Should I sell my condo or rent it out?

[MattInCali]

I'll be quick and to the point:

We purchased the 1 bedroom/1 bathroom condo in 2003 for $250,000 in a highly desirable area of Los Angeles (finding tenants will not be a problem). I currently owe $165,000 on a 5/1 ARM (3.125% for 2013; resets every January; 20 years remaining). Monthly costs for condo total about $1475-$1550 (900 mortgage, 215 HOA dues, 300 property taxes, 50 insurance, give or take a hundred for fluctuating interest rate and repairs).

We've had interviews with 4 agents so far. General consensus is that condo would likely sell from between $300,000--$320,000. My goal was $350,000, but that seems like a stretch (would have gone in the 400's back in 2005). We could probably rent it out for about $1500 a month -- possibly a little more, possibly a little less.

Two babies have forced us to move to an apartment that we are renting about an hour away. It is a desirable area and we can see ourselves purchasing a home here. Our rent is $1575 a month.

Should I:

1) Use the help of a family member with landlord experience and try renting out condo for at least a year? This would allow time for possible price appreciation while letting me confirm whether my landlord fears are justified. Maybe it's easier than I think.

2) Put the condo on the market? Then I could use the $100,000 or so profit for a nice down payment on next house. I'm hesitant to do this because I do think the condo will appreciate quite a bit in the long run, plus it's in such a desirable place for renting that I'd feel like I was letting a nice investment opportunity pass me by. I don't want to regret this decision in the long run.

Thanks for any advice.

[Valuethinker]

There are no good answers on this. Crystal ball is cloudy.

Don't underestimate the potential hassles of renting (although a 1 BR unit in a condo should have less of those).

But do think Opportunity Cost. It's what you do with the money as an alternative.

If by selling now, then could you buy sooner? Still get the property you want, long term?

Because

- US housing prices have likely bottomed, US housing starts were at 1991 levels, thus big unmet demand. I think prices could shoot up more than we think (say 5-15%). Calculated Risk, the best housing blog by a mile, seems to be hinting that way. The US economy is getting stronger, when that happens, people will start buying houses

(obsessive attention to CR is rewarded, in my view, in terms of understanding the US economy and housing market-- he lives in Southern California btw).

- principal residence is capital gains tax deferred/ exempt? So you want to concentrate your housing wealth in the place you live-- most tax efficient, also you get the benefit of living there!

Given both factors, selling now, and buying *a home you want to live in for 5-10 years* could be an excellent strategy. I stress that, because the costs of buying and selling houses (some of which are invisible, the fact that you have to sell a house probably for less than it is worth, and buy for more than it is worth) 'flipping' of principal residence is seldom a great strategy, long term. My parents made a lot of money on their house, but they lived in it for over 50 years.

2) Put the condo on the market? Then I could use the $100,000 or so profit for a nice down payment on next house. I'm hesitant to do this because I do think the condo will appreciate quite a bit in the long run, plus it's in such a desirable place for renting that I'd feel like I was letting a nice investment opportunity pass me by. I don't want to regret this decision in the long run.

Given that your next home will cost more, losing say 10% on this one by selling now rather than in a year, vs. your next home costing 10% more, you'd be better off owning your next home-- assuming selling the condo brings that forward by a year?

Otherwise it probably does not make much difference whether you rent it out for a year or sell it now.

Just focus on the Opportunity Cost-- what else you could do with the money left over when you sell. Sitting it in the bank right now is not going to give you a great return.

[aquifer]

The wrong renters can bring you more agony than you can imagine. My suggestion is that if you have someone you know who will be good then renting will be fine. Sell it rather than rent to complete strangers. It might gain in value but the wrong renters can easily cost you more money than you dreamed of spending. I know that sounds cynical but I have owned a rental property. It's also better if you live close and can do most repairs yourself and keep an eye on things personally. If you can't do those things, sell sell sell! If you owned an apartment complex or several dwellings then your tenant risk is diversified but a single condo is a make or break deal imo.

