So I had a discussion with a friend over what to do. Should he sell his condo or rent it out? He is in the military so his salary is set and his job secure. He is being relocated, unfortunately his condo has lost value. But here are the numbers.
Income – $6534/month = $78411/year
BAS (Base Allowance for Substitance) – $223/month = $2676/year
BAH (Base Allowance for Housing) – $2345/month = $28140
Total Income – $8991/month, but I think only $6534 is taxable
Mortgage
Home Purchase $385k, 5% Down Payment
$366k mortgage @ 5.25% = $2021/month
Taxes – $200/month ($2377/year)
HOA – $350/month
Total – $2571
The renting potential is $1800-$2200/month for the condo. That means that the rent will likely not cover the PITI for the condo, especially since a property manager will have to be hired.
Assuming a $2200/month rent – 10% property manager = $2000/month, leaving a shorfall of $571/month. Thus if my friend chooses to sell, he could likely sell for around the same value, but with a loss of his down payment in closing costs.
Thus assuming a $30k loss on the sale, he could hold the condo for 5 years renting before the monthly loss is greater than the loss from the sale. However, this is assuming there is always a tenant and the rent is always paid on time and in full. And there are no extra expenses.
What do people think? Should he sell now and eat the loss? Or should he rent it out and assume the monthly loss in hopes of not selling for such a great loss?
I think that this decision is tough. A lot has to do with whether you believe in being a landlord or not. But with the numbers laid out, what is the best decision?
17 responses so far ↓
1 TuesdaysTip // Feb 22, 2009 at 1:24 pm
I don’t think the decision has to do with being a landlord or not, it has to do with one’s predictions for the housing market.
A couple of important questions:
1. Where is the property located?
2. What is the motivation for wanting to sell the property? Buy a new property or because he wants to be a landlord?
My hunch, hold on to the property and sell it within the next 5 years when the market has (hopefully) rebounded. He should be able to sell it without losing money.
I cannot justify losing $600/mo on a property based on his income, and that’s assuming it rents for 2,200. In this market, with rents falling along with home prices, its a gamble. I suppose to make a more educated decision I would need to know the answers to the two questions posed earlier.
2 LAL // Feb 22, 2009 at 4:04 pm
Can’t say but it’s a very HCOLA. In an expensive metro area.
Second, the person is unsure but thinks maybe renting it out is better than coming to the table with cash.
Third, he is planning on buying another property at his next location. So he could be on the hook for two mortgages if the renter doesn’t show up or doesn’t pay the rent.
I am not sure if he could get $2200 and neither is he. If he got $1800, then things start to get a lot more expensive right?
But he said the property manager told him he could write off the HOA and property taxes, etc. That it would all work out.
Since I”m not a landlord, I’m very unsure.
3 TuesdaysTip // Feb 22, 2009 at 6:26 pm
I think the better option is to look into purchasing an investment property where the numbers work more in his favor. Losing $600-$1000 per month on an “investment” property just to have an opportunity to play landlord is not the right way to do it.
A few hundred dollars is acceptable, but the risk is way too high for him. He can’t really afford to carry two mortgages based on his net income. I’m sure he THINKS that he can, but I see this scenario at least once a week when I get a phone call from a borrower in the same scenario.
I’d sit on the property for a couple of years, unless he’s concerned about it losing value. At that point he can determine if the market has recovered enough to break even on the sale. If he’s doing it to purchase a new property, he’s better off taking the loss now and getting a better deal on the purchase of a new property.
4 LAL // Feb 22, 2009 at 9:03 pm
He is going to buy a new place to live where he is moving to, and this was where he was living for 3.5 years. So it was never meant to be an investment property until the market went south. Thus he is now stuck with bringing cash to the table and selling it, or renting it out for a few years while living afar.
He isn’t sure which is the best decision. And yes of course he thinks he can carry it if it’s not rented out. It’s very risky and very expensive should the renter not pay or something go wrong.
