Rent or Sell Old House? (Calculator?)

Before wading in, I'll throw out a request for anybody with a good calculator or spreadsheet (it's easy to find some, harder to find some I have faith in) for answering the "sell or keep and rent?" question for a house you're no longer living in...

We've just moved, and were working under the assumption that if we can, that we should keep the old house and rent it out. It's in inner SE Portland, and thus an area that's likely to see only increasing demand over the coming years, regardless of the general ebb and flow of the market. It may fall from it's current value with a "market correction," but it would seem set to become more valuable over the long haul.

However, we had it so filed as a "no brainer" that we only just did a little cocktail napkin math and realized that between mortgage, taxes, and property management fees, we probably wouldn't be collecting enough on the projected rent to stay much ahead of maintenance costs, if at all. We thought we were being thoroughly conservative by saying to ourselves "We don't expect to make any money on rent, just for the house to take care of its own expenses." It turns out it's reasonably likely to fail to do so.

Certainly, it'll be paid off in the middling future, at which point it'll pay for its own maintenance and then some. Which exposes that whole question of whether it's relevant that the house won't cover its own costs. If we paid it off instead of investing elsewhere, the cost of running the house would remain the same, and the rent would remain the same. It's really a question of the total wins/losses over the full term.

Which sort of brings me back to the search for a calculator. When we pick, say, 20 years out, how does this pencil out, so we can compare it to other investments? Real estate feels generally solid in the long run, but even farming out the management we have the worry of getting a bad tenant and winding up with damage or legal wrangling.

Can't offer a good calculator, but a couple things often overlooked:

- Income from your rental is taxable income.  It's a business.

- Expenses will now be tax deductible.

- Cost of running the house will definitely not be the same after you've paid off the mortgage

- Your insurance may go up.  A LOT. (could be 3X)

- You will definitely have times with zero rent income.  Could be worse (long time, damage, legal wrangling, etc)

- Appreciation will now work in your favor (and is taxable)

- Gains at the time of sale will be taxable unless you have lived in it for 2 of the last 5 years as your primary residence (according to current tax code)

Stuff to think about...

I don't have a great calculator. Wish I did. This will vary wildly between people and places. There are a hundred ways to do the math and it is easy to convince yourself one way or the other.

Big unknowns are the maintenance costs of the property (both $$ and hours you might spend fixing stuff) and number of months between renters. Both are hard to estimate.

I will say three things:

1. Of all the "side-hustles" studied in a recent report I read, real estate property management had the highest average hourly wage. (Some stuff like youtubeing had crazy maximums, but the averages we're low).

2. In general, in order to beat the stock market (or just keep up with it) with rental property you must be pretty highly leveraged (say that you still own less than half of the house with equity or so). If you have already paid off much of the house this is actually a reason NOT to rent it out. In a place with high population density, there will be strong market forces normalizing rental rates and sale prices and equalizing them to a similar growth that an investor could get in the stock market with a similar investment. And the investors will all be minimally leveraged, so that is why having lots of equity is actually making your return potential lower than other investments.

3. The one protection you have right now is that transacting on real estate has a large cost in both time and money. That means you might have a slight starting advantage over other types of investments.

Here's my favorite math:

Take monthly rental income minus monthly rental costs. Multiply by 12 for annual estimated "profit". Maybe knock 10-20% off for unknowns. Then take your annual salary and divide by the rental annual profit to see how many homes you would need to own and manage to replace your day job.

You can take it own step further and see what the minimum and maximum dollars you would need to own that many houses (at 30% equity and 100%). If instead you just had that number in a 401k could you retire? If so, having the 401k is infinitely less work than managing all those properties...

The question is, would you buy this house right now to rent it out if you didn't already own it?

Any investment must be compared to a general market index fund. That's the "easy button" that is likely to earn in the neighborhood of 7% over the next 30 years without any oversight. Just set it and forget it. So that's the baseline that all other investments should be compared to. If you're not going to beat the market by a decent amount with an alternative investment, then it's easier to just stuff money into an index fund.