[Watty]

We purchased the 1 bedroom/1 bathroom condo in 2003 for $250,000 ....... General consensus is that condo would likely sell from between $300,000--$320,000.

You have $50,000 to $70,000 in capital gains (less any selling costs) .


It sounds like you will likely qualify for the homeowneres capital gains tax exculation so that is likely tax free. If you keep it as a rental then after a couple of years you will lose this and that will all become taxable capital gains some day.


I would likely not keep it as a rental just for that reason.


The other reason is that it might be easy to sell at that price right now, but if you keep it five or ten years then interest rates could be much higher than they are not an it might not be very easy to sell if the buyer has to qualify for a 7% mortage. It was not all that long ago that they were that high.

[bogleblitz]

i was in your similar situation. I rented it out for 2 years, then sold it 2 years later.

No regrets, but dealing with renters was a pain (your mileage may vary). I made more money than if I sold it right away.

[Taylor Larimore]

Matt:

If you did not own your condo, would you buy it today?

Happy Holidays
Taylor

[bikenfool]

IMHO, sell.
That isn't enough return to justify the risk and the hassles. Your cap ratio (http://en.wikipedia.org/wiki/Capitalization_rate) is only about 3 or 4% . Most real estate investors expect better.

[bdpb]

Two babies ...

This would drive my decision more than anything. I wouldn't want to spend even one minute of my time as a landlord in this situation. The extra cash will make it easier to own a home to raise my family.

[MattInCali]

Thanks to all of you for the excellent advice. I am definitely leaning toward selling right now. However, would any of you change your advice if I were not planning on buying another house at this time? In other words, would getting rid of the condo be more of a lost opportunity if I wasn't putting the profit into a down payment on a new home?

[harrychan]

Sell. I'm very familiar with the condo / housing market in LA. I cannot foresee condo prices to significantly appreciate over the next 3-4 years and maybe more. On the other hand, the inventory for SFH are becoming less and as a result, drive prices up. Homes in my area that sold for the mid $500's just a year ago were recently sold for $600+. I would sell the condo and put it to your own personal residence and not worry about it.

[Valuethinker]

Sell. I'm very familiar with the condo / housing market in LA. I cannot foresee condo prices to significantly appreciate over the next 3-4 years and maybe more. On the other hand, the inventory for SFH are becoming less and as a result, drive prices up. Homes in my area that sold for the mid $500's just a year ago were recently sold for $600+. I would sell the condo and put it to your own personal residence and not worry about it.

Harry

Bowing to superior local knowledge.

Is this a supply-demand thing? Condo market in Southern California fundamentally overbuilt?

My logic was that 'a rising tide lifts all boats'. I think we agree (or rather I agree with Calculated Risk, who agrees with you) that SFH in Southern California are likely to be in short supply, and as the economy and housing market are clearly now in recovery, that will drive prices up (my experience is that when housing markets move, they 'spike' because supply lags demand).

So my thought was that if that happens, condo prices get dragged up:

1. people don't want to pay rent if they can own
2. investor buyers step in-- all they need is a feel markets have stabilized rather than going up per se (argument against that: cap rate of 4%-- I guess it depends on market, but 6-7% seems closer to what investor buyers want?)
3. people who might have bought a starter home cannot afford, but are in position 1, and so buy condos
4. (sociological factor) - as people divorcing or trading down can now sell their houses, they buy condos

[Valuethinker]

Matt:

If you did not own your condo, would you buy it today?

Happy Holidays
Taylor

Good advice.

Nicely encapsulates how to think about this thing (ie the importance of 'opportunity cost').

[Valuethinker]

Thanks to all of you for the excellent advice. I am definitely leaning toward selling right now. However, would any of you change your advice if I were not planning on buying another house at this time? In other words, would getting rid of the condo be more of a lost opportunity if I wasn't putting the profit into a down payment on a new home?

