Rent vs sell condo with big capital gain

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capitalG
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Rent vs sell condo with big capital gain

Post by capitalG » Sat Jul 29, 2017 11:47 am

Hello,

My SO and I are expanding our family and are close to buying a SFH home. We are debating what to do with the condo we currently own/live in and I am interested in the Board's opinion on whether to rent or sell from purely financial standpoint - time/stress of being a landlord is understood and accepted. My initial take is that the risk of housing prices dropping and passing on the capital gains exclusion outweighs the financial benefit of renting. If we sell the condo, proceeds would be new investment into our current BH-style mutual fund portfolio.

2 BD / 1.5 BA condo in a HCOL area, owned / lived for 5 years
Purchase Price = $475,000
Current Value = >$875,000k (based on couple recent sales)
Depreciable Value = $180,000

Mortgage = $314,000 remaining @ 3.5% / $1550/mth / 4yr into a 30-yr fixed
HOA fees = $575/month
Property Tax = $6,600/year
Marginal Tax Rate = 33%
Capital Gains Rate = 15%

Rental Potential = $3700-$4000/month (based on similar units in building)

Thank you!
capitalG
Last edited by capitalG on Sat Jul 29, 2017 6:24 pm, edited 1 time in total.

Finance-MD
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Re: Rent vs sell condo with big capital gain

Post by Finance-MD » Sat Jul 29, 2017 12:37 pm

You do have 3 years to sell after moving out to still qualify for the capital gains exclusion.
What are the terms of the mortgage? 30 year? How much Is principal at this point?
That 3.5% mortgage is a thing of beauty. I'd hate to give that up.
It looks like you'd be cash flow positive... do you know how much prop mgmt will cost you and what vacancy rate is expected?
How is the outlook for appreciation as a rental and as a property for sale?
Remember you'll take a big haircut on the sale of the property (commissions etc.) whenever it is you do sell.
I do like rentals personally and would rent it for a year and see how it goes... continue up to 2 more years if I like then consider selling writhin my capital gains exclusion window.
If you need the Equity to invest other places, you could try to refinance or take out a 2'nd loan. This would give you more leverage on the property / more risk / more deductions. I would do this while still occupying it as your homestead.

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grabiner
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Re: Rent vs sell condo with big capital gain

Post by grabiner » Sat Jul 29, 2017 3:23 pm

Finance-MD wrote:You do have 3 years to sell after moving out to still qualify for the capital gains exclusion.
What are the terms of the mortgage? 30 year? How much Is principal at this point?
That 3.5% mortgage is a thing of beauty. I'd hate to give that up.
A balance of $314,000 and payment of $1550 implies 25 years left on the mortgage. 3.5% is slightly below the market rate on a 25-year mortgage (if one existed, it would be between the 15-year and 30-year rates), but it isn't a huge bargain; you'll probably get a lower rate if you take out a 15-year mortgage on your new home.
Wiki David Grabiner

avalpert
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Re: Rent vs sell condo with big capital gain

Post by avalpert » Sat Jul 29, 2017 4:44 pm

Using your numbers for current value and rents (and ignoring mortgage interest) you are already only looking at returns <4% and that assumes zero maintenance/repair costs and no vacancy.

Doesn't seem like particularly enticing returns to me even before you consider the hassle.

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capitalG
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Re: Rent vs sell condo with big capital gain

Post by capitalG » Sat Jul 29, 2017 6:14 pm

Thanks for the responses thus far. To answer the question on mortgage terms, Grabiner is roughly correct, we are 4 years into the loan (refi once) and it is a 30 year fixed - will update my OP for this.

Regarding future growth potential, given the steady climb over the last 5 years in local housing prices and a number of new large condo complexes going up in the area, in the next five years I would speculate that my condo value either goes up another 10% (best case) or level off/drops 10%-15% (more likely). Then again, no one can predict housing prices, so your guess is as good as mine :D

capitalG
Finance-MD wrote:You do have 3 years to sell after moving out to still qualify for the capital gains exclusion.
What are the terms of the mortgage? 30 year? How much Is principal at this point?
That 3.5% mortgage is a thing of beauty. I'd hate to give that up.
It looks like you'd be cash flow positive... do you know how much prop mgmt will cost you and what vacancy rate is expected?
How is the outlook for appreciation as a rental and as a property for sale?
Remember you'll take a big haircut on the sale of the property (commissions etc.) whenever it is you do sell.
I do like rentals personally and would rent it for a year and see how it goes... continue up to 2 more years if I like then consider selling writhin my capital gains exclusion window.
If you need the Equity to invest other places, you could try to refinance or take out a 2'nd loan. This would give you more leverage on the property / more risk / more deductions. I would do this while still occupying it as your homestead.

