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Author: madbrain Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121572  
Subject: To become a landlord or not ? Date: 4/1/2011 10:11 PM
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Last year, I bought a new house without selling my previous home first. It's been sitting on the market since october, and I haven't been able to sell it, despite some significant price reductions and it looking good versus the comps. Two sales have fallen through due to banks not lending. Those sales were pending at prices much higher than what it's listed for now, the last one as recently as february. But no new buyers have come at reasonable prices since.

I am trying to figure out whether it makes sense to rent it out for some period of time until prices rebound. Home prices keep hitting new lows every month, and it doesn't seem like it's a very good time to sell.

On the other hand, I think it will take more than 2 years for the housing market to come back. And by that time, I would no longer be able to take the $250,000 exclusion on the sale of my primary residence. I moved out in September 2010, so the latest I could sell it to avoid tax on appreciation would be September 2013 - to make it 2 of the last 5 years as owner-occupied . If there is still appreciation by then, that is.

From what I hear, the rental market isn't that bad. I would definitely be able to recoup all my monthly expenses on the property. But the profit would be very small. What concerns me is that when I eventually sell, I would owe much higher taxes, and this could offset all the money made from renting it out, and then some.

Here is what the numbers look like :
- Townhome originally purchased for 228,000 in October 1997.
- 80k of improvements made to the house, including new kitchen, remodeled bathrooms, new zoned HVAC.
- Currently have a HELOC for 250k at 3% as only loan
- Listed for 445,000 in October 2010 based on comps at the time. First offer came at 429,000 in 3 weeks. But lender denied the PMI at the last minute in December due to "too many non-owner occupied properties" in the complex, and less than 20% downpayment
- Lowered the price to 435,000 in January 2011 . Second offer came in February 2011 for 430,000 . This was a VA loan. The lender backed out after only 2 weeks, despite having pre-approved the buyer.
- Got a new realtor with lower commission, and lowered the price to 399,000 in March 2011 . The hope was to generate multiple offers asking price with the low list price. This didn't work.
Only one lowball offer came, at 365,000, stupid people with 2.5% downpayment and FHA loan. I did not bother to counter because the price was way low.

If the financing had come through for either both of the previous offers, I should have netted about 140k, tax-free since this is below the 250k exclusion.

My rental agreement with my new realtor expires in 4 days and it doesn't appear that any other offer is forthcoming unfortunately.

I really hate the idea of becoming a landlord due to the headaches. I don't want to be spending a single minute even thinking about it. I just don't see how this home can be sold given the current market unless I discount the price to something unreasonably low, and let an investor pay cash for it, since these seem to be the only people that can actually buy houses right now. As I typed this email my realtor told me one investor wanted to send a cash offer for 350k. Based on that offer, I would only net about 80k.
On paper, the home value should definitely be above 400k based on comps. I think the 2 offers around 430k prove that too. I don't see the prices going anywhere but down for at least the rest of this year. And I don't have any confidence that the prices will have recovered before september 2012, the date at which I would have to pay capital gains on the proceeds.

The loan on this property is a HELOC at prime minus 0.75% with a 3% floor. This is a variable rate. Currently it's at 3%. The reason I got a variable rate was because I didn't intend to keep the house long term. Market conditions make it very difficult, though. I am not very comfortable with keeping a HELOC for more than 3 years.

There is no chance that I will ever move back into the property to take advantage of the capital gains after I rent. It is too small and I no longer wish to live in a townhome.

On the rental side, here is what the numbers look like per month :
- a property manager says it can rent for 1950
- HELOC payment (interest only) of 650
- HOA is 220
- property taxes 270
- property manager 195
- insurance 35
- maintenance estimated at 150
- vacancy estimated at 120

Net income per month is $310 . Or $3720/year.
Assuming $130k equity, this is a only a 2.8% return, very low for being a landlord. Equity is not growing since the HELOC is interest only.

Of course, that's still a whole lot better than the -15% with my expenses and no rental income right now. But the equity is going down every month with the home prices, while the expenses are not, so it really is even worse than -15%. And expenses will go up when rates go up, also.

Things start looking even bleaker when I account for depreciation on rental, and capital gains. I am not sure that I understand how this really works. But here I go.

My original purchase price was 228k. About 100k was land and 128k buildings. Plus 80k of improvements. So, the current basis is 308k. 188k can be amortized over 27.5 years. Or $6836 per year.
This means I would have a rental loss of about $3000/year.
0% of this loss would be tax-deductible, since I wouldn't be actively managing it, and my AGI is too high anyway.

At the time of sale, I would owe capital gains.
Let's say I sell for 400k in 2014 - that's assuming banks have started lending again by then.
The basis would be 308000 - 3* 6836 + 3*3000 (non-deducted rental losses added back) = $296,490 .
Capital gains would be $103,510. The federal rate will be 20% starting 2013, and 9.6% for California. So, I would owe $30,638 at time of sale.
That's 8 years worth of rental income.

The net would be about $110k then. Better than the $80k I could net from an investor today. But still way less than I should if banks were lending today like they should be.
Of course, prices could go down too, and the banks might still not be lending in 2014. And my interest rate on my HELOC could go up, making the losses even worse.

Do I have my numbers right when it comes to the depreciation ?

What would you guys do in my shoes ?
- Rent now, or keep trying to sell ?
- Rent now and try to sell before september 2013 to avoid capital gains tax ?
- Rent this property long-term, without the intent to sell it ? If so, refi the HELOC for something with a fixed rate ? I fear this would make the house cash flow negative, as the rate on an investment property will be much higher than 3%, and there will be principal payment
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