Should I Sell My Rental Property And Simplify Life?

Median Sales Price San Francisco. Source: Trulia

Source: Trulia. Median Sales Price San Francisco.

There are two reasons why I’ve been thinking about selling my main rental property. Real estate is on fire here in San Francisco and it’s always better to sell higher than sell lower. We’ve clearly passed through the worst of the property market and sales prices are up anywhere from 15-25% in the last 12 months alone. Meanwhile, the median asking rent is commensurately up 21% YoY to $3,398. Spending $41,000 a year after tax on rent seems hard to sustain, even if you are making over $150,000 gross a year and working for Google.

The second reason for wanting to sell has to do with hassle. The older I get, the less I want to deal with conflict. I’m currently writing this post during a moment of frustration so my thoughts may be biased. However, it is my hope by writing things out we can come to a rational decision for those who are also thinking about selling their rentals.

At about 2pm the other day I get a blast e-mail from our HOA management company saying,

“I have seen a number of complaints regarding tenant occupied units which needs to be addressed by the Unit Owners. In particular are the following issues:

1. Parking without authorization in someone else’s parking stall.
2. Parking beyond the confines of the parking stall’s floor marking.
3. Not breaking down and bundling their cardboard boxes in the garbage area.

The lack of compliance by tenants places the Unit Owner in serious jeopardy as the Board will be meeting next month to discuss in conjunction with other business matters, solutions and punitive assessments. You are required to have your tenants sign off acknowledging receipt of these documents.”

I’m accustomed to receiving such e-mails because it’s always the same three issues over and over again when a new tenant moves into the complex. No matter how much the landlord stresses these three issues to our tenants, an owner will inevitably complain to the HOA or the property management company about new tenants. The older the owner, the more they will complain, especially if the tenant is younger.

Owners feel they own more of the place than their condo dictates. The longer the inhabitant, the more rights they think they have. Furthermore, there is a bias against younger people because they are viewed as more inconsiderate, entitled, rude, and lazy. The funny thing is an older generation’s bias against a younger generation has held true even during the times of Socrates.

“The children now love luxury; they have bad manners, contempt for authority; they show disrespect for elders and love chatter in place of exercise. Children are now tyrants, not the servants of their households. They no longer rise when elders enter the room. They contradict their parents, chatter before company, gobble up dainties at the table, cross their legs, and tyrannize their teachers.” – Socrates, 470 BCE.

A PHONE CALL SOME TIME PAST MIDNIGHT

The next morning I woke up to a voice mail complaint from my tenant’s downstairs neighbor saying that my tenants were still letting people into the complex at 11:49pm. Because the neighbor lives near the entrance of the complex’s main door, she can hear the buzzing and slamming sounds every time someone enters and leaves. The building rules states there is a quiet period after 10pm, which is loosely defined as being respectful to your neighbors and not throwing large parties with music. Entering and exiting the building after 10pm is fine. This isn’t jail.

The unexpected voice mail I received rudely stated that tenants are not welcome and neither are landlords. It almost sounded like a hate crime insult. She plans to complain to the HOA board and try to institute fines against me. I’m a pretty calm fella who hates getting disturbed at night as well so I sent her a cordial e-mail saying,

“Hi Jane (neighbor) – I apologize for the disturbance and will be having a word with my tenants today and get back to you. I also understand that b/c your unit is next to the main entryway that the buzz and door closing sound can be a problem. Regards, Sam”

I then proceeded to send an e-mail to my tenants to hear their side of the story and get as much info as possible to defend myself from allegations,

Hi Shirley and Stephanie (tenants),

I received a pretty nasty voice mail around midnight from Jane complaining about the noise from your apartment last night. She’s basically going to complain during our next HOA meeting and try to institute fines against me.

I’ve got to now defend myself so I need to know the details of what was going on the evening of October XX, 2013. I’ve noticed their complaints always make things seem bigger than they are, so I hope you can provide some details as to:

* The number of people at the party

* When were the people coming in

* How long did the party last

* Did Jane call/visit you guys to ask to turn it down

* How loud do you think you guys were e.g. blaring music, jumping around, etc.

* Did you violate the house rules?

Because Jane lives right next to the main entryway, she can hear the buzz and doors slam shut the most. I can understand that if she was trying to sleep at midnight how this would be very inconvenient for her. Please let me know your side of the story. And if the party was out of hand I encourage you to visit her and apologize.

Thanks,

Sam

MANAGING RELATIONSHIPS IS DIFFICULT

“Can’t everybody just get along?” said Rodney King. This current scenario brings me back to the time of managerial duties at work where egos needed to be massaged and expectations needed to be managed. Sometimes you get lucky and hire the superstar employee who is humble, collaborative, and hardworking. Then there are other times when you make a mistake and hire a prima dona who believes he deserves to make at least $125,000 his first full year out of college like one of my old subordinates. It’s the same thing with finding a great tenant.

To keep the peace I was apologetic to my tenant’s downstairs neighbor even if my tenants didn’t throw a rager. Whatever the true story is, my tenants disturbed the neighbor and that is the bottom line. I have to deal with the neighbor for as long as I own my place while my tenants can simply leave once their lease is done. Maybe I’ll even buy the neighbor a bottle of wine.

So how passive is being a landlord with no property management company really? I include my rental income as a key part of my passive income portfolio. Property management is usually very quiet as my turnover average is once every 2.5 years. Meanwhile, I only get a work order request or complaint once every nine months on average so it doesn’t take much time at all. Most of the complaints are in the first six months and then there are no more complaints for the remaining two years because my tenants start “getting it.”

Thank goodness everything turned out OK in the end as my tenants did apologize in person the next day. My hope is that this is the last complaint about my tenants for a long while.

TIME TO SELL MY RENTAL AND SIMPLIFY LIFE?

