Rental Property--Do numbers make sense to keep??

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Topic Author
dachshunddad
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Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

Hello all,

I have a condo that I lived in and turned into a rental. I'm wondering if it makes sense to keep or think about selling. I use a property manager and it involves little time/energy.

My monthly cost: $2500 (includes mortgage/tax/Hoa/etc)
My collected rent after manager : $2100
Amount paid to monthly loan principal: $1250
Value: 395k with 180K mortgage, purchase price 330k

I am paying to float it each month but it pays down my principal. Since this was not bought as an investment the numbers aren't that great for a rental and I'm on the fence for selling. The subjective side is that I like the condo and the location is excellent. There may be a time in the future I could downsize back, but this is 20 years away so not on the imminent horizon.

Thoughts?
Thanks in advance
rgarling
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Re: Rental Property--Do numbers make sense to keep??

Post by rgarling »

Sell. Those are bad numbers for an investment property.
chevca
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Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

If you have to ask.... :happy

I'd sell that one ASAP.
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Brianmcg321
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Re: Rental Property--Do numbers make sense to keep??

Post by Brianmcg321 »

Your losing money every month.

You either need to raise rent $1,000 or sell it.
Rules to investing: | 1. Don't lose money. | 2. Don't forget rule number 1.
PaleoWorx
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Re: Rental Property--Do numbers make sense to keep??

Post by PaleoWorx »

on the surface doesn't seem like a good deal.

calculate your tax liability before you sell it though so there are no surprises.
think recaptured depreciation, capital gain.
rascott
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Re: Rental Property--Do numbers make sense to keep??

Post by rascott »

Sell without question. Terrible, money losing numbers. Not even accounting for repairs and vacancies.
Topic Author
dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

I appreciate all the input so far. It seems like there is a complete consensus. I will run the tax numbers but I'm thinking selling when the lease ends is the wise move.
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big bang
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Re: Rental Property--Do numbers make sense to keep??

Post by big bang »

What are the terms of your mortgage?
Can you refinance to lower your monthly payments?
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.
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dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

big bang wrote: Sat Jan 18, 2020 12:45 pm What are the terms of your mortgage?
Can you refinance to lower your monthly payments?
15 year @ 3%. 10 years left.
chevca
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Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

Taxes will be what they will be. Don't even worry about that. Doesn't even seem like they will be too bad with a $330k purchase price and doesn't seem like it's been a rental very long. There's no real good reason to hang onto this one rental on the possibility you could return to the area or downsize 20 years from now.
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big bang
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Re: Rental Property--Do numbers make sense to keep??

Post by big bang »

Also, how much you are paying to the property manager? Can you reduce it?
The point is, try to look at your expenses and see if you can lower them to improve the cash flow.
Is there a way to increase the rent in the near future?
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.
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big bang
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Re: Rental Property--Do numbers make sense to keep??

Post by big bang »

dachshunddad wrote: Sat Jan 18, 2020 12:48 pm
big bang wrote: Sat Jan 18, 2020 12:45 pm What are the terms of your mortgage?
Can you refinance to lower your monthly payments?
15 year @ 3%. 10 years left.
There might be an opportunity here...
Just for the exercise:
By how much $$ you can lower the monthly payment by refinancing to a 30yr?
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.
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dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

big bang wrote: Sat Jan 18, 2020 12:53 pm
dachshunddad wrote: Sat Jan 18, 2020 12:48 pm
big bang wrote: Sat Jan 18, 2020 12:45 pm What are the terms of your mortgage?
Can you refinance to lower your monthly payments?
15 year @ 3%. 10 years left.
There might be an opportunity here...
Just for the exercise:
By how much $$ you can lower the monthly payment by refinancing to a 30yr?

A 30 yr mortgage would probably save close to $900/month if I refinanced starting the clock again. So total monthly cost from $2500 to $1600
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big bang
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Re: Rental Property--Do numbers make sense to keep??

Post by big bang »

dachshunddad wrote: Sat Jan 18, 2020 1:00 pm
big bang wrote: Sat Jan 18, 2020 12:53 pm
dachshunddad wrote: Sat Jan 18, 2020 12:48 pm
big bang wrote: Sat Jan 18, 2020 12:45 pm What are the terms of your mortgage?
Can you refinance to lower your monthly payments?
15 year @ 3%. 10 years left.
There might be an opportunity here...
Just for the exercise:
By how much $$ you can lower the monthly payment by refinancing to a 30yr?