The risks are:

- that the house you want to buy in the future, the price moves up

- that the apartment you are selling, the price doesn't move up (ie you sold it) or it moves up by less than the price of what you want to buy

- renting out the apartment inflicts some particular pain on you (hassle, or an unexpected bill)

Given that I think it is unlikely, except for local conditions, that US housing prices are going to go down significantly from here your real risk is the difference between what that money might do in your existing apartment vs. the returns you can get on it in fairly safe investments like FDIC insured CDs.


(Rrather I am expecting the reverse-- no boom, but solid 5-15% growth rates in house prices in many places for 3-4 years, perhaps). But that will be concentrated on single family homes in most places.

Consider. A house sold for $1m in 2007 (start). It now sells for $600 (-40%) and prices rise for +10% pa for the next 4 years.

In 2016, after 9 years, the house will sell for c. $878k. From the perspective of the owner it has not been a great ride. But it has still gone up +46% in recent years.)

An additional risk is that when you are ready to buy our new home, you cannot sell the existing property (liquidity risk). Also the risk you might pay capital gains tax on the sale.

[donall]

I see a lot of good reasons to sell, but only one reason...... err... hope that there is future price appreciation on the condo. You are one of the lucky ones who bought in the 2000s that can actually sell with a profit. But then California is different. With twins, I doubt you will have time to be an effective landlord and will probably resent the time landlording will take away from the family. Good luck with your decision.

[Valuethinker]

I see a lot of good reasons to sell, but only one reason...... err... hope that there is future price appreciation on the condo. You are one of the lucky ones who bought in the 2000s that can actually sell with a profit. But then California is different. With twins, I doubt you will have time to be an effective landlord and will probably resent the time landlording will take away from the family. Good luck with your decision.

Good point. In that I have been assuming housing prices can only go up from here. For all kinds of reasons I think that is likely, but the reverse is also true-- they can go down.

[MattInCali]

Thanks again for these most excellent replies. Selling sure does seem to make the most sense, yet there are a few things that are still giving me pause.

1. The area where we are renting now is high-risk for natural disasters (earthquake, fires). I'm sure earthquake and fire insurance will be quite expensive. Isn't it irresponsible to buy a new house in such an area? True, the condo we'd rent out is also in earthquake country, but fire insurance is included in HOA.

2. I have quite a bit (too much) in my emergency savings account (around 120k; more than 2-3 years worth of expenses). What if I attempted to aggressively pay down the 165k that I owe on the condo with the help of emergency savings and the small profit I'll hopefully make from renting it out? Would a paid-off investment property be a lot more appealing, especially if I decide I don't want to buy another house at this time?

[MattInCali]

I should add that if the condo were paid off, monthly expenses before repairs would be about $600 (HOA, taxes, insurance). So renting it out at $1500 a month would mean a profit of about $900 a month.

[harrychan]

$900 of positive cash flow can be completely wiped out with one bad tenant. Sometimes it might not be a bad tenant. Say the tenant gets ill and simply can't pay rent. You start the eviction process and that will cost money. Is your rental unit in city of LA? I would much rather put some of your emergency fund in a mutual fund than to pay down your condo.

Part of living in LA is dealing with earthquakes and when the next big one will hit. There isn't too much you can do. Anywhere you move you will have to deal with natural disasters. You just need to plan accordingly.

Don't get me wrong, I'm in big favor of owning investment properties. That is how my in laws manage to retire in their 40's. This just doesn't seem the ideal situation in my opinion.

[MattInCali]

Thanks, Harry. The 1bedroom condo I own and would be renting out is in Los Angeles (Brentwood, to be exact). We are now renting in Valencia, which is where I'm considering buying a single-family home even though we are happy with the complex we are renting at. I just don't like the fact that I'm spending $1575 a month on rent when my 800 plus credit could allow me to pay less than that monthly on a mortgage.

[lavenchy]

Sell it.

Revenue does not cover expenses to justify renting it out.

[STC]

Being a landlord was the worst experience in finance in my life. I would need to see massive return potential to even consider dealing with the hassle. If you are going to run an investment property, you NEED to have a passion for it. It isn't just math. It's lifestyle.