When I was working, I’d get more stressed when dealing with my tenants. Now I can easily go visit during the day and help out where needed. I still love rental property despite the work it entails because it’s tangible with a income stream, but as I grow my online business, rental property is losing its favorite nation status. Let me highlight the pros and cons to help readers and myself come to a better decision.

PROS OF OWNING A RENTAL PROPERTY

* Relatively passive income stream. So long as a tenant doesn’t do much damage to the property, gets along with the neighbors, and pays on time, rental income is relatively passive.

* Someone pays your mortgage. A tenant is paying your mortgage and helping build equity in your property. This is usually a net positive over the long run.

* Rents increase over time. Thanks to inflation and general population growth, rents consistently increase over time. The most recent rental income increase for San Francisco is 21% year over year as previously stated.

* Mortgage rate is fixed over time. Not only is the mortgage rate fixed over time, the percent of payment going towards principal also increases over time. Meanwhile, you are paying down your mortgage with inflating dollars making the real cost of mortgage even cheaper.

* Tax shelter while you build equity. All expenses related to operating a rental can be deducted from the rental income stream. If you happen to be in a high income tax bracket, the expense deductions are even more valuable. I wanted to receive 0 net rental income while I was working because I was in the 36% (39.6% equivalent today) tax bracket. Now that I’m no longer working, I’m more inclined to pay down my mortgage and raise the rent because the income will now be taxed at 28% or less.

* A real asset to utilize. Unlike a stock or a bond, you can derive utility in your rental by moving in. My general rule of thumb is to always buy a rental that I’d be willing to live in for two years. I’ve always envisioned having a paid off pied de terre in San Francisco if and when I relocate to Honolulu. I so wish I bought a place in NYC back in 2000 when I had the chance. Even if I lose everything, I’ll at least have my rental to come home to.

* An asset I can pass down to my children. My grandparents left my parents property when they died and such property will likely continue to be passed down. If I have children, I hope to give them a head start by providing a subsidized or free place to stay when they first graduate. I’ve seen so many young adults really progress faster in their career if they don’t have to worry as much about housing costs. Moving to San Francisco or NYC are no brainers for college graduates who want to participate in robust economies.

* Wealth accumulation. Property appreciates with inflation over time. If you can hold long enough, even a 3% increase is a 15% cash on cash increase of your 20% downpayment. I put down $120,000 back in 2003 for my $580,000 condo. Zillow.com currently has it valued at $910,000. Let’s take a 10% discount to $910,000 and we get $819,000. If I sell for $819,000, I’ll receive gross proceeds of ~$485,000 after subtracting my mortgage and 6% selling fees. I’ll end up paying at most a 15% long-term capital gains tax on a profit of roughly $239,000, for net proceeds of roughly $450,000. Of course I could live in the place for two out of the next five years to avoid the $34,500 in taxes altogether, but let’s stay conservative. My $120,000 downpayment turned into $450,000 over 10 years (includes paying down mortgage, excludes depreciation recapture which I will write about in the future). That’s a 375% cash on cash return after all fees and taxes annualizing at around 18% a year. The return based on a $580,000 purchase price and $819,000 selling price is only 3.7% a year. But as my numbers just demonstrated, the real cash on cash return is much better.

CONS OF OWNING A RENTAL PROPERTY 

 * Stress. If you are a busy person who works a stressful job, the last thing you want is a scenario that I’ve provided in this post. Fixing a toilet is easy because the job is outsourced to a plumber and just costs money. Ditto goes for installing a new dish washer. Maintaining harmonious relationships is much harder when there is conflict. Conflict is what’s most stressful.

* Liability. Whenever people are involved there is liability. Liability is the main reason why I rejected two Google tenants because they both wanted to have their parents stay with them for six months to a year in my two bedroom. One could slip and fall or get in a fight with another owner. That’s not something I want to deal with hence the reason for my large landlord insurance policies. Make sure your tenants take out renter’s insurance as well. Read: How To Prevent Tenants From Abusing The Lease With Multiple Long Term Guests.

* Crowding out. The crowding out effect in economics refers to when government initiatives crowds out more productive private sector initiatives, thereby stunting optimal growth. Having a rental property may take time away from you doing something more productive or fun. A rental property also ties up your money, preventing you from making potentially more lucrative investments. I’m pretty sure I could not match a 18% IRR for 10 years with the same amount of stress investing elsewhere. However, putting everything in Google stock would have done just as well.

* Property taxes. Property taxes is the #1 thing I hate about owning property, especially if you feel you are not even coming close to getting your money’s worth. Property taxes makes you realize how inefficient and greedy the government is. When the markets were imploding in 2008-2010, property taxes kept on going up for property owners not savvy enough to fight the tax assessors office. I fought every year for five years in a row and won my appeals. The government counts on its citizens to lay down and eat bitter pills. Stand up people. At least property taxes are deductible. Read: How To Lower Your Property Tax Bill.

* Lower cash flow. Real estate really starts to generate positive cash flow once a long enough period goes by thanks to inflation and a fixed mortgage cost. A $810,000 property in SF will generate approximately $45,000 a year gross revenue, or $33,000 a year after property tax and HOA, equivalent to a 5.6% gross and 4.0% net rental yield, respectively. The $450,000 proceeds from the sale will only generate approximately $13,500 a year if it’s dumped into a 3% dividend yielding portfolio. Read: How To Correctly Value And Analyze Rental Property Like A Pro.

* Can’t get back in. There’s never been a point over the past 15 years where I thought real estate was cheap. There were certainly some good values here and there, but cheap never entered the lexicon unless I were to buy in the middle of nowhere. If you time your sale wrong in hopes of getting back in, the market may very well price you out. Ask any long term tenant under rent control whether they wished they bought the day they first signed the lease and they’d emphatically say yes. We’re seeing this happen in more expensive cities such as San Francisco, Manhattan, Singapore, Hong Kong, London, and Paris. Just when you thought prices couldn’t go any higher, they do. I remember when $1,000/sqft was unheard of in Manhattan. Now $1,000/sqft is the price of a nice apartment in Brooklyn!