Real estate can be lucrative, but it requires more work than an index fund, is less diverse than an index fund, and is harder/more expensive to sell when you decide to move on.  If something goes bad in an index fund you can lose all of that money, but the impacts stop there. If something goes bad in real estate, not only do you lose money, but it can have far reaching impacts like bankruptcy that will hang onto your life for years. You also have tax implications and insurance to deal with that aren't a concern if you're just invested in an index.

So that's the framework we're dealing with. Indexes are simple and about 7% return. Rental property is more work and risk for pontentially more gain. If you're still ok with the idea of real estate, then it's time to move on to the math:

The 1% rule: The first general rule in rental math is the 1% rule. If you can't get 1% of your purchase price in rental income each month, it's probably not going to outperform the stock market without significant appreciation which is a gamble.

The 50% rule: It's safe to assume 50% of gross rent will be needed for expenses. Take the monthly rent, subtract the mortgage, and then the 50% of rent gets devoted to, insurance, taxes, maintenance, etc. Whatever is left is your cash flow (return). Assume 10% of rent for property management. Large capital expenses in the future need to be accounted for too (roof replacement, appliances, HVAC, etc). All of those add up to the 50%. So, a $1000/mo property with a $400/mo mortgage and $500 toward the 50% rule leaves $100/month in cash flow. Not having a mortgage will significantly impact that math of course (But it also means less leverage and poor cash on cash return).

Vacancy: Real estate is only not losing you money when it's occupied at the proper rent. Every property has some percentage of vacancy. In very desirable areas it can be low (2% maybe), and in less desirable areas it can be 10% or more. But it's going to take some time between tenants to clean/repair the property and find new tenants.

Understanding all of that, I like this calculator. Plug in your numbers to the best of your ability and see what the return might be. That's your reliable cash flow. For me, I'd want at least 10% Cash on Cash return to justify the extra work and risk associated with real estate. If I can't get that, I'd be better off just getting the easy 7% from the market. Any appreciation on top of that is gravy. If the numbers aren't great on cash flow alone, then you're just assuming/hoping/guessing/praying that the property will appreciate in value faster than inflation. I don't have a crystal ball, so I'm not comfortable with guessing/hoping on an investment that could bankrupt me, but tons of people still make that assumption in expensive, popular metro areas all the time. For some, it works out, and for others, they'd have been better off just indexing and kicking back. You have to make your own choices there.

I'll also add that it's important to understand tenant/eviction laws in your area. IN some places, it can be extremely difficult to evict somebody which is a nightmare for landlords. You hope that properly screening your tenants will take care of that, but nothing is perfect.

Have you considered AirBnb and VRBO?  In a busy area it's possible for income to double or triple your mortgage.  Lots of work, which you could outsource, but potential for keeping the house and making some money.  I like https://www.airdna.co/ for their take on earning potential from a property.

Maybe this will help?
 

Interesting read.  When I retire my plan is to sell my dental practice and rent out my building to the new buyer.  A lot here to think about...

Crxpilot said:

Have you considered AirBnb and VRBO?  In a busy area it's possible for income to double or triple your mortgage. 

Double or triple?  That is grossly overly optimistic.

We have about 15 AirBnB properties in the family, and my daughter makes her living managing other people's AirBnb's in the Atlanta area.  Double or triple isn't gonna happen, and in some cases long term leased rentals make MORE (because the tenants pay the utilities, and do not with AirBnB)

I've heard the 1% rule used before....basically, if the place is worth 200k on the open market, if you could rent it for $2000/ month (1% of 200,000)  then you'll probably make out well.  That's pretty conservative.  We have a house we rent out at about 0.75% of market value and do OK.  It pays the mortgage and the expenses for the year.  Between depreciation and expense deductions on taxes it's net positive for the year, and hopefully the place will appreciate by the time we eventually do sell it.  

It's work, though- either that, or a check every month to the management company.  And dealing with tenants can be dicey at times.  I've had to evict- once.  I was lucky- they left quickly, I just had to pick up the mess.  I didn't get to deal with any legal hassles.  