[z3r0c00l]

I would sell it right away, probably with reduced or no tax due to it being a primary that sold for a reasonably small amount. That gets you debt free, and gives you a nice chunk to help when you buy the new place. By putting more down on the new place, both from the sale of the old place and that extra EF money that is burning a hole in your bank right now, you can get totally debt free faster, something that most bogleheads will agree is the smart choice. I would want to put nearly 50% down on the new place if possible and get it on a 15 year at current, extremely low rates. But then again, I don't see owning a home as an investment at all, instead it is a place to live that involves costs and possible financial benefits. Renting is a pain, and would only be worth it if you clearly profited 1000 per month, maybe more! Would I deal with the hassle for even $12,000 a year? That is questionable! Id rather get a part time job at that point, and not worry about the risks, collecting rent, damage to my property, the mortgage, etc. Or take my chances and invest 30,000 or 40,000 more aggressively. In other words, unless it is a major source of income, I see several better, less stressful ways to earn $12,000 a year, let alone what you may wind up earning here which could be somewhat less.

[johnep]

It seems like you are unduly worried about selling condo and then having it go up in value. Look at your needs and let that drive you situation. Holding the condo may deprive you of buying another home for your family, which sounds like a greater need. Any opportunity cost you forego by selling condo would likely be more than offset by buying another home for your family. If real estate prices are depressed, it likely applies to both your condo and future home. Conversely, if they go up, both are likely to increase.

Also, IMO, being a landlord does not make sense unless you have expertise doing that and economy of scale, i.e. own enough properties to make it worthwhile. Best wishes.

[Valuethinker]

Thanks again for these most excellent replies. Selling sure does seem to make the most sense, yet there are a few things that are still giving me pause.

1. The area where we are renting now is high-risk for natural disasters (earthquake, fires). I'm sure earthquake and fire insurance will be quite expensive. Isn't it irresponsible to buy a new house in such an area? True, the condo we'd rent out is also in earthquake country, but fire insurance is included in HOA.

2. I have quite a bit (too much) in my emergency savings account (around 120k; more than 2-3 years worth of expenses). What if I attempted to aggressively pay down the 165k that I owe on the condo with the help of emergency savings and the small profit I'll hopefully make from renting it out? Would a paid-off investment property be a lot more appealing, especially if I decide I don't want to buy another house at this time?

Actually paying down a rental condo is the worst thing you can do-- at least it is in tax codes (not US) I am familiar with. AFAIK you can deduct the interest from the rent for tax purposes. It should be fairly easy to structure the whole thing so you pay no tax on the rental income. The way professional landlords do it is to do this, and then, when the mortgages are finally repaid, they can sell the properties as and when they need to release capital.

Getting trapped on capital gains on a condo that is *not* a long term investment for you is something you really want to avoid.

On earthquake and fire insurance that's something YOU are going to have to research. The iron principle of insurance is 1). self insure as much as you can SUBJECT TO 2). buying as high a 'total wipe out' coverage as you can get (high deductible, high coverage). Ie it's more important to be insured against a $500k loss than a $10k one.

With this additional information I'd probably say sell the condo now and look to buy a new home (reducing your emergency savings down to 6 months, say) within 12 months. You want/ need to put at least 20% down on a new home to give yourself the most flexibility and lowest cost re mortgage options, I believe. (a piece of advice about new homes, if you can, keep $10k-$40k say out for 'surprise' expenditures post purchase-- we effectively doubled our home renovations budget post purchase. ie an 80% mortgage not a 75% one, say. Houses always have something that surprises you on the cost and repair side).

I sense you are caught in 'sunk cost fallacy'. You keep thinking about what you paid for the condo. Also you are worried about what might happen to it in the next 12-24 months.

Losing the capital gains tax exemption should tip you over right there-- if you still have it, you really want to use it. I cannot work out the tax you would pay on that property, but it could easily be 30% of your gains.