EXPECTATIONS FOR THE FUTURE

From a financial standpoint we must make best guesses as to how much property prices and rental prices will appreciate. San Francisco is estimated to show another 4-5% increase in 2014 and 2015. I don’t doubt continued appreciation with Twitter going public, Google at all time highs, and AirBnB likely next on the IPO docket.

We should also question how important rental property income is for our retirement. Currently I save 100% of my passive income and live off my active online income. However, my online income could one day disappear and my rental income makes up a good 35% of my passive income. Losing this income stream would crimp my style. The other big question is what to do with the proceeds after a sale.

By the summer of 2015 I’d like to have the full flexibility of relocating to Hawaii if I so choose. Having multiple properties in California is an impediment to freedom even if I do hire a property manager. I have no desire to pay California taxes. At the same time, owning real assets is a huge part of financial security. I’m leaning towards holding on to my main rental until my current tenant moves out (soonest would be June 2014) and selling after it is vacant. One or two more years of ownership should see at least a 2% per annum appreciation with tens of thousands more paid down in principal.

I’ll use the proceeds from my rental property to purchase another piece of property in Hawaii for myself or for my parents to live via a 1031 Exchange in order to not pay taxes. This way I’ll still maintain my real estate net worth allocation percentage. It’s my hope that by the time I move, online income will consistently surpass the minimum Hawaiian household income level of $67,000 a year. It’s not too expensive to live in paradise with no rent or mortgage!

Recommendations For Renters And Homeowners:

* Check Your Credit Score: Take a moment to check your free TransUnion credit score through GoFreeCredit.com, a company I trust. 30% of credit reports have errors, which could put a serious hamper on your refinancing or new loan borrowing abilities. I had a $8 late payment I didn’t even know I owed crush my score by 100 points come up during my last refinance! The average credit score for rejected mortgage borrowers has risen to 729 due to more stringent lending requirements. Landlords will often ask for a renter’s credit score as part of his/her analysis.

* Refinance Your Mortgage. LendingTree Mortgage Refinance offers some of the lowest refinance rates because they have a huge network of lenders to provide mortgage loans, home equity loans, and home equity lines of credit. If you’re looking to buy a new home, consider using LendingTree to get multiple offer comparisons in a matter of minutes. When banks compete, you win.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Chris says

    Good article Sam. If you move to Hawaii, what’s your gameplan? What kind of business plans would you be interested in? Honolulu area or the other side of Oahu?

    • says

      Game plan is to just run my online business from Hawaii since the business can be run from anywhere in the world nowadays. Maybe I’ll even become a BMW or Range Rover salesman for 20 hours a week if they’ll have me since I love cars so much.

      When you can play golf for cheap, play tennis for free, surf, body board, and hike for free and feel warm all year around, it’s hard to beat.

  2. nbsdmp says

    Hmmm…so this is a tough one Sam. My first thought was going to be “hey remember your last point about not being able to get back in once you sell” prices will always trickle up and as long as you might be kicking yourself in 12 years when see that your same condo just sold for $1.5M at which point it probably would be have been paid for.

    But, on the other hand the scenario you laid out where you are going to buy a property in Hawaii to live in is essentially exactly what my plan is. Here is another thought I know you’ve mention in previous articles…but how about you sell now at the high of a fevered pitch market, but the property in Hawaii as a “rental” and do a 1031 exchange to avoid the taxes. You are not planning to move anyway for a couple years so it gives you a glide path to get there once you can occupy the place to satisfy the conditions of a 1031 exchange. Plus you’ve participated in the property appreciation in paradise along the way.

    I have a nice little deal where my paid for commercial property throws off about $15k/month before taxes after operating expenses. Great deal right? Of course it is, but eventually just like yourself, I’d like to turn this property into my retirement home once I’m ready to make that transition. Currently I’m using this cash flow to look for other property investment opportunities…I just think that it is going to be good to own hard assets in the future. Inflation has to eventually start to creep again and interest rates can’t stay this low forever can they?

    • says

      The 1031 exchange is a no brainer, and property in Honolulu/Oahu is much cheaper than property in San Francisco.

      In fact, I’m going to take a business trip in November-December to Hawaii to look for property.

      • nbsdmp says

        I figured that would be a part of your overall plan. This is probably a really dumb question, but can a 1031 be done when purchasing property outside the U.S.? I don’t imagine it can, but if I’m paying taxes as a U.S. citizen maybe I can? Also, do you know what the lock-up period is that you have to be actually renting the property before you can live there as a permanent residence?

        • nbsdmp says

          The second question is in reference to the period of time that it has to be maintained as a “like kind” property. I’ve not had the opportunity to do it before, so I’m not real sure how that whole process works. I imagine there are other options as well and a lot probably depends on the individuals tax situation at the time of the transaction.

  3. says

    The first question to ask when you consider change is: what else will you do with the money? Bonds? Mutual funds? Stocks? Seems to me you have the landlord thing wired and, as you noted, the hassle factor goes down as the tenants “get it.” If I was a betting man, I’d put my money on you staying put. :)

  4. says

    You should encourage the woman who lives in the bad condo next to the door to complain to management about insulating the door area so she does not hear the buzzing and banging. It is not your fault that she chose to buy the worst condo in the building.

    I hate to be bothered about anything and I would dump the property to avoid headaches. It sounds like you could do some profit taking now and come out ahead.

    BUT – I deal with headachy stuff like this all the time at my health care job and I thrive on the conflict and fast thinking that it requires. Your life is pretty quiet and if you took out real estate your life would become even quieter. Could you handle a completely conflict free life? When would your adrenalin flow?