A 30 yr mortgage would probably save close to $900/month if I refinanced starting the clock again. So total monthly cost from $2500 to $1600
Well......now its a decision that you need to make.
If you want to keep the property and have a positive cash flow, you can.
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.
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dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

chevca wrote: Sat Jan 18, 2020 12:50 pm Taxes will be what they will be. Don't even worry about that. Doesn't even seem like they will be too bad with a $330k purchase price and doesn't seem like it's been a rental very long. There's no real good reason to hang onto this one rental on the possibility you could return to the area or downsize 20 years from now.
Correct, I have rented less than a year. Rental rates have dropped due to numerous new apartments coming online.
chevca
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Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

You barely have anything to worry about taxwise then.

You lived in it 2 of the last 5 years (more actually) to meet that rule. A little depreciation recapture to worry about or cover. Not really much of a concern for you to worry about any taxes for selling this one.
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dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

chevca wrote: Sat Jan 18, 2020 1:09 pm You barely have anything to worry about taxwise then.

You lived in it 2 of the last 5 years (more actually) to meet that rule. A little depreciation recapture to worry about or cover. Not really much of a concern for you to worry about any taxes for selling this one.
Yeah, I'm thinking this is making a lot more sense. I should be able to avoid most of the tax. I initially liked the idea of owning a rental property but the lower rent just isn't making it much of an investment. I could sell and use the gain to buy more total market index fund.
LittleMaggieMae
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Re: Rental Property--Do numbers make sense to keep??

Post by LittleMaggieMae »

How is the rental effecting your current taxes? How does that look if you keep it after doing a refi? Look long term.
Topic Author
dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

LittleMaggieMae wrote: Sat Jan 18, 2020 1:36 pm How is the rental effecting your current taxes? How does that look if you keep it after doing a refi? Look long term.
I would have to check but I don't recall it giving me much income after expenses and depreciation.
petulant
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Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
chevca
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Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

Maybe the other posters just didn't feel like making a long drawn out explanation when the outcome would still be OP should sell? :wink:
petulant
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Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

chevca wrote: Sat Jan 18, 2020 1:48 pm Maybe the other posters just didn't feel like making a long drawn out explanation when the outcome would still be OP should sell? :wink:
Point taken, but maybe I wanted to be a bit more explanatory :P
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unclescrooge
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Re: Rental Property--Do numbers make sense to keep??

Post by unclescrooge »

petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
+1
Unless you can figure out how to get double digit ROE I would bail.
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Re: Rental Property--Do numbers make sense to keep??

Post by geerhardusvos »

dachshunddad wrote: Sat Jan 18, 2020 11:32 am Hello all,

I have a condo that I lived in and turned into a rental. I'm wondering if it makes sense to keep or think about selling. I use a property manager and it involves little time/energy.

My monthly cost: $2500 (includes mortgage/tax/Hoa/etc)
My collected rent after manager : $2100
Amount paid to monthly loan principal: $1250
Value: 395k with 180K mortgage, purchase price 330k

I am paying to float it each month but it pays down my principal. Since this was not bought as an investment the numbers aren't that great for a rental and I'm on the fence for selling. The subjective side is that I like the condo and the location is excellent. There may be a time in the future I could downsize back, but this is 20 years away so not on the imminent horizon.

Thoughts?
Thanks in advance
Sell. If the location is so excellent, why doesn’t the rent cover more?
VTSAX and chill
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Re: Rental Property--Do numbers make sense to keep??

Post by abuss368 »

I would prefer to invest in both the Vanguard US REIT Index and the Vanguard International REIT Index.
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tonsofthorns
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Re: Rental Property--Do numbers make sense to keep??

Post by tonsofthorns »

If this location is 'great,' and your city/town allows; switch to a vacation rental. Management fees will be higher, but you could possibly double or triple the income. Just another idea.
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dachshunddad
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Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
Thank you for breaking down the analysis. I’m not a seasoned real estate investor and that was helpful. I do own a home (with mortgage) in the same city. If I count the condo portion as a bond I would be about 25% bonds and 75% stock so it isn’t too much of a concentrated risk. But I don’t want to hold something that is considered a poor investment.
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boomer
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Re: Rental Property--Do numbers make sense to keep??