But if you are really resolved to buy a new home in that time period, it does not really matter. Whilst the condo could easily be worth +10% more in a year's time, it's hard to see it being +20% (warning: I don't live in USA don't know market, I am really levering off reading Calculated Risk).

My contribution to your decision process is limited, what I want you to do is:

- not to focus on what you might 'lose' by selling now, but what you might gain depending on what property you do buy (and what timing)

- remember the hassles of being a landlord. Don't 'drift' into landlordism, make a conscious decision this is part of the your investment portfolio going forward

- remember US tax law, AFAIK, is generally incentivized towards personal home ownership, not rental property ownership

[MattInCali]

Ok, I'm convinced! I will definitely sell the condo. I'm so glad I decided to post on Bogleheads, as I was set on renting it out. Thanks to all of you.

Now for my last question. Should I just choose the most experienced real estate agent who gives me the most confidence they can sell condo at high price and not worry about negotiating commission down from 6% to, say, 5%? With the two babies, I definitely don't have the ability or time right now to sell the place on my own. Any other advice on choosing an agent?

[STC]

Ok, I'm convinced! I will definitely sell the condo. I'm so glad I decided to post on Bogleheads, as I was set on renting it out. Thanks to all of you.

Now for my last question. Should I just choose the most experienced real estate agent who gives me the most confidence they can sell condo at high price and not worry about negotiating commission down from 6% to, say, 5%? With the two babies, I definitely don't have the ability or time right now to sell the place on my own. Any other advice on choosing an agent?

I would go with the real estate agent who has a proven track record, AND offers staging services. Pay a little more for staging, but you will make it back in selling time and offer price in most situations. Since it is a condo, you should also look at the agents that have sold comparable units recently.

[Taylor Larimore]

STC:

Except for high price property, I would not negotiate for a lower commission because the agent is more likely to sell comparable property with the highest commission and may also spend less on marketing. You might insist on a shorter "exclusive" listing as an incentive to act fast.

If your condo is in a large building, the manager will know who is selling the most units. Accepting the manger's recommendation will also get the manager on your side when applicants are screened and again at move-in.

Happy New Year!
Taylor

[Honobob]

http://www.neighborhoodscout.com/ca/los ... ood/#rates

Seems like one of these new posters shows up every now and then and sees the "light" . Are you real??? Brentwood CA 12.15 average annual appreciation since 1990!!!!!! Figger the returns with leverage and tax advantages and PROP 13!!

OOOOH but dealing with real life people is two hard. Sell NOW No money to be made in real estate unless you sell yourself and make $20,000!!! for a few hours work . Hell sell the neighbors and now you're makin a living. It's ALL good Happy NEW Year

[justus]

Now for my last question. Should I just choose the most experienced real estate agent who gives me the most confidence they can sell condo at high price and not worry about negotiating commission down from 6% to, say, 5%? With the two babies, I definitely don't have the ability or time right now to sell the place on my own. Any other advice on choosing an agent?

Go with the agent with the best track record of selling in your neighborhood/community. Be aware that some agents will claim to be able to get you a "high price" to get you to commit to an exclusive listing agreement then immediately ask you to reduce your asking price (buying your listing). From what I understand of the Socal market, many agents bring in stagers to help market the property.

[MattInCali]

Hobnob, I am real -- yes. I am concerned about the midnight call from a tenant that the water heater is broken while I'm dealing with crying toddlers an hour away. I'm also not excited about losing capital gains advantage after renting it out for two years. Do you think my concerns are unjustified? Thanks for your input.

[Honobob]

Hobnob, I am real -- yes. I am concerned about the midnight call from a tenant that the water heater is broken while I'm dealing with crying toddlers an hour away. I'm also not excited about losing capital gains advantage after renting it out for two years. Do you think my concerns are unjustified? Thanks for your input.

I'm not convinced you are real. Have you figured out your advantages using the 12% appreciation and the Prop 13 subsidy to your landlord endeavor? Probably will blow away any capital gains advantage. Does your condo actually have a hot water heater? Less than 20% of mine do. In 35 years of real estate ownership I've replaced ONE water heater. Drove to HD, picked up a new one and installed it myself in less than two hours. Could have paid someone a couple of hundred to do it, and if my rental was an hour away I'd have a handyman lined up.