    • says

      That’s a good point. I’ll bring that up in the next HOA meeting to have a different closing door. Like one of those slow closing toilet lid seats!

      I’m impressed you thrive on conflict! I just can’t be bothered anymore. All the small stuff doesn’t bug me as much in retirement, so when I see small stuff bothering other people, I get annoyed.

      Adrenaline flow comes from competitive tennis and other sports! No bigger adrenaline than sports.

  5. says

    I have no experience investing in real estate, so my only comment would be that it seems like largely a personal decision. We can’t tell what the future will bring in terms of returns, so I’d say that’s a wash in terms of whether you will win or lose with your decision. The way you’re talking now, it sounds like holding onto the property doesn’t really fit into your long-term life plans, so if that’s the case then I would try to sell. No sense holding onto it when you can make some nice cash off the sale AND improve your overall happiness in the process.

  6. says

    Sam – I personally find that, 90% of the time, being a landlord on rental property is quite a fulfilling investment. Although it can be time consuming, it allows you to provide a service to make someone else’s life better whilst earning monthly income and capital appreciation at the same time.

  7. says

    Wow, great post Sam. I guess ultimately you have to decide if the headache is worth the stream of income. Considering your comparison between the passive income the dividend portfolio kicks of versus the rental, you certainly would be taking a step back, plus losing some diversification in your asset allocation. If you were to sell it, would there be other means of allocating those funds to real estate, via REITS or other locations around the US where the numbers still make sense?

    And just to clarify, won’t you have some ordinary income as a result of depreciation recapture on the rental? If I’m not mistaken it won’t all be capital gains. Your capital gains might be the $239k, but whatever depreciation taken or “allowable” depreciation (even if not taken) should result in recapture. I quote from the IRS, “For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you did not claim it.” With a 27.5 year life, and we will assume that you have an 80/20 allocation between land value and property, you might have depreciated (or been allowed to) $160k+. Given your current income, that would put your average a bit above the 15% rate, correct? Something else to consider.

    As someone said above, that certainly makes the opportunity for a 1031 exchange much more attractive as a means to defer that tax hit. And I don’t blame you for the California taxes… yuck indeed.

    • says

      You bring up a great point about depreciation recapture. For the first 2 years, the property was cash flow negative, so I didn’t need the depreciation recapture. In fact, the three years increased my cost basis. For the last six+ years the property has been cash flow positive and it will continue to increase. The timing works well b/c I’m in a lower tax bracket now.

      I’ll have to write a more detailed post on this topic later. But very good point, and I won’t know the numbers until it’s time to sell.

      • says

        Sam, the cash flow of the property has very little to do with the depreciation recapture. Since the recapture is based on the actual or allowable (can’t emphasize the allowable part enough) depreciation, your basis in the property is reduced annually. Using your 580k purchase, and an assigned value of 464k (80%) to the improvements, your annual depreciation would be just under ~17k per year (464k/27.5). The only way your basis reduction is less than that in a given year is if you are making capital improvements to the property.

        So even if the property didn’t cash flow, because you are allowed to depreciate the property, the IRS assumes you did, therefore it will recapture all of the possible depreciation since the acquisition of the property. So in your case, you will have the 239k in capital gains, and 160-170k of depreciation recapture classified as ordinary income and taxed as such. Even at a lower tax bracket… that will certainly cause quite the hit and affect those return numbers.

        *Normal disclosure… talk to you tax adviser, blah, blah, blah :)

        • says

          This is great to know. That doesn’t make sense though for a property that let’s say loses $10,000 a year. If a property loses $10,000 a year, then there’s no need for taking depreciation, and therefore no need to lower the capital base to pay more taxes.

          But I guess where it does make sense is carrying over the depreciation and losses to offset future income yes? That has to be the case.

          In other words, the worst is to buy a 3 year negative cash flow property and then sell, unless the price has gone way up.

          * pls respond to another comment of mine as the thread is done.

      • says

        Make sense or not, that is how the law is written. I know for my unintentional rental property, which is essentially your last example you’ve mentioned, that even though it is losing money, the tax basis of the property is eroding due to the depreciation. So I could sell it for less than the purchase price and still be on the hook for some gains.

        Bottom line, the laws can get really tricky when selling a property or anything that depreciates. The allowable language is such a catch all that there is never NOT a point in which you should take depreciation as it will be counted against you as if you had.

        • says

          Fascinating and good to know. Then the bottom line is to always take depreciation and always try to make as much from one’s rental as possible. Raise em up landlords! The government is making us do it.

  8. Austin says

    Why don’t you test the FSBO market. FSBO listings usually take longer to sell but sell at a higher price. If you couple that with saving 3-6% I bet you might feel pretty good about not leaving much on the table against your 2015 target.

  9. Chris says

    Yes, Sell. The argument for keeping it is “it may go up in value and you’ll regret that later.” This is called gambling in my book. We own rental property for the cashflow, not appreciation. You can buy a LOT of decently priced rental units in another city if you want to be a landlord still. The cap rates in SF are far too low to be sustainable.

      • Chris says

        Fair enough. You’re the guy making showing the world how he’s been making a few hundred grand as the bubble keeps growing. It sounds like you have your mind made up. If we both sleep well, then that’s all that matters.

        I think investing is a calculated gamble. Speculating is blind gamble. I also think you’ll land rich side up either way so my post was really for the billion other folk who think “real estate never goes down” after what happened only a few years ago. For them, if a highly leveraged rental property drops significantly in value and the cashflow can’t cover it, then that’s usually financial suicide.

  10. says

    My rentals are a lot of headache too. I’ll give it until the end of 2015 and see how it goes. If the rental income improves, then we will probably keep them. I want to eventually do a 1031 exchange too. Once you’re in Hawaii, maybe you can help us look for a nice property.