Post by boomer »

My vote is to definitely sell. You said you aren't particularly interested in being a landlord and it isn't making much money. Sell it before it gets damaged by a renter or something happens to the property that causes costly repairs.
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unclescrooge
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Re: Rental Property--Do numbers make sense to keep??

Post by unclescrooge »

geerhardusvos wrote: Sat Jan 18, 2020 4:14 pm
dachshunddad wrote: Sat Jan 18, 2020 11:32 am Hello all,

I have a condo that I lived in and turned into a rental. I'm wondering if it makes sense to keep or think about selling. I use a property manager and it involves little time/energy.

My monthly cost: $2500 (includes mortgage/tax/Hoa/etc)
My collected rent after manager : $2100
Amount paid to monthly loan principal: $1250
Value: 395k with 180K mortgage, purchase price 330k

I am paying to float it each month but it pays down my principal. Since this was not bought as an investment the numbers aren't that great for a rental and I'm on the fence for selling. The subjective side is that I like the condo and the location is excellent. There may be a time in the future I could downsize back, but this is 20 years away so not on the imminent horizon.

Thoughts?
Thanks in advance
Sell. If the location is so excellent, why doesn’t the rent cover more?
Because of the 15 year mortgage. 50% of rent is going towards principle pay down.
bighatnohorse
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Re: Rental Property--Do numbers make sense to keep??

Post by bighatnohorse »

It's a loser. Just pray that property values don't drop. Sell. Sell. Sell.
manatee2005
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Re: Rental Property--Do numbers make sense to keep??

Post by manatee2005 »

Keep it. Let someone else pay down the principal.
SovereignInvestor
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Re: Rental Property--Do numbers make sense to keep??

Post by SovereignInvestor »

You have 215K equity and it is producing 850/month of equity gains since the net cost is 1250 per month excluding equity and you get 2100 in rent income.

The 850 a month is 10,200 annualized income against 215K equity now. That is a ROE of about 5% before any appreciation. If we assume 2% appreciation then that's an additional 8K gain per year which boosts ROE to 9%

Doesn't seem like a home run...ROE under 10% unless you start assuming hot appreciation, but not really a total loser either. Since there's leverage and probably work...should probably see 10% + ROE for it to be winner.
SovereignInvestor
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Re: Rental Property--Do numbers make sense to keep??

Post by SovereignInvestor »

petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
Glad to see someone else is doing ROE and not just focusing on cash flow. Cash flow is very misleading...if OP had a killer 30% ROE property but financed it with a 5 year mortgage it would bleed cash flow but Make OP much wealthier (30% ROE) and the cash flow people would shoot that money maker down.
.
Great points about comparing it to his view on stocks. But the sub 10% return is bad if he likes stocksmm.but if he loved stocks he can always just pull equity from rental in refi and take excess equity and invest in stocks...that would boost ROE. Again risky...of course but if there was issue with meeting his ROE...that's viable. But if he hates stocks and see doom then it's great because he can even pay down mortgage quickER for guaranteed return.

Diversification benefit helps...if he's super bullish on stocks can tap equity or very bearish..accelerate mortgage paydown..or neither extreme then just keep doing what he's doing.
runswithscissors
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Re: Rental Property--Do numbers make sense to keep??

Post by runswithscissors »

In my area those numbers are outstanding for a rental property; not even 1 in 100 would advise to sell. People here will buy older apartment buildings and be very content with a 4% CAP. Brand new individual condo units sell for 2.5-3% CAP all day. CAP rates are always depressed in "old money", HCOL, high demand areas. Like certain city centers and urban cores. And coastal property (where population density is dense). On the other hand, many properties in less desirable LCOL areas sell in the 10-15% CAP range. Value is always relative to location. A property with a 4% CAP could be a far better value than one with a 15% CAP; that difference in value is not something members on this forums are going to distinguish. You really need to be asking people in your area; feedback here isn't going to be very helpful.
Topic Author
dachshunddad
Posts: 170
Joined: Mon Sep 03, 2018 8:22 pm

Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

SovereignInvestor wrote: Sun Jan 19, 2020 12:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
Glad to see someone else is doing ROE and not just focusing on cash flow. Cash flow is very misleading...if OP had a killer 30% ROE property but financed it with a 5 year mortgage it would bleed cash flow but Make OP much wealthier (30% ROE) and the cash flow people would shoot that money maker down.
.
Great points about comparing it to his view on stocks. But the sub 10% return is bad if he likes stocksmm.but if he loved stocks he can always just pull equity from rental in refi and take excess equity and invest in stocks...that would boost ROE. Again risky...of course but if there was issue with meeting his ROE...that's viable. But if he hates stocks and see doom then it's great because he can even pay down mortgage quickER for guaranteed return.