He doesn’t want to lose his 5% DP. But he’s going to have to use up a lot of cash buying another property.
It’s a rock and a hard place.
5 Double Journey // Feb 23, 2009 at 1:53 am
Seems rather simple to me actually.
Investments should not give you negative cash flow. Which this is not only doing, but is doing by a lot. Hoping that the market recovers is foolish. It is the same trap that caused people to hold on to technology stocks as they crashed to 0 in 2000 and it is going to cause a lot more pain in housing over the next several years.
Believe me when I say this, the housing market is not going to rebound in the next 5 years. Flat maybe, but no way is it going to recover the losses we just experienced. I thought a lot about assets and pricing this past weekend,
http://www.doublejourney.com/2009/02/22/the-secular-bear-market/
And I just couldn’t, no matter how hard I tried, come up with a scenario where I was bullish on asset prices.
6 Kristy // Feb 23, 2009 at 7:40 am
I agree with Double Journey. He should cut his losses. There is not going to be a housing rebound for years, probably 10 years…at least.
7 Tuesdays Tip // Feb 23, 2009 at 8:23 am
I agree with you DJ and Kristy, the market won’t completely recover in 5 years. I don’t think we’ll see home values where they were within 10 years. But if he has an opportunity to cut his losses and gain back some value in the next couple of years, he’s better off waiting.
Great point DJ on investments not showing a negative cash flow. I say this to the borrowers that call me all the time telling me they want to purchase an “investment property” then show me that the rental income won’t even cover PITI + maintenance. Some people should not play landlord.
In this case, it appears he has no choice but to move. That being said, take the loss now and gain on the other side by getting more house for your dollar on the purchase.
8 LAL // Feb 23, 2009 at 3:26 pm
Tuesdaystip, that’s the question. Should he sell now, or wait an rent it out.
The market may not recover, which means selling now he’ll take a hit and move on.
But if he waits, he might have a chance to recoup some of his losses. Granted he’ll be eating into the recouping because he’ll have to pony up at least $600/month. Plus unexpected expenses.
9 Tuesdays Tip // Feb 23, 2009 at 3:35 pm
sell, Sell, SELL! Without a doubt. I don’t trust the market and I’d rather know that I’m getting a great deal on the purchase of a new property.
10 LAL // Feb 23, 2009 at 9:00 pm
How do you know you are getting a good deal where you are moving to and it won’t go down more?
11 Tuesdays Tip // Feb 24, 2009 at 8:18 am
That’s a loaded question. I can’t be the judge of someone’s ability to pick the right property. There are several properties in HCOL areas that a borrower could purchase for 25%-50% below value. Look for the 3 D’s of real estate:
-Divorce,
-Debt
-Death
It’s sad, but true. Find someone in one of those 3 scenarios and you’re more likely to get a better deal on a property. I would HOPE that if you get a property 25% below value that the real estate market will not tumble another 25%. If it does, then we all have much bigger issues.
12 Pearl // Feb 24, 2009 at 10:01 pm
A few other numbers that should factor in to the decision:
On the side of keeping the condo and renting out:
1. From the numbers you gave, about $420 a month of the mortgage payment is going toward debt reduction. This is not the same thing as a “loss,” as it increases net worth.
2. Depending on your friend’s tax bracket, he may also benefit from the depreciation deduction on the property (a non-cash flow item) as well as deductions for all the cash items like interest, homeowners association fees, taxes, repairs, and travel to the area to handle business related to the property. On a condo purchased for $385,000, assuming the land value portion of that is, say, 20%, the depreciation deduction alone probably would be over $12,000 a year, so at a 28% tax bracket, that would save about $280 a month in taxes.
Those two factors alone more than cover the cash flow shortfall mentioned. Also, property management fees are somewhat negotiable, especially in the current climate. They are not automatically 10%.