  11. Marcel says

    Hi Sam – I’ve been thinking about this a lot this past few months. In fact, I almost decided to sell last month and instead ended up renting to new tenants who are moving in today. Both are young and doing very well in the tech and pharmy sector. One thing I’ve been noticing about San Francisco tenants is that they’re a bit high maintenance and I get it with the rents being so high. I’m thinking the same as you. Rent out for another year or so and then, if the market is still strong, sell in 2014. I agree with Chris above, cap rates are too low in SF and there’s way better places to be a landlord.

    • says

      Guess we are in a very similar boat! My tenants just signed their one year lease this past June.

      I make it a point to be very responsive and nice. I also don’t nickel and dim em. If there’s something wrong, I tell them to spend whatever it costs to fix and bill me after checking in first. It’s my place they are maintaining at the end of the day.

      • Marcel says

        Congrats on the new lease! I agree about being responsive and nice and giving your tenants the freedom to fix whatever needs to be fixed. It’s just getting weird now because rents are so high which translates into increased expectations from the tenants. First day in and they’ve already complained about the parking spot being too small. Yes, being a landlord can be a headache sometimes, and I still think it’s worth it.

  12. Ken says

    How did the neighbor get your phone number? I have some crappy neighbors right now that always play their bass music when we’re trying to watch TV after a long day at work. They say the sub is turned off, but I can hear it over my TV. Or they say no one is home, or they blame it on the unit on the other side. I’ve complained to the HOA several times, but they don’t do anything. The only other thing I can think of is calling the landlord of the tenants next door.

      • Ken says

        We’ve tried going the nice route. And she turned down the bass on her stereo for months, but now that her new boyfriend moved in they turned the bass back up and refuse to turn it back down. For a while they’d have parties in their garage and their friends would park in front of our townhouse garage and we’d have to wait while they got the owner to move the car. When we’ve asked them to turn it down they lie and say it’s not on or blame it on my other neighbor when we can touch the wall and feel the bass. I’m sick of going over and asking them constantly to do something they shouldn’t be doing in the first place. They’re by far the most inconsiderate neighbors we’ve ever had, they don’t seem to care how their actions affect others. BTW, “next time” is every night. Should we have to tell them every night to turn their bass down?

        • says

          No answer for you Ken. Noisy neighbors is one of the main reasons why I decided to buy my own house. In other words, I ended up moving in the end. The dull bass sound drives me crazy as well.

  13. Bob says

    Great article Sam. I sold some rental property last year that I owned remotely (about 400 miles away). With the annual property taxes, caretaker expenses, and general maintenance costs it just wasn’t worth the stress and hassle. I’ve taken the proceeds into developing a stock market based revenue stream; since then the after tax cash flow is about 3x what it was previously. I realize the market will have ups/down but the stress-free lifestyle this has provided is terrific for my situation. Best wishes…

    • says

      Bob, a 3X cash flow return with stocks vs. property sounds incredible! Can you share with us the numbers and how you did it? Was your property just really bad, or did you pick some real stock winners?

      In my case, I’ll let go of about $33,000 in after expenses cash flow a year if I had no mortgage, and could only get maybe $13,500 a year, so 60% less. If I could get $100,000 a year in stocks like your 3X case, that would be a no brainer!

  14. says

    Wow that lady owner sounds like a grouchy old woman. I can understand being upset about noise but she didn’t have to lash out like that and be so rude in her voicemail. I’m glad to hear things worked out ok. If your average tenant turnover is 2.5 years that’s pretty good. The tricky part now is if one of your current tenants moves out when the lease is up but the other wants to stay and has to try and find another roommate. But maybe they’ll both decide to stay for longer which would be good.

    • says

      The biggest bummer was her hate-crime like threat, “tenants are not welcome and neither are landlords.” In my younger years, I would have driven up there and given her a mouth full. Now, I just let her vent her age away.

  15. Jason says

    Great article, Sam. I do have some advice for you, from a purely investment perspective. It will also address your stress level.

    I’m in a similar boat for my rentals here in California. I bought them at the low and, although they’ve been cashflowing nicely, I’ve decided to liquidate everything here in California and instead buy out-of-state. This gives some advantages:

    1) Releverage – because I’ve gained a lot of equity, my position in each of the properties is now well over the 20% for the normal mortgage. (One is as high as 60%) Selling will free that capital up to invest in better/bigger/newer units. This means more cashflow.

    2) Management – because it’s out-of-state, I’m forced to get property management, freeing up my time to work on my business rather than in my business. This also gets rid of California rental law headaches. At one time, I thought wanted to do the management even after FIRE, but these days, I’d rather just have that handled by professionals.

    3) ROI – California prices no longer give a great bang-for-the-buck and moving the capital gives a much better return. As an example, one of my current units rents for almost 1800 / month. For the same price, I can get a newly-built duplex out-of-state which rents for 1350 per side. That’s just one example, there are a lot of deals out there like this.

    Sam, if you want to give your passive income a boost and remove headaches, sell your rental here and releverage out-of-state. There are great companies out there that I can recommend.

    Hope this helps

    • says

      Jason, where are you planning to buy? I’ve got a tough time buying in a place I wouldn’t want to live. I’ve also got a tough time buying a property I wouldn’t want to live in for two years. Call me conservative I guess.

      But there definitely seems like some good deals in Arizona, Florida, Texas, Nevada etc. Arbitrage. The problem is, it’s hard to live anywhere else other than SF or Hawaii once you’ve been.

      So which state and city are you recommending?

      • Jason says

        So, I’ve already sold one of my CA rentals and with that money, was able to leverage up to multiple units in Memphis, TN because of the good price upswing here. Cashflow was increased. Next year, all the rest will be sold, the capital gains will be releveraged, and cashflow increases again. All just because I moved my money to another market.

