to refi. But since it is not my primary residence the interest rate is about a percentage higher than the current rates. The value of the house is about the same when I purchased it. The future of the local housing market doesn’t appear it will increase in value much. So I am leaning to selling vice re-renting. The tax benefit hasn’t been that beneficial as my other places. Thoughts?

    • David Toelkes on

      .
      Bryan,

      So what if the investment property finance rate is higher than the owner-occupied interest rate. It has almost always been that way. I had a 6.5% rate with GMAC that they lowered to 4.5% on a HARP loan program. My monthly payment went down, but I chose to use the saving as additional principal reductions each month. Doing so, will pay off my new loan six years faster than I would have paid off the old loan.

  22. Hold. He’d be crazy to sell.

    He’s already gone through all the pain of purchasing AND he refinanced.

    Even if this tenant moves and he has repair costs, someone else is STILL paying down his mortgage (he’s not) and it will end up free and clear. If he wants to pay off a property (which I don’t recommend) pay off this one. It will eventually be pure cash flow.

    PLUS he has tax write offs from this property. It will be a HUGE benefit for his retirement. His own property has very little value to him. It will NEVER be income producing and, if he pays it off, his money is GONE. If he ever wants to use the money he sunk into his personal residence, he has to pay for the privilege.

    HOLD this property. It may be near break even now, but in 10 years it will be a huge cash cow and he will be kicking himself if he sells it for the little bit he may make today.

  23. If the guy really doesn’t want to be in real estate I’d say sell it while the market is doing okay and he can get out without losing much if anything.
    If he wants out and waits he MIGHT get screwed if there is another dip and doesn’t come all the way back to this level to fast.
    It might be a small risk, but not worth taking if he wants OUT.

    Now if he wants to roll the dice and see if it bounces back even more and is HAPPY to still do what he has been doing then for the love of god refi the place. Even with the uptick I’d think he should be able to bring that down like 1% and as much as he might not like to think about restarting the clock it will give him more of a cushion month to month if there is ever an issue.
    If he wants to pay it faster then throw all the savings into additional principle payments until there is a major repair or vacancy.

    • He’s in the process of trying to refinance the house, and then throw a ton of extra payments at it in order to pay it off in full.

      If that doesn’t work (if for some reason the refi doesn’t get approved), his second choice is to sell. The current tenants are moving out in the spring, which will be a good time for him to list the house.

  24. I would hold on for a bit longer as the market is appreciating. If after that time, the owner is inclined to sell and re-appropriate the funds and equity increase, then have at it.

    Yes, the cashflow is low, but the owner has progressed significantly far into the amortization schedule and if the positive cashflow is not needed at this time, it could be applied toward principle to get closer to free-and-clear ownership.

    In all, I would keep the property and potentially pursue refi to 15 yr amm with lower current rates of 4%, significantly increasing the cashflow.

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