Long-term, in HCOLA areas, rents can rise rapidly with any significant inflation. Since the feds are spending money they don’t have like identity thieves with someone else’s credit cards, inflation is a very likely scenario. This could make renting more profitable. The last time we had major inflation in the 1970s(political remark redacted here), rental property was like a gold mine.
On the side of selling:
When running the numbers, you need to include a vacancy factor, supervision fees from the property manager for handling repairs, and likely higher wear and tear than in owner-occupied property.
You need a GOOD property manager, who will thoroughly check references and credit reports for prospective tenants, do periodic inspections, follow up promptly on late payments, act promptly to fill vacancies and obey instructions such as no smoking or no pets. A bad tenant can cost thousands in lost income, legal fees and damage, and will sour your views of human nature pretty much for life ( I speak from bitter experience here). Long distance rental ownership means you are at the mercy of your property manager so pick a good one.
From the information you gave, this is really not as open and shut a “sell” call as other commenters seem to feel. Personally, if I could find a good property manager and had any interest in returning to that area either to live or to visit family on a regular basis, I’d be inclined to keep it, unless it’s in a city with or likely to get rent controlled.
13 Pearl // Feb 24, 2009 at 10:02 pm
One other thing to mention is that tenants are always possible buyers, often with little or no commission involved.
14 LivingAlmostLarge // Feb 24, 2009 at 10:12 pm
Pearl excellent points. I gave you the numbers he is in the 15% tax bracket, not 28%. I don’t think condos have land value. You only own in a condo (especially high rises) from the paint in. You may or may not own the studs. Thus the condo fees.
I agree this is NOT an open and shut case.
I don’t like to hear about bad tenants because I’ve always been a good renter when renting. I can’t imagine a bad renter, I haven’t known any personally.
One thing not mentioned which I’ve personally experienced with condos having been on the board, etc. The maintenance fees can also escalate with inflation. Right now it’s only $300. His best friend in the area pays $750. The likelyhood of it going up? Definitely he says.
Second, with condos, you can get hit with a special assessment. Meaning they need an emergency repair not in the budget? They assess a fee against each unit.
One condo we considered had an assessment of $12k. The sellers had disclosed it and had set the money aside with the management company. However, many people were wary of buying after such an assessment. This can happen at any time.
Condos are lot more risky than a single family home with regards to repairs, maintenance fees, and assessments. It’s not within personal control.
In our old condo we sold before the assessment was announced, so we weren’t liable. There had been rumors that the next fiscal year would hit our old condo with a fee. And it did, of $5k.
15 Funny about Money // Mar 4, 2009 at 9:03 am
I’ve been thinking along the same lines where my son’s and my “investment” house is concerned: it’s time to cut our losses and sell. Even though it provides a roof over his head and the cost is tolerable as long as he rents at least one room, his renter will finish graduate school this spring and presumably move on; meanwhile, son would like to go to graduate school but wants a better program than is offered in our city. We couldn’t rent it for enough to cover the PITI, much less mortgage payments plus maintenance.
We thought we were buying near the bottom of the market when we picked up that place. Turns out we weren’t, and frankly, I don’t think we’re anywhere near what ultimately will be the bottom. It’s becoming more and more clear that real estate will never recover its value — even its pre-”bubble” value.
16 karla (threadbndr) // Mar 5, 2009 at 12:21 pm
Have him double check with his Family Readiness Officer – there may be help
From “Jarhead Online”
The Senate Proposes Military Homeowner Relief The “American Recovery and
Reinvestment Act” (S. 336), the economic stimulus bill offered by the Senate
Appropriations Committee this week, includes a provision that would provide
significant relief to military homeowners on PCS orders who are upside down
on their mortgages or otherwise suffer a significant loss on the sale of
their homes. It would also cover certain wounded warriors and their
survivors.
17 LivingAlmostLarge // Mar 5, 2009 at 9:53 pm
Interesting, thanks Karla,
Sorry to hear FM that it’s not a clear cut case for you to sell either.
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