chevca
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Re: Rent vs sell condo with big capital gain

Post by chevca » Sat Jul 29, 2017 7:29 pm

I would sell and call it good. A big capital gains tax means you made big money. That's not necessarily a bad thing, IMO.

As you said, we can't predict housing prices. A bird in the hand, and all that...

chuppi
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Re: Rent vs sell condo with big capital gain

Post by chuppi » Sat Jul 29, 2017 9:06 pm

chevca wrote:I would sell and call it good. A big capital gains tax means you made big money. That's not necessarily a bad thing, IMO.

As you said, we can't predict housing prices. A bird in the hand, and all that...
I followed this advice. Didn't want to be a landlord. Dealing with HOA is a pain as well. I prefer to avoid headaches irrespective of financial implications.

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Re: Rent vs sell condo with big capital gain

Post by Sandi_k » Mon Jul 31, 2017 10:44 pm

capitalG wrote:Hello,

My SO and I are expanding our family and are close to buying a SFH home. We are debating what to do with the condo we currently own/live in and I am interested in the Board's opinion on whether to rent or sell from purely financial standpoint - time/stress of being a landlord is understood and accepted. My initial take is that the risk of housing prices dropping and passing on the capital gains exclusion outweighs the financial benefit of renting. If we sell the condo, proceeds would be new investment into our current BH-style mutual fund portfolio.

2 BD / 1.5 BA condo in a HCOL area, owned / lived for 5 years
Purchase Price = $475,000
Current Value = >$875,000k (based on couple recent sales)
Depreciable Value = $180,000
I am not understanding the dilemma. It's worth $400k more than you paid for it. Presumably, you'll have transaction costs to sell, reducing that gain even more.

Current tax law allows the two of you to shield $250k each - or, $500k. By the info you've provided, there is no tax due. I would sell it in a heartbeat.

What am I missing?

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capitalG
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Re: Rent vs sell condo with big capital gain

Post by capitalG » Tue Aug 01, 2017 11:34 am

So it sounds like most of you would take the guarantee of selling at today's property price and tax free capital gains vs chasing a potentially higher return by holding & renting the condo. Thanks for the feedback, that reaffirms our conclusion - it is tempting to keep the property given the relatively low cost basis but as they say, one in the hand vs two in the bush...

CapG

limeyx
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Re: Rent vs sell condo with big capital gain

Post by limeyx » Tue Aug 01, 2017 2:24 pm

chuppi wrote:
chevca wrote:I would sell and call it good. A big capital gains tax means you made big money. That's not necessarily a bad thing, IMO.

As you said, we can't predict housing prices. A bird in the hand, and all that...
I followed this advice. Didn't want to be a landlord. Dealing with HOA is a pain as well. I prefer to avoid headaches irrespective of financial implications.
I second this, HOA's can be a royal pain. Had a remote rental for 5 years, hated the HOA and sold it. Sadly had to bite the bullet on the Capital gains and got hit with every tax they could throw at us (city of LA taxes, medicaid tax blah blah ... that hurt. The saving grace was our capital improvements knocked it down a lot)

bigred77
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Re: Rent vs sell condo with big capital gain

Post by bigred77 » Tue Aug 01, 2017 2:35 pm

capitalG wrote:So it sounds like most of you would take the guarantee of selling at today's property price and tax free capital gains vs chasing a potentially higher return by holding & renting the condo. Thanks for the feedback, that reaffirms our conclusion - it is tempting to keep the property given the relatively low cost basis but as they say, one in the hand vs two in the bush...

CapG
I don't understand why you are considering the low cost basis as an incentive to keep and rent the property.

Think of the scenario this way:
You have 561k in cash today.
You own no rental property.
Would you buy this unit if it was owned by someone else for 875k as an investment property?
Would you put down all of your cash and finance 314k @ 3.5% for 25 years?