Diversification benefit helps...if he's super bullish on stocks can tap equity or very bearish..accelerate mortgage paydown..or neither extreme then just keep doing what he's doing.
Thank you for your perspective. I am more of a stock investor than real estate (about 75%) portfolio in stocks including rental value.
I’ve thought of this rental as more like a bond portion than stock. Is that flawed thinking? It seems like most analysis want a similar return as stocks.
chevca
Posts: 3473
Joined: Wed Jul 26, 2017 11:22 am

Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

runswithscissors wrote: Sun Jan 19, 2020 3:47 am In my area those numbers are outstanding for a rental property; not even 1 in 100 would advise to sell. People here will buy older apartment buildings and be very content with a 4% CAP. Brand new individual condo units sell for 2.5-3% CAP all day. CAP rates are always depressed in "old money", HCOL, high demand areas. Like certain city centers and urban cores. And coastal property (where population density is dense). On the other hand, many properties in less desirable LCOL areas sell in the 10-15% CAP range. Value is always relative to location. A property with a 4% CAP could be a far better value than one with a 15% CAP; that difference in value is not something members on this forums are going to distinguish. You really need to be asking people in your area; feedback here isn't going to be very helpful.
Yes, but those are landlords/RE investors/it's a business for them. The OP is not those things. They basically wondered if they should keep the condo just in case they want to move back in 20 years from now. Those bringing up CAP rates and ROE and all have valid points..... to a RE investor/someone in this business. They are pretty much overboard for the situation brought up in this thread though. So, the more basic feedback is probably pretty helpful since I don't think OP is looking to get into the rental property business.
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

dachshunddad wrote: Sun Jan 19, 2020 11:19 am
SovereignInvestor wrote: Sun Jan 19, 2020 12:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
Glad to see someone else is doing ROE and not just focusing on cash flow. Cash flow is very misleading...if OP had a killer 30% ROE property but financed it with a 5 year mortgage it would bleed cash flow but Make OP much wealthier (30% ROE) and the cash flow people would shoot that money maker down.
.
Great points about comparing it to his view on stocks. But the sub 10% return is bad if he likes stocksmm.but if he loved stocks he can always just pull equity from rental in refi and take excess equity and invest in stocks...that would boost ROE. Again risky...of course but if there was issue with meeting his ROE...that's viable. But if he hates stocks and see doom then it's great because he can even pay down mortgage quickER for guaranteed return.

Diversification benefit helps...if he's super bullish on stocks can tap equity or very bearish..accelerate mortgage paydown..or neither extreme then just keep doing what he's doing.
Thank you for your perspective. I am more of a stock investor than real estate (about 75%) portfolio in stocks including rental value.
I’ve thought of this rental as more like a bond portion than stock. Is that flawed thinking? It seems like most analysis want a similar return as stocks.
The RE is not a bond. It is equity in a business. You have significant risks including bad tenants, no tenants, or just bad things happening. You are the last to get paid after all expenses.
SovereignInvestor
Posts: 601
Joined: Mon Aug 20, 2018 4:41 pm

Re: Rental Property--Do numbers make sense to keep??

Post by SovereignInvestor »

petulant wrote: Sun Jan 19, 2020 12:46 pm
dachshunddad wrote: Sun Jan 19, 2020 11:19 am
SovereignInvestor wrote: Sun Jan 19, 2020 12:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm Many of the posters here are acting like cashflow is king, which is generally true if you are considering a new rental project with a 30-year mortgage rate in a typical Midwestern/Southern market. However, an existing project with a 15-year financing plan with low interest that pays down debt rapidly should be evaluated on a ROE basis followed by a consideration of risk.

For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.

The ROE above does not include any appreciation in value for the condo. Appreciation is hyperlocal and should be considered very carefully. However, for talking purposes here, imagine the value of homes tended to increase with inflation at 2% per year. You would add 1.5% to the ROE (since 6% of the additional value may be subject to commission on sale and the additional gain may be subject to LTCG at, say, a combined 20% state and federal). The ROE with appreciation might be 6.9% then.