        Currently, I am closing on another place in Texas, in a good area near San Antonio. My current retirement advisor is from CA, but has been in the Texas market for many years now and considers it a much better investment than CA. After seeing the numbers and with my experiences in TN, I definitely agree.

        I’ve also talked with REI folks from Birmingham. Their numbers look comparable to TN, but they are still really new at this, so I decided to go into Texas instead. But they make some impressive guarantees (a one-year buyback guarantee, 2 year rent guarantee, etc. etc.) and seem very solid.

        I guess it’s a mental shift you have to do (or not do) and try to start seeing things from a more detached point of view. In your case, you’re already sitting easy, so there’s less pressure. But, in my case, time is ticking and I need to doing everything I can to maximize my opportunities, so I have to be very pragmatic.

        I know I’m not going to live in these places, they are strictly retirement vehicles. If I want to move somewhere else, I’ll just sell my current place and buy something new. Chances are, it’ll be cheaper than where I’m living now, so that’s an easy shift. (BTW, I’ve been looking at Paso Robles for wifey and I later on, it’s nice and quiet down there)

        Just for giggles, here’s a link to a great video that explains things better than I could:

        http://bawldguy.com/your-favorite-market-video/

  16. says

    Sam,
    Even if you moved in for two years you still have to factor depreciation back in when you sell, which you will get taxed on. Do a 1031 exchange 6 months before you come here. What neighborhood were you thinking of? I wanted to buy in town in Manoa and Kaimuki but I can’t afford a million plus for a decent home.

    • says

      I’m definitely doing a 1031 exchange.

      Are homes in Manoa and Kaimuki $1 million+ now? I’m thinking of getting a condo for my parents in the Ala Moana area, but I don’t really like big condo complexes b/c someone down the hall might foreclose, thereby hurting your exact match property too easily.

      What about Hawaii Kai? I know Kahala is out of reach, but am thinking of joining Waialae CC.

      • says

        The type of homes my wife likes is $1 million +. A decent older home is around $800K. In the Ala Moana area in the new buildings there are a lot of overseas investors that buy as a second home. some of the buildings are in litigation which will make obtaining a mortgage difficult.

        Hawaii Kai is nice, if you want Kahala there are townhouses around 600K+. If you roll your SF house you can buy a house in Kahala, unless you want to live mortgage free.

        • John says

          You should definitely consider Kailua. It’s away from all the hustle and bustle of Honolulu, but literally a 15 minute drive into town. Homes in the area range from $700k – $1.2M within a block from the most beautiful beaches on the island, Kalama/Kailua beaches, IMO. I’m a realtor so feel free to contact me if you’re not already working with an agent down here.

  17. says

    I’m still a believer in rental real estate, mostly because of the benefits you mentioned (regular income and there’s something nice about it being tangible). In a worst case scenario, it still has a use value (I can live in it) even if its exchange value plummets.

  18. No Name Guy says

    Hmmm….it sounds like some of this issues with your rental are due to the fact that it is in a condo.

    That banging door? Nope, on a SFR rental.
    Grouchy neighbor….well, those happen anywhere, but she’d likely be calling the cops with a noise complaint instead of you were that the house next door.
    HOA issues with parking, cardboard, etc: None of those in SFR (especially if you carefully pick one to NOT have covenants.)

      • No Name Guy says

        I don’t know enough about swaps / 1031′s etc to say anything intelligent on the prose and cons.

        More generally, I’m not a fan of Condo’s or HOA SFR communities as they add one more layer of complexity to owning real estate. What happens if the condo board is run or taken over by a bunch of short sighted folks who delay needed repairs to the point of causing major damage? Or the control freak with a Napoleon complex who gets on the HOA board of the SFR community and obsessively cruises the ‘hood for trivial violations of the covenants?

        I personally avoided these situations by buying in a non-HOA / non-covenant neighborhood. Typical zoning enforcement is sufficient (IMO) to take care of neighbors who let their places go to heck (and I called ‘em on the one down the block that started to let their front yard turn into a junk yard). And I could really care less what style of fence the guy across the way puts up, or what color he paints his house.

  19. says

    I love your website. I’ve been reading for a few months.
    I like in Wrigleyville in Chicago and am a teacher. It is mostly 20-30 year olds. I live on the first floor near the front door and Intercom. We had issues with our front door and got a new closer. We especially have issues in the winter and we have to have the door slam shut to close so that the freezing air doesn’t invade the building. However, I finally got fed up. While being home over the summer, I researched how to have the door close slower and used an Allen Wrench to close it quieter. This has helped immensely as I would wake up early or in the middle of the night due to the door slamming shut repeatedly by owners, tenants and guests.
    A loud fan at home or a personal heater helps with the noise in my building. However, I bought in the area and I know the consequences. I feel that I have no right to complain about drunks and noise living two blocks from the most popular strip of bars in the city of Chicago. San Francisco is also a very young town and the noise should be expected by many. Also, I have had some crazy nights myself, but as I get older they occur with just more time in between.
    I have warned work that one day I will have to call in sick because I wasn’t able to sleep because of the noise of upstairs neighbors. It will happen one day. I know it.
    Contacting your neighbors has been helpful. Even a text message helps making an excuse that you are sick and cannot sleep due to the noise. I have also told my neighbors to tell me ahead of time if they are having a party as I can always make other plans for the night. I try to tell them ahead of time if I will be out of town so that they can invite all of their friends over and go crazy. Calling the cops should be the last option regarding noise.
    I also have a parking spot behind the building that backs up into the alley. I will call the cops if people park in the alley and we have a contract with a towing company that will do the same. Chicago police have no issues making money off of parking. In fact, I will call if someone is even slightly in the alley as it is a safety hazard and my car has been hit with $1,000 damage with cars trying to get out of the alley. In fact, if a fire truck or other emergency vehicle cannot get down the alley, this is a reason for ticketing cars. It is a $120 ticket. When one neighbor hears about it, trust me, it will never occur again. My neighbors were about to park with their car partly in the alley. I told them I will call the police. They confronted me and were not happy that I “threatened them” and “their vehicle”. I explained to them my car has been hit and it is too hard for my neighbors and I to get out of the alley safely from our deeded parking spots ($32K) and that the police will gladly ticket them. (I also live by a school and there is plenty of parking in the evening, weekends and in the summer where parking around the school is permissible.) I gave them fair warning and they moved their car.

