We are very fortunate to be home owners with a 30 year mortgage at low interest rate. We are also in a desirable location of Johns Creek but want to downsize closer to the city. At this time we are in a quandary of whether we should rent or outright sell our home.
Here are the details:
Bought the home at 550k 10 years ago in a gated club and owe $450k (had to take a Heloc).
Can sell today at $825k
Can rent at $4000/month
Property Taxes - 550/month
Homeowners Insurance - $200/month
HOA - $250/month
What makes a better financial decision if we don’t need the funds outright today? Thank you so much in advance.
If you sell, you can pocket the $275k gains tax free (assuming you are married). If you rent it out, you will soon lose the ability to shield the gains from taxes (because you must have lived in the house 2 of the 5 years prior to sale to qualify for the capital gains tax exclusion).
I think a fundamental mistake most people make is thinking house = money. Markets can go hot and cold quickly. What you think it’s worth is pretty much meaningless. You’re highly levered with a $450k mortgage. If you had a smaller mortgage, like $250k I’d say do whatever you like. $450k is too much, you could theoretically get underwater if the housing market swan dives. I’m not predicting, I’m just saying - protect against the risk of leverage magnified loss.
Can you expand? My interest rate is low and I have 20 years to pay off the debt. If I have a tenant, they would pay off the home in 12 years (assuming any increase in rent will pay off for any repairs). After that I will have likely at least a $850k home free and clear.
Apart from that I can use the property tax/mortgage interest/hoa to offset my current salary thereby bringing down my taxable income.
Unless, you mean the appreciation of time value of $, which is $275k in hand (after RE fees) free and clear which could be invested gaining a higher rate of return.
If I lived in the house 9 years and had it as my primary residence, can I not rent it out now, and change my primary residence to another home?
Can you please share how will I lose the ability to shield the gains from taxes?
Whenever you sell your current residence (which you’ve lived in at least 2 of the last five years), any gain up to $500k (for married filing jointly) is not counted as income. If you move somewhere else, and then sell this house within three years, you can still claim the exclusion. If you sell in 3.5 years, then you’ll have to pay long-term capital gains taxes on the profit. You can do the same on your next home, if you make a profit on it and live there more than two years. Note that you can only do this every two years, so if you wait three years to sell this one, then you’d have to wait two more years to sell the next one if you want to claim the exclusion.
This is just one factor of many to consider. I find tax-free profit hard to pass up, but you can do what works for you.
With all due respect that is a hyper conservative way to look at Real Estate. You have to take into account the person’s annual income, their age, is it a one or dual income household and long term/short term savings. Because in my humble experience RE is a fantastic catalyst for income/wealth generation. If I had a conservative outlook, I wouldn’t have been able to accumulate rental income properties thanks to Uncle Sam subsidizing the cost of borrowing with amazing interest rates. In one way I can see how borrowing more than you can afford could put one at risk, but it’s all relative. Again, this is just my humble opinion and thank you for your post.
SELL here’s why: no one today has any sense of obligation to honor commitments. Look at the COVID crisis No one had to pay rent and you couldn’t evict. The tenants got rent help but they didn’t have to pay the rent no one could evict.
You will have only one property to rent and what happens when the renter stops paying? Evictions can take months and then the tenant could destroy your house to spite you. Then what?
We own a fair amount of investment real estate, both SFR and Vacation properties. I am looking at your numbers purely from an investment perspective:
NOI = $48k rent - $12k operating cost = $36k
Cap Rate = ($36k / $825k) = 4.4
From my perspective, not a high enough Cap Rate with these numbers. Using Clarks (and many investors) 1% rule its not even close. Rent does not scale linearly with the price/value of a home and your home is much too expensive to be a rental. The sweet spot is probably down in the mid $300k range right now in the Atlanta area, but even there the Cap Rates aren’t as high as I would prefer.
The question isn’t if rental real estate is great investment…because it certainly is…but rather if this specific situation makes a great investment…which it doesn’t. Does your HOA even allow rentals? Have you considered taking the equity and buying 2 lower priced homes with higher Cap Rates?
20-25 years ago, there was a financial call-in radio program hosted by Bruce Williams. He was an advocate of small business and rental property. He used the 1% rule (1% of FMV as monthly rent) to determine if the rental was a good investment. It’s still true.
You’ll always have sufficient cash flow to service the loan.
You’ll always be able to find a suitable tenant for your leveraged rental.
You’ll always have a primary source of income.
Insurance will always cover anything that happens to the house.
All of the above risks, and more, come with a leveraged rental and any one of them can be financially catastrophic.
Any or all of the above become just a financial setback if you own the property outright.
Cash and real estate work well together, I’ve heard of very few bad outcomes when that is the case. On the other hand, I’ve heard too many to count when the element of significant (over 30%) debt is part of the plan.
I wish I had all of the modest tract homes I lived in over the years as a kid in California, I’d be a multi-millionaire just by inflation. The problem is how the average person or family could rent it out, and still have the means to buy the next home, and so on. You’d almost have to become a small time real estate mogul.
I wonder if any of the gains of the last decade in real estate turn out to be durable. No one can afford housing - why is it so high? Feels like a bubble, now deflating. But corrections take time. Peak to trough Great Financial Crisis or Great Depression… Three years roughly. I’m keeping dry powder for 2025.