This 6.9% ROE comes with significant risk. A bad tenant could hurt rent for several months or require costly repairs. Vacancies will happen if you have additional apartment inventory coming online. The HOA could hike fees due to various problems. The market value could stay flat or fall due to local real estate dynamics.

Now, with this kind of analysis, we can make a conclusion based on OP's risk tolerance and other finances. Myself, I would be reluctant to keep a local real estate investment like this unless it had a forward-looking ROE of 10% or more, especially if I own a home I live in and located in the same metro. Further, I view the stock market as more diversified with an expected return of 7-8%, and I believe having $189000 in RE would be a large, large portion of my overall assets.

If OP does not own his home currently but lives in the same metropolitan area, then the condo may provide a hedge against rising rent.

If OP has $1,000,000 in the rest of his portfolio right now, this might not be a bad investment if OP believes in alts.

If OP really abhors stocks due to volatility but believes the risk of a market decline is low in his metropolitan area, then keeping the condo might not be a bad idea. (I think this would be silly.)

If OP believes stocks will only return 1-2% per year going forward without any impact on this rental unit, keeping the condo is not a bad idea. (I think this would be very silly.)

I doubt any of these apply to OP right now, so he should sell.

Hope that helps OP!
Glad to see someone else is doing ROE and not just focusing on cash flow. Cash flow is very misleading...if OP had a killer 30% ROE property but financed it with a 5 year mortgage it would bleed cash flow but Make OP much wealthier (30% ROE) and the cash flow people would shoot that money maker down.
.
Great points about comparing it to his view on stocks. But the sub 10% return is bad if he likes stocksmm.but if he loved stocks he can always just pull equity from rental in refi and take excess equity and invest in stocks...that would boost ROE. Again risky...of course but if there was issue with meeting his ROE...that's viable. But if he hates stocks and see doom then it's great because he can even pay down mortgage quickER for guaranteed return.

Diversification benefit helps...if he's super bullish on stocks can tap equity or very bearish..accelerate mortgage paydown..or neither extreme then just keep doing what he's doing.
Thank you for your perspective. I am more of a stock investor than real estate (about 75%) portfolio in stocks including rental value.
I’ve thought of this rental as more like a bond portion than stock. Is that flawed thinking? It seems like most analysis want a similar return as stocks.
The RE is not a bond. It is equity in a business. You have significant risks including bad tenants, no tenants, or just bad things happening. You are the last to get paid after all expenses.
It's probably not be to treat it like an extreme of either or debt. When bond is used some may think of risk free treasurys which it's not. It's also not as risky as a stock.

It's probably akin to a risky bond depending in risks. Bonds provide fixed income unless there's default and that is similar to rent. But if leverage is used then it becomes so risky akin to equity.


Great point...OP isn't a Pure RE investor it seems. It's not a business.

But RE can supplement stocks well. Hindsight is 20/20, but in late 1990s...with stocks at 25x forward PE and mortgage rates 8% or so..very attractive to unload stocks to paydown mortgage...or focus on selling stocks and buy RE.

Flash forward to late 2018..lasted a couple months..but mortgage rates around 4% or so and stocks at under 14x earnings...may have favored shift rom RE to stocks. If one is big risk taker....pull equity from RE to put in stocks...and now that stocks nearing 20x earnings may be more atractive to reduce stocks to pay down any mortgages.
Stormbringer
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Joined: Sun Jun 14, 2015 7:07 am

Re: Rental Property--Do numbers make sense to keep??

Post by Stormbringer »

I've been a professional landlord for 26 years.

The property doesn't seem like a "great" investment, but also not as bad as many are saying. The negative cash flow is a bit of a drag (and probably understated), but that gap may close over time as the rent increases while the mortgage stays constant.
  • In 10 years, OP will have a free and clear property.
  • The returns are in the form of equity, and probably completely shielded from taxes due to depreciation. An eventual 1031 exchange could defer taxes indefinitely.
  • It isn't clear what the local market conditions are, but in my mid-western city property values increased 8% last year. That would be a 16% return on a 50% leveraged property.
  • If the property is sold now, you're looking at about $25K in selling costs, and possibly trigger capital gains taxes and depreciation recapture on the profits.
OP also needs to consider what the proceeds would be invested in. Bonds paying 1.8%? CDs paying 2%? A 25 P/E stock market?
"Compound interest is the most powerful force in the universe." - Albert Einstein
international001
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Re: Rental Property--Do numbers make sense to keep??