Clark Howard wrote a good book on this. I read it like 10 years ago, though and forgotten more than I remember. Worrh checking out. He’s a smart investor. 

I think my takeaway was that there was way too much work/risk involved in the property we were considering renting at the time.

Here's some guidance on evaluating rental properties: https://forum.mrmoneymustache.com/real-estate-and-landlording/evaluating-a-rental-property/

Treat it not as keep vs sell, but as if you're buying it. Would you buy it at the price you would get out of it now? Because the situations are pretty much identical. Do keep in mind the cost to sell though - your transaction costs including commissions, etc.

Don't forget that if it's a rental for long enough to lose your capital gains exemption, then when you do sell it, you'll not only have capital gains, but depreciation recapture tax to pay. And you have to pay the depreciation recapture whether or not you actually take the depreciation. (So make sure to take that depreciation!)

I went through this twice in the last decade and both times decided to sell. Every penny I made on the sales, I put in the stock market. And it's treated me very, very well. It could crash tomorrow, but then again a tenant could trash a house tomorrow too. Temper my decision with the fact that my "day job" is as owner of an office building so I am heavily invested in real estate, just not single family houses. So I have little motivation to buy more real estate as that would not be diversification for me.

I can say, a rental that just covers its mortgage payment and taxes and insurance is not making you money. You will be losing money once vacancies and maintenance are factored in long term. Very, very many small landlords - I would say the majority - do not make as much as they think they do since they don't accurately track income and expenses and calculate total return.

Great question!  We kept our old house when we upgraded.  It's been a rental since '03.  Sometimes I wonder if it is worth the hassle and always come to the same conclusion:  YES, it's worth it!  The rental income is part our our retirement plan.  We perform maintenance as needed and rent below market so good tenants stay.  When vacant, I just put a 'For Rent' sign in the yard with our phone number.  It's in a desirable area so we never have it empty for long.   Applicants pay a fee for a background check with a Tenant Evaluation Company.  

The place is 45 minutes from our home, so that is a little inconvenient.  Cash flow has always been positive even with maintenance on a house built in 1956.  Currently, cash flow is funneled back into the property for upgrades.

You need to decide how valuable your time is and how much will be consumed as a landlord.  Also, what are your long-term plans.  Owning property tends to keep you from being mobile for another job.

SVreX said:

Crxpilot said:

Have you considered AirBnb and VRBO?  In a busy area it's possible for income to double or triple your mortgage. 

Double or triple?  That is grossly overly optimistic.

We have about 15 AirBnB properties in the family, and my daughter makes her living managing other people's AirBnb's in the Atlanta area.  Double or triple isn't gonna happen, and in some cases long term leased rentals make MORE (because the tenants pay the utilities, and do not with AirBnB)

 

https://www.airbnb.com/s/Portland--OR--United-States/homes?query=Portland%2C%20OR%2C%20United%20States&checkin=2019-05-24&checkout=2019-05-26&adults=2&children=2&infants=0&guests=4&place_id=ChIJJ3SpfQsLlVQRkYXR9ua5Nhw&refinement_paths%5B%5D=%2Fhomes&toddlers=0&search_type=UNKNOWN&allow_override%5B%5D=&s_tag=Kvrs-ezB

Some of these homes are bringing great nightly rates and are booked over 20 days per month.  Yes, the right house could double or triple a mortgage payment.  YMMV. Caveat emptor.  It's worth considering, as are the other ideas and suggestions.

In reply to Crxpilot :

You are using that data incorrectly.

This isn't worth the argument, but I am trying to give the OP some honest data to make good decisions from.  You are assuming places are rented because they are blocked out on the calendar (not true).  You are also using gross numbers, instead of net. Portland has a buttload of fees.  $4 per night booking, 11.5% local lodging tax, 1.8% State lodging tax, 2% City lodging fee.  Portland has a $5000 fee for any building with 3 or more rental units.

80% of the AirBnbs in Portland operate illegally. There is risk.

