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Advice needed: sell primary residence or keep as rental?

Started by swbluedevil, September 13, 2018, 04:34:23 AM

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swbluedevil

Hey everyone! I'm a long time reader of FS and am super excited about getting your advice on whether to sell my primary residence in the Bay Area or keep it as a rental. For background, my family and I are being relocated overseas for a potentially multi-year assignment and will probably will not return to the Bay Area - if we do return, it definitely would not be to the city where the home is located.

When I run the numbers, it seems fairly clear that we should sell and reinvest the tax-exempt proceeds in a diversified portfolio though I'm getting fairly mixed opinions about what to do. Most of the recommendations I'm getting from family / friends / coworkers to keep the property and rent it out are based on expectations of continued price appreciation (and overall bullish sentiment about the Bay Area). Personally, I'm neutral to pessimistic about the local housing market for the short to mid-term due to the huge run-up in the past few years.

Here are some details about the property:

Appreciation since purchase in 2015: $500K
Current equity in the home: $800K ($250K down-payment, $50K of principal payment, $500K in appreciation)
Estimated selling price: $1.7M
Selling fees: $0 (company will cover as part of re-location)
Estimated monthly rent: $5,000 / month
Net operating income: $2,150 / month (includes one month per year vacancy, HOA, prop insurance, prop tax, 10% property management fee, and 7.5% allowance for maintenance)
Cap rate: 1.5% (using the estimated selling price)
Monthly cash flow: -$2,250 / month
Monthly net profit: -$600 / month

From my perspective, just taking the proceeds ($800K) and investing at the risk-free rate would lead to a better expected outcome than keeping the house as a rental. Is there anything I'm missing or is the best source of action pretty clear in this situation (i.e. sell)? The only viable reason why I would keep it is if I believed there would be another run-up in prices due to Uber / Lyft going IPO in 2019...

defomcduff

Great question and good situation to be in!  We have faced something similar in prior years.

My two cents:

1. I'm a bit more bullish on housing than you are, recognizing recession risk.  It wouldn't be a bad time to lighten up, especially if you are moving away from the Bay Area and no longer need to be risk neutral to Bay Area prices.

2. It's a lot of work and a concentrated asset.  Probably better to diversify.

My only hesitation is that I think we have a few more years of this housing bull market before it ends.  But if you're nervous about that, I think it makes sense to sell.  Although, I would encourage you to sell Bay Area and buy in your new market, so that you're not changing housing exposure so rapidly in any one point in time.  In other words, buying / selling into housing markets keeps your risk reduction less extreme and thus less important of a decision.

Good luck!!



Quote from: swbluedevil on September 13, 2018, 04:34:23 AM
Hey everyone! I'm a long time reader of FS and am super excited about getting your advice on whether to sell my primary residence in the Bay Area or keep it as a rental. For background, my family and I are being relocated overseas for a potentially multi-year assignment and will probably will not return to the Bay Area - if we do return, it definitely would not be to the city where the home is located.

When I run the numbers, it seems fairly clear that we should sell and reinvest the tax-exempt proceeds in a diversified portfolio though I'm getting fairly mixed opinions about what to do. Most of the recommendations I'm getting from family / friends / coworkers to keep the property and rent it out are based on expectations of continued price appreciation (and overall bullish sentiment about the Bay Area). Personally, I'm neutral to pessimistic about the local housing market for the short to mid-term due to the huge run-up in the past few years.

Here are some details about the property:

Appreciation since purchase in 2015: $500K
Current equity in the home: $800K ($250K down-payment, $50K of principal payment, $500K in appreciation)
Estimated selling price: $1.7M
Selling fees: $0 (company will cover as part of re-location)
Estimated monthly rent: $5,000 / month
Net operating income: $2,150 / month (includes one month per year vacancy, HOA, prop insurance, prop tax, 10% property management fee, and 7.5% allowance for maintenance)
Cap rate: 1.5% (using the estimated selling price)
Monthly cash flow: -$2,250 / month
Monthly net profit: -$600 / month

From my perspective, just taking the proceeds ($800K) and investing at the risk-free rate would lead to a better expected outcome than keeping the house as a rental. Is there anything I'm missing or is the best source of action pretty clear in this situation (i.e. sell)? The only viable reason why I would keep it is if I believed there would be another run-up in prices due to Uber / Lyft going IPO in 2019...
DeForest
Boston, Massachusetts