  20. says

    Size matters! There are no less problems in larger buildings, but you can afford a resident manager to take those phone calls. When you have these annoying calls or problems in general, it is important to think about your goals. If you want to continue earning “passive” income, you may have to think about multiple unit buildings.

    • says

      I should have bought a 5 unit building 10 years ago instead. But then again, those cost a pretty penny. I guess I could have bought 8 years ago a Multi unit instead of my existing house, but I was at the point where I wanted to live in a nice place and not in an apartment anymore.

  21. says

    Either way, it seems like a good problem to have. I like your idea of selling and using the 1031 to buy something in Hawaii. You could live like a king. We plan on acquiring more rentals and not selling for a long time, if ever. I kind of like the idea of passing along a little rental empire to our daughter, as long as she doesn’t join the circus or become a groupie on the Justin Bieber comeback tour.

  22. says

    It is refreshing to hear you are experiencing some of the same issues I am having, Sam. I own a condo in a 20 unit complex and my tenants are by far the youngest people there. I have had four sets of tenants in four years and I have no doubts the revolving door is at least partially a result of the way the condo owners treat my tenants. The speed limit is 10 MPH; I get calls that they are doing 15. My tenant has a little camp-style grill (it sits 6 inches off the ground); I get calls that he is trying to burn the condos down. Their 3 month old baby leaves a toy on the front porch (a PRIVATE PORCH – it isn’t shared with others!); I get a call (despite the fact that the chain smoker who is calling me leave her nasty ashtray outside her unit!). I got a call because one of the shrubs outside the unit died. I call my tenant, a professional landscaper, and he tells me the elderly lady next door trimmed his shrub without his permission and she took so much off the shrub that it died. But I am the one who has to replace the shrub that the neighbor killed.

    I finally figured out the solution to my problem. Like you, I used to be so nice and accommodating. But now, I follow the association guidelines to a T. Regarding my tenant cooking out on a grill – there’s nothing prohibiting that. I told the wicked old lady who called me that I wasn’t going to tell my tenant to stop. She said something about “I hope you have enough money to re-build all 10 units on your side when he burns them down,” to which I replied, “If he is creating a fire hazard, I suggest you call the fire chief and register a complaint.” It was when I started pushing back that they slacked off a bit.

    • says

      Oh man, sorry to hear your neighbors are such sticklers! 4 tenants in four years is also kind of painful.

      I can see how pushing back and being fierce can cause them to back off. I’ve thought about it before too, but just can’t be bothered now that I’m older and have other financial means. That’s one of the good things about being financially independent, you stop giving a crap as much.

      Good luck on your property!

  23. M says

    I have 9 single family and duplex rentals. I have managed my own in CA, but got tired of midnight water heaters bursting, so I have sold a few over the years. Now, I buy duplexes for cash flow out of state and have them managed. A good manager is like gold. If you factor the cost of management, you can still enjoy the wealth accumulation that the asset class affords. However, I am selling a few under performers this year to simplify as well so I understand your decision.

  24. david says

    the tax rules have been changed regarding the occupancy/ two years out of the last 5 rule,,,,new rules took place in 2013…not sure the law but it is less favorable for landlords

  25. says

    18% annualized over the past 10 years would be extremely hard to beat. No one knows where future valuations are going, and we may be nearing another real estate bubble in the Bay Area, but I think you’d be OK hanging on to what you have until you find a property in Hawaii. I was glad to hear that your tenants went and talked to the lady they bothered. That is a sign of reasonable people. And I think you handled the conflict very reasonably, as well.

  26. says

    Well…I can see why you would want to get out of the rental business. My dad had rental properties and they were a challenge in other ways-renters doing drugs or other things that you might not like down the road. Collecting payments can be a nightmare sometimes if you are not fully prepared to deal with those issues.

    If I was in your position, I might actually go ahead and sell. I would then take a part of that money towards a move somewhere else, part towards taxes, part towards some sort of 401(k)/IRA, and maybe the last little bit towards my online ventures to help them grow as much as possible. But maybe that is just my input.

  27. Ace says

    Sam,

    Per the chart you posted, it likes real estate has very much recovered in San Francisco.

    This is certainly good for you! My personal thoughts about the real estate in San Francisco are very complex. I appreciate that a combination of high paying software jobs and lack of unbuilt land will put upward pressure on prices. This is a trend which I assume will continue for a least a few years.

    On the other hand. Software is portable. Coding can be accomplished anywhere. At what point do employers say enough is enough, let’s move these occupations to a cheaper location?

    It’s not like prices can go up forever.

    • says

      Hopefully this post is relevant in a way that helps anybody who is contemplating selling their rental.

      Hopefully the post helps people think about the pros and cons and what to so with the proceeds.

      I have a feeling prices will go up forever because inflation is generally forever.

      • Ace says

        But Sam,

        Inflation is very low (almost deflation actually). The price increases you are witnessing are a local economic phenomenon. This is a very good thing for you.

        At the same time, from an investor point of view, it is very important to take a step back and look at the big picture. The real estate demand in San Francisco is primarily a function of no open land available to build on and a strong computer industry in the South Bay.

        Housing in most of the country has a tough time growing at a rate beyond inflation (around 2% at best right now). What makes real estate worthwhile as an investment is leverage (and it’s familiarity to ordinary people).