In a recent study by SmartAsset, they excluded Portland from the financial analysis because of a lack of reliable data for the private room market in that city.   I don't know how you can possibly pull sufficient data from AirBnB's website to make that statement.

How would we know what the mortgage payment is?  The average mortgage in Portland is $1479 (in 2017).  Three times that would mean an average rental rate of $221 per night (assuming 20 nights per month booked, like you said).  That's a much higher average than your search results.

The average annual revenue from the 15 largest AirBnB markets in the country is $20,619.  That's a very nice number.  But it's not 2-3 times most people's mortgages.

Don't believe everything you read on the internet.  

AirBnB and those types of sites are also SO tough to stay competitive.  It's not just "change the sheets and set out towels,"  The market is fierce.  You get reviews, and the ones who leave fresh fruit, bath salts, and kiss your butt get good reviews.  If you just set out towels and leave the key, your reviews will tank and you won't get any bookings.

My neighbor does AirBnB.  Her last booking was in February for a guy fighting with his wife.  Her place still smells like beer vomit and urine.  That's an extreme example, but people like me in the suburbs can't really make money on something like that.

This thread is relevant to my interests, though.  I'm considering renting a warehouse-y type place to tuck an extra RV into and renting my house.  I could probably get $850-900/mo for it and my mortgage is about 1/3 of that.

Let me preface this by saying I was in a similar situation a few years ago, and i decided to sell the house.  

So far, nobody has brought up that a rental is one of the few situations where someone else pays for your assets. If you can get a tenant to pay for a 15 year mortgage and the up keep/expenses, then you will be have equity in the end. If you put 20% down on a house and rent it for 15 years and then sell it when the mortgage is paid off, that is about a 10% annual return (which is difficult to sustain for 15 years in any investment). Plus after Mortgage is paid off the property makes cash. It seem like a great investment.

But it was a lot of work a hassle which is why I bailed on the idea. 

These threads always interest me.

If you aren't paying a management company to manage your rental, take care of repairs, etc, then what you have is a second job.  Thats ok, if thats what you are looking for, just be weary of it.

1% rule seems a bit on the low side in my calculations.  Seems like 1.25%+ is needed unless you are really highly leveraged.

Renting for double my mortgage would still be a loss for me.  I'd sell the house long before dealing with that.

Had pretty much the exact situation pop up for us. We are selling, and here's why:

Having rental property sucks, you are one bad tenant from losing a lot if worth in your house.

The market went up a lot, we are looking at a pretty nice chunk of change from selling.

And eviction laws suck in Washington. A lot

It comes down to what you can get out of it now, is it a couple thousand? Is it many tens of thousands? Can you trust that you won't get an shiny happy person renter that blows everything for you? Is rent high enough that you are making enough?

A companion to the 1% rule is the 50% rule. That says that in general, 50% of market rate rents for a residential rental property will be consumed by expenses - ie maintenance, management, vacancies, interest, and taxes. That leaves 50% to pay the principal on the mortgage.

Many people will claim to beat the 50% rule but most of them are people that don't budget for maintenance, don't account for vacancies, and/or don't compensate themselves for managing the property.

It may be helpful to think about commercial properties and how they are priced. Meaning, exactly what do they ask for when selling?

It goes like this:

Annual rent - annual expenses = some (hopefully positive) number, call it X.

Then, take X (the annual profit), and figure out what number X is 8% of (x/.08). This should be 30% of the price of the real estate. So, (X/.08)/.3 equals the asking price. If the seller is aggessive and wants to price low, use 10% instead of 8% or whatever. 30% comes from the standard minimum equity the investor would need to keep in the property.

Example, the property 100k/year but has 50k expenses. X = 50k. 50k/.08/.3 is 2.08M. So the value is right about 2M. This is because a potential investor could put 30% down (625k) and expect to make an 8% return on the down payment annually. Like STM says, if it's not beating 7% you're wasting your time. If the buyer negotiated the price down a bit, their return would be better than 8%.