Jim

Here's another consideration...
If you keep the Calif property as a rental, you'll probably have to file Calif taxes.
I moved out of Calif and choose to sell the house rather than deal with Calif taxes.
So if you're sure you will not return to the Bay Area, then I'd sell.

defomcduff

Quote from: Jim on September 15, 2018, 10:10:44 AM
Here's another consideration...
If you keep the Calif property as a rental, you'll probably have to file Calif taxes.
I moved out of Calif and choose to sell the house rather than deal with Calif taxes.
So if you're sure you will not return to the Bay Area, then I'd sell.

Agreed.  Good point.
DeForest
Boston, Massachusetts

Sam

I would sell.  Having your firm cover the 5% commission cost is an extra $85,000 in your pocket. However, you should clarify with the firm whether that cost savings will be reported as income on your W-2.

The risk-free rate of return is 3% right now where you don't have to do anything.  With a cap rate at half that level, you need 1.5% appreciation to stay even.  For me, the cost to maintain and the stress was not worth the money.

You are in a price point that is in very high demand. But I have noticed housing prices above $2 million, and definitely above $2.5 million start to slow. It's better to rent then to buy right now in the San Francisco Bay area. Where are you located?

Tax free $500k gains is great.
Regards,

Sam

swbluedevil

Hey thanks so much for the great perspective. I think I'm most likely leaving money on the table, but I'm ok with that as I am pretty happy with $500K in tax-free gains in ~ 3 years. Just as important is that I don't have to deal with tenants / worry about the property while half a world away!

I hadn't seriously considered buying in my new location, because I assumed there were too many restrictions against foreigners buying property, but upon further research it looks like those restrictions are not as onerous as I thought. I think after 6 months, we'll have a better idea as to whether this is somewhere we want to stay long term or if we want to settle back in the states (most likely Seattle).

Quote from: defomcduff on September 13, 2018, 06:10:43 AM
Great question and good situation to be in!  We have faced something similar in prior years.

My two cents:

1. I'm a bit more bullish on housing than you are, recognizing recession risk.  It wouldn't be a bad time to lighten up, especially if you are moving away from the Bay Area and no longer need to be risk neutral to Bay Area prices.

2. It's a lot of work and a concentrated asset.  Probably better to diversify.

My only hesitation is that I think we have a few more years of this housing bull market before it ends.  But if you're nervous about that, I think it makes sense to sell.  Although, I would encourage you to sell Bay Area and buy in your new market, so that you're not changing housing exposure so rapidly in any one point in time.  In other words, buying / selling into housing markets keeps your risk reduction less extreme and thus less important of a decision.

Good luck!!



Quote from: swbluedevil on September 13, 2018, 04:34:23 AM
Hey everyone! I'm a long time reader of FS and am super excited about getting your advice on whether to sell my primary residence in the Bay Area or keep it as a rental. For background, my family and I are being relocated overseas for a potentially multi-year assignment and will probably will not return to the Bay Area - if we do return, it definitely would not be to the city where the home is located.

When I run the numbers, it seems fairly clear that we should sell and reinvest the tax-exempt proceeds in a diversified portfolio though I'm getting fairly mixed opinions about what to do. Most of the recommendations I'm getting from family / friends / coworkers to keep the property and rent it out are based on expectations of continued price appreciation (and overall bullish sentiment about the Bay Area). Personally, I'm neutral to pessimistic about the local housing market for the short to mid-term due to the huge run-up in the past few years.

Here are some details about the property:

Appreciation since purchase in 2015: $500K
Current equity in the home: $800K ($250K down-payment, $50K of principal payment, $500K in appreciation)
Estimated selling price: $1.7M
Selling fees: $0 (company will cover as part of re-location)
Estimated monthly rent: $5,000 / month
Net operating income: $2,150 / month (includes one month per year vacancy, HOA, prop insurance, prop tax, 10% property management fee, and 7.5% allowance for maintenance)
Cap rate: 1.5% (using the estimated selling price)
Monthly cash flow: -$2,250 / month
Monthly net profit: -$600 / month

From my perspective, just taking the proceeds ($800K) and investing at the risk-free rate would lead to a better expected outcome than keeping the house as a rental. Is there anything I'm missing or is the best source of action pretty clear in this situation (i.e. sell)? The only viable reason why I would keep it is if I believed there would be another run-up in prices due to Uber / Lyft going IPO in 2019...

swbluedevil

Thanks, Jim! I definitely do not want to be paying CA taxes if I don't have to :-) I hadn't considered this factor in my decision-making process, but this totally makes sense.