Post by international001 »

petulant wrote: Sat Jan 18, 2020 1:43 pm
For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.
Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
petulant
Posts: 1901
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Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

international001 wrote: Mon Jan 20, 2020 10:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm
For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.
Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
Hi there. Cap rate is a conventional real estate measure for returns before applying leverage. The post I did discussed equity returns assuming OP's existing capital structure. The math on the 5.4% is available in the post you quoted. Return of 10200 divided by 189000 in realizable equity (the amount that would be obtained after sale minus mortgage payoff, taxes, and costs) equals 5.396 rounded to 5.4%. This is may not be the conventional way to evaluate new real estate projects but was an attempt to evaluate OP's existing project given the facts at hand.
Topic Author
dachshunddad
Posts: 170
Joined: Mon Sep 03, 2018 8:22 pm

Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

Stormbringer wrote: Sun Jan 19, 2020 5:07 pm I've been a professional landlord for 26 years.

The property doesn't seem like a "great" investment, but also not as bad as many are saying. The negative cash flow is a bit of a drag (and probably understated), but that gap may close over time as the rent increases while the mortgage stays constant.
  • In 10 years, OP will have a free and clear property.
  • The returns are in the form of equity, and probably completely shielded from taxes due to depreciation. An eventual 1031 exchange could defer taxes indefinitely.
  • It isn't clear what the local market conditions are, but in my mid-western city property values increased 8% last year. That would be a 16% return on a 50% leveraged property.
  • If the property is sold now, you're looking at about $25K in selling costs, and possibly trigger capital gains taxes and depreciation recapture on the profits.
OP also needs to consider what the proceeds would be invested in. Bonds paying 1.8%? CDs paying 2%? A 25 P/E stock market?
Thank you for the response. The rental does not appear to generate significant taxes given depreciation as you mentioned. Selling costs have been a deterrent in my mind also. If I sold the equity would be placed in stocks. But I’m fairly diversified with a 75% stock allocation with bonds and this property rounding out the rest.
The property has been very low maintenance so far. I’m using a property manager who charges 8%. The property is on the doorstep of a major university so occupancy has always been very high. They have built lots of apartments in the city the past five years which have lowered rent. My tenant is in a five year graduate program so there is a chance they could rent the entire time. One barrier to selling is that it has been little hassle so far. Of course, I am well aware this can change on a dime. My biggest concern was keeping it if it was a “terrible” investment and the numbers didn’t make any sense.
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Sandtrap
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Re: Rental Property--Do numbers make sense to keep??

Post by Sandtrap »

Sell.
Today.
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international001
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Re: Rental Property--Do numbers make sense to keep??

Post by international001 »

petulant wrote: Mon Jan 20, 2020 11:01 am
international001 wrote: Mon Jan 20, 2020 10:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm
For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.
Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
Hi there. Cap rate is a conventional real estate measure for returns before applying leverage. The post I did discussed equity returns assuming OP's existing capital structure. The math on the 5.4% is available in the post you quoted. Return of 10200 divided by 189000 in realizable equity (the amount that would be obtained after sale minus mortgage payoff, taxes, and costs) equals 5.396 rounded to 5.4%. This is may not be the conventional way to evaluate new real estate projects but was an attempt to evaluate OP's existing project given the facts at hand.
Tx. This makes sense. 180k is the 'real' value of the capital you have in case you want to sell it. From what I read cap rate is without any loan, and the ROE includes the loan.

