iwannaretire said:
My wife and I are discussing whether or not to rent our condo when we buy a house in 4-5 years. To make the numbers close enough to work, we would have to pay off the second mortgage ($52K) before moving.
Over time, I imagine that we will be able to turn this condo into a passive income generator, while gaining equity. I realize a lot can change in the next 4-5 years - I just want to bounce this around a bit.
This question has three aspects: financial, vocational, and emotional. You should make the decision on any one of those aspects and not be bullied into choosing another aspect just because it "makes more sense". In other words, it's not just a financial decision and you have to be able to sleep at night.
Let's look at the finances first. Say that the bank calls you on the phone to offer you a CD. If you give them $52K, which you may or may not be able to get back someday, they'll pay you $371/month. Except for months that have "unexpected vacancies" or "repair costs" or "student vandalizing". You get to pay the taxes and all the other expenses associated with keeping the CD. You can redeem it any time by paying the bank about 6% of its face value, which fluctuates with market conditions but might appreciate at the rate of inflation over the long term.
I've tortured the analogy enough-- would you sign up for the CD?
Landlords used to look for properties that returned 10% cash-on-cash (after properly accounting for depreciation, repairs, vacancies, taxes, and a host of other unexpected expenses that many gurus forget to mention!). Maybe that works for thefed in his part of the Rust Belt, but my impression is that today's average is more like 6-7% and in Hawaii it's 3-4%. You're not just able to beat rental income with a CD, you're able to beat it in some parts of the country with a good dividend-paying stock or mutual fund. None of those investments will call you at 3 AM about a burst water pipe, either.
Vocational: do you enjoy rehabbing & redecorating? I know the place is in good shape now, but tenants will never take care of a house as well as you will. I'm not talking the kind of fun rehabbing like putting in a whirlpool tub or adding corner moldings. I'm talking about unbelievable kitchen depreciation (including shabby treatment of every horizontal surface with cutlery) and patching the holes in every wall. OK, you enjoyed it five years ago the first time you did it. How many more times would you like to do it? Oh, you're going to hire someone to do it for you... now we're back to the financial analogy.
Emotional: will you derive great pleasure & comfort from having a piece of the land to call your own? Will you feel good about taking care of your tenants? Will your kids or aging parents want to move into it someday? These are all great reasons for owning rental real estate, and I'm guilty on all counts, but don't confuse these with the financial aspect.
If you've read this far, then go read some more:
(1) Investing in Real Estate, 4th edition or later, by Andrew McLean & Gary W. Eldred (who's taken over the new editions) and
(2) Landlording by Leigh Robinson (7th edition or later).
Eldred has specific examples about marketing & renting to college students. It's not as easy as it looks. The occupation of landlording (and it is a job!) also gives your tenants specific legal rights, not necessarily a bad thing, but which can make some landlords wonder if we really do live in a representational democratic republic. After you read the books, get a copy of your local "Renter's Rights & Landlord's Duties" legislation and read it while watching the movie "Pacific Heights".
That's as objective as I can be this month, but let me take you through our subjective thought process. We're rehabbing our 28-year-old 4BR 2BA 1875 sq ft rental (on a 5400 sq ft lot) after five years of what's best described as benign neglect by well-meaning but fiercely independent family tenants. I've already had three four-hour mornings hacking back the tropical jungle that used to be a beautiful yard and we have to reassess the landscape plan in terms of easy maintenance instead of attractiveness. We have about six of those four-hour mornings left (along with a big bottle of ibuprofen) while simultaneously riding herd on three batches of contractors inside the house. We have enough green waste to fill trash cans at two different locations for a month. Sure, we could hire more contractors for the yard, but it's not the kind of decisions they can make and it's not the kind of work they want to do.
We're also stripping & resurfacing the popcorn ceilings (contractors x2!), putting in a couple new light fixtures, dealing with some nasty rot caused by bad sprinklers, recarpeting (150 sq yards, contractor again), fixing all the walls, filling in the atrium pond (for tenants with small kids), cleaning the whirlpool tub, exterminating the ants once and for all and this time I really mean it, installing 150 sq ft of vinyl flooring, grooming all the sprinklers that no one told me were broken, and finishing a full hand-written page of "Oh, yeah, we need to..." items. Then next year we're going to replace a 50-foot privacy fence with a wall (hope the incumbent lasts that long). Thank goodness we did the kitchen three years ago and the bathrooms will be good for another 5-10 years. We have a great neighborhood with a decent HOA and reasonable expenses. We should probably repaint the exterior by 2010.
I'm in pretty good physical shape and I'm still surprised at how sore I am-- definitely a different use of my muscles. Meanwhile I have home-improvement projects of my own to catch up on, we're way behind on our own yardwork (with a comparable volume of green waste), our xeriscaping plans keep slipping every month, I'm way too surfing deficient, I haven't started the tax returns yet, and I have way many other things I'd rather be doing than hacking raphis & schmoozing contractors.
The good news is that this work would be required anyway to sell the house, and we're raising the rent to $2800/month in a market full of military tenants with comparable housing allowances. Cash-on-cash return will be about 4% but I need to update my spreadsheet to verify that I've correctly separated all our owner occupancies from our rental periods. The property has appreciated at about the rate of inflation over our 18 years of ownership. I think this is about as good as it gets and the house has served us well over our years of building our ER portfolio-- it owes us nothing. Spouse and I have gone over all of the above factors and we'll probably decide to rent it for a year before revisiting the issues.
Our kid doesn't want the house due to some of her deeply-ingrained childhood phobias memories. We don't need it for any other family members. We could live there ourselves someday, but I'd rather have our current home or (in my 90s) a smaller condo.
It's too late for me. But you can still save yourself!