Quote from: Jim on September 15, 2018, 10:10:44 AM
Here's another consideration...
If you keep the Calif property as a rental, you'll probably have to file Calif taxes.
I moved out of Calif and choose to sell the house rather than deal with Calif taxes.
So if you're sure you will not return to the Bay Area, then I'd sell.

swbluedevil

Hi Sam - thanks for the heads up about having to report my firm's covering of the commission cost on my W2. It is reportable income, though my firm is going to provide a plus up to cover the tax burden.

Also, I totally agree that investing at the risk-free and not having the stress of managing a property from a far sounds much more appealing! In actuality, I'll probably beef up my real estate crowdfunding exposure (I'm really interested in something like RealtyShares's domestic equity fund) and invest a good portion of the rest in Wealthfront (at a low-moderate risk setting).

The home is located down in the South Bay not too far from the new Apple spaceship campus :-)

Quote from: Sam on September 15, 2018, 07:45:28 PM
I would sell.  Having your firm cover the 5% commission cost is an extra $85,000 in your pocket. However, you should clarify with the firm whether that cost savings will be reported as income on your W-2.

The risk-free rate of return is 3% right now where you don't have to do anything.  With a cap rate at half that level, you need 1.5% appreciation to stay even.  For me, the cost to maintain and the stress was not worth the money.

You are in a price point that is in very high demand. But I have noticed housing prices above $2 million, and definitely above $2.5 million start to slow. It's better to rent then to buy right now in the San Francisco Bay area. Where are you located?

gkc

and one thing no one else has mentioned, being a landlord isnt for everyone. I did it for a while and it truthfully sucked.

Eric

Definitely sell.

Very low cap rate in the Bay area, suggesting the market is pricing in a good amount of appreciation.

If you can get an unlevered 6-7% cap rate outside of the Bay area (with much of that being tax deferred due to depreciation), you need a significant amount of outperformance in the Bay area to make that trade work. Without ties there, invest the money elsewhere and don't look back.

swbluedevil

Thanks for the great advice everyone! I have decided to sell my current property and reinvest part of the proceeds in buying a primary residence in the overseas market we are moving to. This overseas market features low interest rates, very low property tax rates, and is in the early stages of a recovery in the property market.

Now if anyone has recommendations on selecting a listing agent, that would be much appreciated  ;D

Kendall

Every real estate investment is unique, so it is difficult to provide advice.

My situation was very similar to yours. I sold a downtown San Jose condo in August 2018. I have never been so glad to have that off my plate of concerns.
I tried renting it for two years to pre-med students with the help of a property manager. The tenants managed to break every kitchen appliance in the condo within the first year. The homeowner's association scolded me and fined me for my tenants' behavior. The property manager was glad to fix and repair things at their rate on their schedule. The property manager was interested in protecting his business and IMO gave tenants too much benefit of the doubt because of potential renters rights issues.

For all that trouble I broke even on the income and took large hits to my cash flow at every tax bill. But, I had a nice return when I finally sold.
This was supposed to be a hands-off investment but I still had to handle issues.

It is so much easier to invest in stocks. California is a bad place to own rental property.

Money Ronin

I own several properties in California--both apartments and single family homes.  Normally, I'm a big proponent of hanging no to real estate, especially for in-fill locations of California because of proposition 13 which indexes your property tax at your purchase price valuation (more or less).  I also want to avoid capital gains taxes.  However, in your case, I'm a proponent of selling for many of the reasons others have pointed out.

1. You are saving the sale commission--that's huge
2. $500,000 of gain is tax free--that's huge
3. Being an absentee landlord is tough (I've done it and I advise against unless you have a good friend or property manager who can keep an eye on the place).
4. Making a clean break from CA (CA is notorious for continuing to try to collect CA income tax on people who've moved away)
5. Diversification.  I think California is a great place to own real estate but lack any ability to predict the market in the short-term.  Wherever you're going may also have great real estate opportunities.  I would love to own some foreign real estate given the opportunity.