I like to calculate the CAP (w/o loan) and then compute any ROE you want.
The CAP would be 2100*12/395k = 6.3%. A little bit less if you do your own math (substracting the sale costs). You can also add 2% of appreciation/ inflation to that. I am not sure if it includes maintenance costs (perhaps you should substract a 1%)

Why is the CAP higher than the ROE? SHouldn't a loan (levearge) increase it? Am I doing something wrong?
petulant
Posts: 1901
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Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

international001 wrote: Mon Jan 20, 2020 2:25 pm
petulant wrote: Mon Jan 20, 2020 11:01 am
international001 wrote: Mon Jan 20, 2020 10:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm
For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.
Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
Hi there. Cap rate is a conventional real estate measure for returns before applying leverage. The post I did discussed equity returns assuming OP's existing capital structure. The math on the 5.4% is available in the post you quoted. Return of 10200 divided by 189000 in realizable equity (the amount that would be obtained after sale minus mortgage payoff, taxes, and costs) equals 5.396 rounded to 5.4%. This is may not be the conventional way to evaluate new real estate projects but was an attempt to evaluate OP's existing project given the facts at hand.
Tx. This makes sense. 180k is the 'real' value of the capital you have in case you want to sell it. From what I read cap rate is without any loan, and the ROE includes the loan.

I like to calculate the CAP (w/o loan) and then compute any ROE you want.
The CAP would be 2100*12/395k = 6.3%. A little bit less if you do your own math (substracting the sale costs). You can also add 2% of appreciation/ inflation to that. I am not sure if it includes maintenance costs (perhaps you should substract a 1%)

Why is the CAP higher than the ROE? SHouldn't a loan (levearge) increase it? Am I doing something wrong?
Hi, no problem. Well, the number I see there is not the cap rate. To get to 6.3%, one has to use 2100, but that's the monthly rent. The cap rate uses income minus all non-financing expenses. So that would be (2100*12 - (property tax) - (landlord insurance) - (HOA dues) )/395000. OP didn't share the missing information, but at any rate the cap rate would be a good bit less less.
Topic Author
dachshunddad
Posts: 170
Joined: Mon Sep 03, 2018 8:22 pm

Re: Rental Property--Do numbers make sense to keep??

Post by dachshunddad »

petulant wrote: Mon Jan 20, 2020 4:04 pm
international001 wrote: Mon Jan 20, 2020 2:25 pm
petulant wrote: Mon Jan 20, 2020 11:01 am
international001 wrote: Mon Jan 20, 2020 10:51 am
petulant wrote: Sat Jan 18, 2020 1:43 pm
For this ROE analysis, the relevant "return" should be cashflow plus mortgage principal paydown. That's 2100-2500+1250=850 per month, or 10200 per year. I'll use this value here, but really the income tax consequences should also be considered. This condo may be generating a passive activity loss right now, or it could be generating taxable income, with either one added to the cashflow component.

The equity is the capital you would actually realize upon selling, not the value you get appraised for or see on Zillow. Thus, if your contract price was 395 with a 6% commission and 2000 in closing costs, your net proceeds from sale would be about 189000. That's 395000*.94-2000-180000. This does not include depreciation recapture or capital gains tax since both are small/nonexistent due to the recency of conversion to rental.

The ROE is thus 5.4%. It will decline over time as your principal portion of mortgage payments goes up, the equity goes up from paying down debt, and each year accumulates future depreciation recapture and capital gains taxes.
Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
Hi there. Cap rate is a conventional real estate measure for returns before applying leverage. The post I did discussed equity returns assuming OP's existing capital structure. The math on the 5.4% is available in the post you quoted. Return of 10200 divided by 189000 in realizable equity (the amount that would be obtained after sale minus mortgage payoff, taxes, and costs) equals 5.396 rounded to 5.4%. This is may not be the conventional way to evaluate new real estate projects but was an attempt to evaluate OP's existing project given the facts at hand.
Tx. This makes sense. 180k is the 'real' value of the capital you have in case you want to sell it. From what I read cap rate is without any loan, and the ROE includes the loan.

I like to calculate the CAP (w/o loan) and then compute any ROE you want.
The CAP would be 2100*12/395k = 6.3%. A little bit less if you do your own math (substracting the sale costs). You can also add 2% of appreciation/ inflation to that. I am not sure if it includes maintenance costs (perhaps you should substract a 1%)

Why is the CAP higher than the ROE? SHouldn't a loan (levearge) increase it? Am I doing something wrong?
Hi, no problem. Well, the number I see there is not the cap rate. To get to 6.3%, one has to use 2100, but that's the monthly rent. The cap rate uses income minus all non-financing expenses. So that would be (2100*12 - (property tax) - (landlord insurance) - (HOA dues) )/395000. OP didn't share the missing information, but at any rate the cap rate would be a good bit less less.