If not I think you should sell. I don't think the fundamentals are enough to make it compelling as a rental property (IMO).

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jimb_fromATL
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Re: Rent vs sell condo with big capital gain

Post by jimb_fromATL » Tue Aug 01, 2017 3:20 pm

capitalG wrote: My initial take is that the risk of housing prices dropping and passing on the capital gains exclusion outweighs the financial benefit of renting. If we sell the condo, proceeds would be new investment into our current BH-style mutual fund portfolio.
A few points to ponder:

Pending some more details and number crunching, it sounds like a good rental investment. But it appears that the cap gains tax exclusion would be an awfully expensive sacrifice at some point in the future -- which will offset quite a bit of the advantage of renting it out.

Because of the cap gains tax exclusion, and IF you really want to be landlords, I suspect you might come out better to sell it, get the exclusion, and use some of the proceeds to buy another rental property.

Next, a biggie -- that sometimes comes as an unpleasant surprises to folks.
  • You need to double-check that condo association rules will allow you to rent it out at all. Even if some units in your complex are rented now, a lot of associations have limits on how many units may be rentals at any given time. (And there are often some pretty good reasons for it -- including insurance and ability for buyers to get mortgages at good rates on other units.). If they do have a limit that has been met, there could be a long time on a waiting list before you could actually rent it out. The better the performance as rentals, the longer before somebody sells their rental unit, and the longer you may have to wait.
Next, how are you going to pay for your new home?
  • If you're buying it with a mortgage instead of paying cash, do you have enough income that the payments for P&I and T&I, and condo fees on the current home plus the mortgage P&I, T&I, and any HOA fees on the new home, plus any other debts you may have will be within lender guidelines for the "back-end" ratio of typically no more than 36% of your gross income? (Or no more than perhaps 45% for conforming loans if you can find a lender who will do it based on you you have plenty of unencumbered assets, savings, and residual income after subtracting the total costs of owning both properties.)
Will you be able to make the payments on both even during vacancies without having to reduce any available tax-deferred or tax-advantaged retirement plans like a 401(k) or other tax-advantage plan?

How much do you anticipate having to spend for maintenance and repairs in the next few years? Is there much likelihood of major assessments for repairs or remodeling of the roof, building, or grounds? Does it seem that similar homes in the area may hold their value and continue to increase in value? (Did they have a big drop in the crash of 2008? If so, how bad, and how long did they take to recover?)

If you rent it out and buy something else with a mortgage too, then after making the down payment will you still have at least 6 months to a year of liquid savings on hand to over emergencies, including the costs of the condo if it's not occupied and also needs repairs, and all the month-to-month costs of the new home too?

A couple of minor details:
  • Bear in mind that insurance costs may change. ("Landord"s insurance is sometimes cheaper because it does not cover furnishings and personal property for the tenants. On the other hand, in some areas it may be more because tenants aren't as careful with the property as owners.) Plus, property taxes in most areas will go up because it won't have the homestead exemption.
Another piece of information to file away ifor future consideration is that most mortgages have a "due on sale" clause or other wording that allows the lender to call the mortgage due in full if the home is changed from relatively low-risk owner occupancy to higher risk rental/investment use.
  • Among other reasons, if times ever get tough financially, owner-occupant borrowers are a lot more likely to try to keep the home where they live and where their stuff than they are to try to keep a rental property that no longer has a personal attachment. So lenders and their shareholders -- like any other investors -- may want to get a higher return on their investment when there's higher risk.

    That means that if at some point in the future, especially if rates have gone a lot higher and yours becomes a considerably "underperforming" investment for their money, they may decide to call the mortgage due, or require you to refinance or recast it to a higher rate to reflect the higher risk and higher market for their money.

    It has happened in the past when mortgage rates went up, and may happen again. In fact in most recent crash and recovery some lenders were notified that they may have to do it. News Article.

    As it turned out, apparently mortgage rates for rental/investment property did NOT go up enough to justify it in the next few years after that mandate. But rates are on the rise, and it seems more likely to happen in the future.
That potential increase in rate could become a big problem if at the same time you had to refinance or sell, we happened to be in another crash of the economy and real estate market, and your property were worth a lot less than it is now.