        I think wealth wise, the average middle class American would do far better to max out their 401K in a diversified portfolio of mutual funds (or ETF’s) and forget about it. But, I understand the emotional appeal of real estate (I own two homes). People are not rational. And there is an intangible utility value to real properties.

  28. says

    I am new to blogging in investment, your site is one of the site I follow every week.
    I am in an awful situation right now. My rental home is out of state, I have been renting for almost 5 years now. The last tenant(staying for 6 months) did not pay the rent and so I had to do eviction. Today was the eviction date and when the property management went and saw the place the tenant had vandalized the place so much, that there are no words to describe. I have called insurance, filed police complaint. I am planning to sell it after whatever it takes to sell that place even if its a lose to me.

  29. whoanelly says

    I had to skim through your post because it’s way past my bedtime, but if you do decide to sell your property, try selling it yourself before going through a realtor. Selling a nice property is far easier than it seems, you just have a lot of phone calls to make. On a $800K+ property, 6% is no small peanuts.

  30. says

    This does not sound like fun. This is sort of my worst nightmare when it comes to being a landlord, actually. Maybe finding new tenants would be better for you right now while you look for a place in Hawaii – it doesn’t look like prices in your area are going anywhere but up.

  31. says

    All of my adult life I have lusted after buying rental properties because of the appeal of making so much money, primarily off of leverage. Then I remind myself that stocks/mutual funds are so much easier. My REIT’s will never call me at 2:00 am with a leaky toilet.

    So far I have stayed strong and resisted the urge to buy multiple rentals and fill my time with unwanted stress and work! :)

    • says

      Neither will my tenants either. The problem with REITs, stocks, and mutual funds is the lack of leverage in a bull market and the utility of the property. What does your REITs and stocks throw off in cash flow a year?

      • says

        I was going to ask the same question as Justin. A REIT like 0 is up 86% the past 5 years with a 5.8% yield.

        We have talked about it in the past and I always go back and forth on the investment property. Eventually I am going to bite the bullet with some buddies on the first one – limit the risk (and reward I guess), thoughts?

  32. moshennik says

    My experience with rental used to be similar to yours, but here are the steps I took
    1) My properties are single family homes – avoid dealing with HOA, neighbors, all that junk
    2) My properties are in a red state, which helps with laws that don’t punish landlords over deadbeat tenants
    3) I charge about 10% under market for rent, in return I ask for first $50 or $100 or $200 (depends on how good of a job i did negotiating) of any repair comes from a pocket of a tenant.

    These steps minimize landlord pain, and over the long term maximizes returns.

  33. says

    Definitely a dilemma. If you’re seriously considering moving to Hawaii in 2015, I’d think about selling the place closer to your move and buying something in HI instead. Less stress and more cash to free up. Hawaii is expensive, but my guess is property is about the same or maybe a little less in HI. You might be able to buy something outright. I love the idea of rental properties, but I think I’d look out of state instead of worry about the CA market. It’s such a roller coaster!

    • says

      Honolulu is actually about 30% cheaper in terms of housing cost. But I’m going on a business trip there this November and December to check houses out and will report back.

      I would have kicked myself if I sold last year. But even if prices continue to go up after I sell this year, I think I’ll be OK bc I will redeploy the cash in HI.

  34. Maverick says

    Sell the RE! As a former GS rep. you had the insight to get into Small Cap Growth earlier this year, correct? Yeah, baby…35% growth YTD :)

  35. Maverick says

    Ha, ha…touche! I knew you’d reply with your Chinese stocks. What percentage are you still in with? “Everybody Wang Chung tonight!”

  36. says

    Tough choice to make. Another thing to think about is the fact that if you sell you will not have great content for articles like this! A lot of your writing about property, real estate, and renting have been some of the best on the site!

  37. says

    Our solitary rental is close to a military post and we’ve had great luck with military renters. I also require renters to do repairs less than $100 on their own, as well as abide by the HOA rules, or they get the fines (though this has never been an issue for us).

    Unfortunately, after several months of real value increases in our rental, the last month has been a dog on Zillow, which I’m sure reflects what I think is the normal post-Summer price slump.

    • says

      I’ve got to imagine military folks to be some of the best and orderly renters around!

      Funny you should mention zillow bc I’ve been monitoring prices daily here in SF and they have literally gone up 3 months in a row. I’m waiting for that post summer slump too. Price moves feel like Internet stocks of 1999.

  38. Kai says

    Hey Bro … I just closed sale of my condo to begin my long waited deleveraging.
    Did you forget to include cal tax so its not 15% but 15% plus 10% cal plus 3.8% if you make too much and get hit with the Obama Medicare tax on long term cap gains?

    Also what are the rules of 1031 exchanges again? 60 days and has to be higher price?
    Was there a rule on whether it has to be rental or primary use?

    K

    • says

      Congrats!

      To elect the 1031 recognition, a taxpayer must identify the property for exchange before closing, identify the replacement property within 45 days of closing, and acquire the replacement property within 180 days of closing.

  39. says

    Headaches are one of the reasons I’d be looking for a 3/2 house rather than a multiplex or condo. No HOA, no shared walls, and you’re more likely to get a family renting so fewer ragers or other hassles.

    Otherwise, there’s always hiring a property manager to handle the headaches for you. Lowers your total profit, but greatly reduces the headaches and time required.

    • says

      What about vacancies and gross rent? With a 4-unit building you will almost always have a renter. With a house you could have a vacancy and go without any rent for months. And how much do you get in rent on a 3/2 single family house. Here in Minnesota, in a good area you could get $1,400. On a 4-unit you could easily receive over $3,000 in monthly rents. Cash Flow is extremely important when investing in Rental Property.

  40. Gilbert says

    I have a client that wants to sell her duplex in SF but she is afraid that the tenants are going to give her a bad time some how. What do you suggest she do in order to sell the property without a hassle?

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