In your case your concerns might be justified. My name is Honobob and you could not get that correct. Attention to detail is VERY important to successful real estate investing. Imagine you, showing up an hour later with a car water heater and a crying baby. Wait, didn't you start out with two toddlers?.

If you are serious do the math and get back to us.

[Honobob]

Hobnob, I am real -- yes.

Bye, bye to another 13 year old girl from Missouri.

[tj]

Actually paying down a rental condo is the worst thing you can do-- at least it is in tax codes (not US) I am familiar with. AFAIK you can deduct the interest from the rent for tax purposes. It should be fairly easy to structure the whole thing so you pay no tax on the rental income. The way professional landlords do it is to do this, and then, when the mortgages are finally repaid, they can sell the properties as and when they need to release capital.

Why does paying $100 to a bank to save $25 on taxes make any more sense as a rental property than a owner occupied?

[Valuethinker]

Actually paying down a rental condo is the worst thing you can do-- at least it is in tax codes (not US) I am familiar with. AFAIK you can deduct the interest from the rent for tax purposes. It should be fairly easy to structure the whole thing so you pay no tax on the rental income. The way professional landlords do it is to do this, and then, when the mortgages are finally repaid, they can sell the properties as and when they need to release capital.

Why does paying $100 to a bank to save $25 on taxes make any more sense as a rental property than a owner occupied?

A complexity of the US tax system I do not fully understand.

Interest on principal residence *is* tax deductible, but *only if you itemize*? Therefore not everyone can exploit it?

Note in the UK and Canada as a rental landlord (who also owns your own home) you *cannot* deduct interest on your principal residence. So it's much better to max your leverage on rental properties.

What I do know is that if you are a rental landlord, and you think of it as a business, then as a business you want to minimize tax-- and the way to do that is to maximize interest expense.

[tj]

Actually paying down a rental condo is the worst thing you can do-- at least it is in tax codes (not US) I am familiar with. AFAIK you can deduct the interest from the rent for tax purposes. It should be fairly easy to structure the whole thing so you pay no tax on the rental income. The way professional landlords do it is to do this, and then, when the mortgages are finally repaid, they can sell the properties as and when they need to release capital.

Why does paying $100 to a bank to save $25 on taxes make any more sense as a rental property than a owner occupied?

A complexity of the US tax system I do not fully understand.

Interest on principal residence *is* tax deductible, but *only if you itemize*? Therefore not everyone can exploit it?

Note in the UK and Canada as a rental landlord (who also owns your own home) you *cannot* deduct interest on your principal residence. So it's much better to max your leverage on rental properties.

What I do know is that if you are a rental landlord, and you think of it as a business, then as a business you want to minimize tax-- and the way to do that is to maximize interest expense.

My opinion is that you should want to maximize after-tax profits, that could mean paying more tax and less interest.

[Valuethinker]

My opinion is that you should want to maximize after-tax profits, that could mean paying more tax and less interest.

Usually you want to make your money as a capital gain (when you sell) at a lower tax rate

AND

in the meantime any excess capital (ie beyond needed by basic downpayments) goes into buying new properties. The principle of leverage.

If you own a 'steady state' portfolio of properties then you want to minimize double taxation (the owning company pays tax, and you pay tax on the dividend income) and one way to do that is to leverage up. There probably are then ways to get that cash out of the property owning company (pay yourself a large salary, put benefits through the business, buyback shares)-- over to a good tax accountant.

The thing is money borrowed against property is the cheapest debt you will ever have, so you don't want to repay it in a hurry.

[Honobob]

Hobnob, I am real -- yes. I am concerned about the midnight call from a tenant that the water heater is broken while I'm dealing with crying toddlers an hour away. I'm also not excited about losing capital gains advantage after renting it out for two years. Do you think my concerns are unjustified? Thanks for your input.

Matt?