If that were to happen, mortgages might be harder for potential buyers to get and might cost a much higher rate. Rates on rental investment property could easily be double your current rate, and you might not be able to sell it nearly as easily or for as much as you probably can now. While the profit would be less if you sold it a loss compared to todays value, chances are you could still owe substantial cap gains tax for the gain from the time you bought it to the amount realized from the sale, plus the depreciation recapture tax too.

If I were in that position, it would be a tough decision. But I'm pretty sure I'd prefer to lock in the cap gains tax exclusion now rather than take that much risk with so much money tied up in one investment.

jimb
Last edited by jimb_fromATL on Tue Aug 01, 2017 4:30 pm, edited 2 times in total.

avalpert
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Re: Rent vs sell condo with big capital gain

Post by avalpert » Tue Aug 01, 2017 3:22 pm

capitalG wrote:So it sounds like most of you would take the guarantee of selling at today's property price and tax free capital gains vs chasing a potentially higher return by holding & renting the condo. Thanks for the feedback, that reaffirms our conclusion - it is tempting to keep the property given the relatively low cost basis but as they say, one in the hand vs two in the bush...

CapG
The cost basis is irrelevant (save for tax considerations) - don't anchor on it at all. The only thing that matters is the value today and potential returns vs investing that value elsewhere.

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Re: Rent vs sell condo with big capital gain

Post by Afty » Tue Aug 01, 2017 3:27 pm

I would take the money and run. Housing prices are quite high right now, and you can take advantage of nearly the entire $500k capital gains exclusion.

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Re: Rent vs sell condo with big capital gain

Post by ThrustVectoring » Tue Aug 01, 2017 6:41 pm

I would sell the condo in a heartbeat. Presumably you're buying a single family home in the area. If so, you'd be far too exposed to the local real estate market.

I'd want at most 33% of my assets be exposure to the local real estate market. At the condo price you're listing, getting another house means your exposure is something like 2 million dollars total (guessing). Do you have four million dollars in your diversified portfolio?

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Re: Rent vs sell condo with big capital gain

Post by celia » Tue Aug 01, 2017 7:12 pm

capitalG wrote:Regarding future growth potential, given the steady climb over the last 5 years in local housing prices and a number of new large condo complexes going up in the area, in the next five years I would speculate that my condo value either goes up another 10% (best case) or level off/drops 10%-15% (more likely). Then again, no one can predict housing prices, so your guess is as good as mine :D
And what growth would you expect if you invested the net proceeds instead?

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Watty
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Re: Rent vs sell condo with big capital gain

Post by Watty » Tue Aug 01, 2017 8:53 pm

Sandi_k wrote: Current tax law allows the two of you to shield $250k each - or, $500k. By the info you've provided, there is no tax due. I would sell it in a heartbeat.

What am I missing?
+1

In addition if you had a burning desire to become a landlord it would be good to run the numbers to see if it might make sense to sell your condo and buy the identical one next door so that could take more depreciation since it would have a higher cost.

PYITEJones
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Re: Rent vs sell condo with big capital gain

Post by PYITEJones » Wed Aug 02, 2017 9:34 am

jimb_fromATL wrote: Next, a biggie -- that sometimes comes as an unpleasant surprises to folks.
  • You need to double-check that condo association rules will allow you to rent it out at all. Even if some units in your complex are rented now, a lot of associations have limits on how many units may be rentals at any given time. (And there are often some pretty good reasons for it -- including insurance and ability for buyers to get mortgages at good rates on other units.). If they do have a limit that has been met, there could be a long time on a waiting list before you could actually rent it out. The better the performance as rentals, the longer before somebody sells their rental unit, and the longer you may have to wait.
I'm glad you mentioned this (also, hello from ATL!). My wife and I rented our condo out for a year and had to first get permission from the HOA board. Be sure that the condo compex/building has not hit its rental limit—usually it's 25 percent of the total units—before you get too far into planning. You can get on a waiting list but at that point it won't be producing any revenue and the unit will be a suck. After the one year of renting the unit we decided to sell.

If you do decide to move ahead, I would recommend finding a property management company. Especially if you move a ways away from the unit, are not handy, and don't have experience in collecting rent. The fee varies based on the company and the unit but is usually around 8-10 percent. They handle maintenance requests (you still have to pay for repairs), marketing, and background/credit checks. It ended up taking a bite but saved us some headache.

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