More information for analysis. My mortgage payment is $1750. Property tax/HOA/other small stuff is $750 for $2500 cost per month.
Rent is $2100 after management fee.
Hope this is helpful in the calculation. Thanks
petulant
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Re: Rental Property--Do numbers make sense to keep??

Post by petulant »

dachshunddad wrote: Mon Jan 20, 2020 4:14 pm
petulant wrote: Mon Jan 20, 2020 4:04 pm
international001 wrote: Mon Jan 20, 2020 2:25 pm
petulant wrote: Mon Jan 20, 2020 11:01 am
international001 wrote: Mon Jan 20, 2020 10:51 am

Do you mind explaining how you get 5.4%

I'm not a RE investor. In my mind, what matters is the CAP + the leverage you get (the lower rate of the loan the better). Of course, that would make only sense if I was refinancing every year, or if I had a interest only payment. I don't get use of the principal since it will change over the life of the mortgage.
Hi there. Cap rate is a conventional real estate measure for returns before applying leverage. The post I did discussed equity returns assuming OP's existing capital structure. The math on the 5.4% is available in the post you quoted. Return of 10200 divided by 189000 in realizable equity (the amount that would be obtained after sale minus mortgage payoff, taxes, and costs) equals 5.396 rounded to 5.4%. This is may not be the conventional way to evaluate new real estate projects but was an attempt to evaluate OP's existing project given the facts at hand.
Tx. This makes sense. 180k is the 'real' value of the capital you have in case you want to sell it. From what I read cap rate is without any loan, and the ROE includes the loan.

I like to calculate the CAP (w/o loan) and then compute any ROE you want.
The CAP would be 2100*12/395k = 6.3%. A little bit less if you do your own math (substracting the sale costs). You can also add 2% of appreciation/ inflation to that. I am not sure if it includes maintenance costs (perhaps you should substract a 1%)

Why is the CAP higher than the ROE? SHouldn't a loan (levearge) increase it? Am I doing something wrong?
Hi, no problem. Well, the number I see there is not the cap rate. To get to 6.3%, one has to use 2100, but that's the monthly rent. The cap rate uses income minus all non-financing expenses. So that would be (2100*12 - (property tax) - (landlord insurance) - (HOA dues) )/395000. OP didn't share the missing information, but at any rate the cap rate would be a good bit less less.

More information for analysis. My mortgage payment is $1750. Property tax/HOA/other small stuff is $750 for $2500 cost per month.
Rent is $2100 after management fee.
Hope this is helpful in the calculation. Thanks
That means the cap rate is 4.1%. 2100-750=1350*12=16200/395000. Not a great project to get into but not an automatic sell just because of that.
international001
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Re: Rental Property--Do numbers make sense to keep??

Post by international001 »

Oh... I read too fast the '(includes mortgage/tax/Hoa/etc)' part. Now it makes sense

In this economy, and rates being global in US, can we conclude the CAP rate is what give us the information we need to decide whether to invest?

If we get a 3% loan with 20% down (5x leverage), the max return on investment we'll get is (4.1%-3%) x 5 = 5.5%. And it will decrease when we start getting more principal. When we have paid everything, we'll get have a 4.1% return.

Do my numbers make sense? Is it normal that return decreases later in the life of the loan because of less risk (no leverage), or it depends on the market?

What is considered nowadays a good CAP rate, assuming the best tenants you can have? San Francisco has a low CAP rate, for instance, but tenants are usually good (high income). Is there a way to get (and quantify) the same quality tenants in other parts of the country with a higher CAP rate? My thought is that if this is possible, then the market is expected San Francisco to appreciate more (otherwise markets are not efficient and you can arbitrage).
chevca
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Re: Rental Property--Do numbers make sense to keep??

Post by chevca »

dachshunddad wrote: Mon Jan 20, 2020 4:14 pm Property tax/HOA/other small stuff is $750 for $2500 cost per month.
This stuff alone would make me want to get rid if it. Those numbers are likely to go up at least as fast as you can bump up the rent, if not more. Plus being a condo, a special assessment could come along any given year.

IMO, not worth it to hang onto this just in case you want to move back in 20 years from now.
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Re: Rental Property--Do numbers make sense to keep??

Post by abuss368 »

Consider reading "Investing in REITs" by Ralph Block and also Sam Zell's (i.e. "The REIT King") book. It provides a different perspective for REITs.
John C. Bogle: “Simplicity is the master key to financial success."
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