The point is that the income DRIVES the  real estate's value directly. If you have a rental house you have a "commercial property" so you can evaluate the value as such.

So, OP, take your current equity in the house (remember to subtract out agent fees and any taxes if you were to sell, you want to find the $$ that you could put into a fund if you sold right now) and find 8% of that number. Do you think you can make more than that on the rental in a year? If yes, then good. If not, then bad.

But again, this all comes down to getting accurate expenses. Which includes at least 3 different types of taxes, and some things that can be very large expenses that are hard to predict. I agree that most small property owners do not track closely and therefore do not know how well or poorly they are actually doing, and even worse, strongly recommend it to others without really knowing how they are doing.

What's funny about all of this is even though I've put a ton of thought into the logic behind renting, I have to say our decision to rent instead or sell was still influenced more than anything by emotional reasons. Like I said at the beginning, you can probably find math to justify either decision...

In our case, we were trying to sell and the FHA inspector got the wrong school district and shorted our value big time. The FHA appraisal sticks with a house for 6 months, and we were frustrated with the real estate sales, banking, appraisal, inspection, basically the entire BS system. So we threw up a giant middle finger to all of that and decided to rent. 

Probably don't follow my lead on that one.

ProDarwin said:

These threads always interest me.

If you aren't paying a management company to manage your rental, take care of repairs, etc, then what you have is a second job.  Thats ok, if thats what you are looking for, just be weary of it.

1% rule seems a bit on the low side in my calculations.  Seems like 1.25%+ is needed unless you are really highly leveraged.

Much truth here.  I have never rented out my property, but if I did I would have a management company take care of it.  I wouldn't mind doing some of the repairs if I have the time, but I don't want to be on the hook for all of it, nor do I want direct interaction with tenants.  I'm not a landlord, I'm a pushover.

The 1% rule is also very regional.  Right now where I live you can easily buy a perfectly liveable 2bd/2ba house for around $100k which puts a mortgage in the $500 range with escrow.  That same house probably rents for $850-1000.  Even downtown Harrisburg, properties are selling cheap, but renting very high.

Curtis said:

The 1% rule is also very regional.  Right now where I live you can easily buy a perfectly liveable 2bd/2ba house for around $100k which puts a mortgage in the $500 range with escrow.  That same house probably rents for $850-1000.  Even downtown Harrisburg, properties are selling cheap, but renting very high.

Real estate is very location specific, but in general it's getting more and more difficult to find properties that meet the 1% rule. The run up in housing prices has outpaced increases in rents. It basically non existent in big metro areas now, and there are fewer in suburbs and rural areas too. Your example of a 100k house that rents for just 850-1k month reflects that. In order to satisfy the 1% rule, that house would need to rent @1k month minimum, and you'd need to run those numbers through a calculator to be sure they work. The 1% rule is the first, easy hurdle for a property owner to check on the back of a napkin, but  As ProDarwin said, it's entirely possible to meet the 1% rule and still not be better than the stock market.

Around me (rural suburb of medium midwestern city), housing is relatively cheap, but a large number of private and organized land lords are selling their properties to capitalize on the high prices because they'd rather harvest the gain in equity than continue to rent. Buying these properties that don't meet the 1% rule is speculating that market rents will increase, or that home values will continue to appreciate. Like anything else, you want to buy when the market is low, and sell when it gets overheated.

In reply to docwyte :

I have often thought this is the answer for small businesses, buying rather than renting creates a hedge for changes in industry. For you personally perhaps the Dental Association or trusted sales rep could point out some wins or losses?

In reply to Rons :

I'll talk to my tax attorney.  Many of the pitfalls of renting out a residential house don't apply in my situation.  I'll have a single tenant, who will sign at least a ten year, triple net lease.  They'll be responsible for paying maintenance, property taxes, etc.  It costs a TON of money to move and build out a dental office, so chances are slim they'd ever move.

I'll have the building paid off when I sell the practice, so hopefully it'll cash flow.  If it makes more sense to sell it and put the money into the stock market instead, I'll do that but I like the idea of getting monthly income out of the building...