Are you wondering whether to sell or continue renting out your home? I had this same dilemma of sell or rent out my home back in 2016. In the end, I decided to keep my rental property to build more passive income.
Things are strange now with many people buying a home during the coronavirus pandemic. It’s almost kind of nuts how strong demand is due to record-low mortgage rates.
Maybe you’re thinking about selling your home because you think the market is going to crash. Or maybe you want to sell your home to upgrade your lifestyle since we’re all spending more time at home now.
Whatever the case may be, the question to sell or rent out my home is one that many people are wondering right now. Real estate is one of my favorite ways to generate passive income for financial freedom. Once you sell your home, you lose a good income source.
Let me share with you my own situation to sell or rent out my home as it may help you better decide as well.
The Sell Versus Continue Renting Dilemma I Faced
2016 was supposed to be the year where I’d finally achieve my passive income goal of $200,000. The goal was first established in 2012 when my passive income machine was generating about $80,000.
I figured, if I could find a way to generate $200,000 a year by 2015, life would be good and I’d never have to work in the salt mines again. In 2015, I came up $25,000 short. Now it looks like I’m going in reverse! What the hell is going on?!
As fate would have it, just a couple weeks before my business trip to Europe, my tenants gave me their 30-day notice on a rental that is generating $4,000/month.
After all expenses, the property nets around $3,000/month or $36,000 a year. This rental has been a champ with not a single month of vacancy since its 2005 deployment.
Now I’m faced with a decision. Do I try and find new tenants or sell the property in what appears to be a weakening real estate market. Maybe you will face this dilemma one day. Let’s discuss some considerations to make the best decision possible!
Sell Or Rent Out My Home?
The older I get, the more I want to simplify my life. When I was working full-time, I used to love real estate. During my darkest corporate hours, real estate was the main HOPE that would allow me to one day break free. I didn’t care about doing house calls when things broke.
I didn’t mind going to the yearly HOA meetings. Hosting open houses was fun because I could meet all sorts of people who shared fascinating details about their lives. I knew that every action brought me closer to financial freedom.
Since escaping my employer with a severance, however, I have slowly become less interested in landlording. Every text message from a tenant with a problem or every flaker at a open house bums me out.
Due to my severance that is still paying out today, the plan to live off my passive income did not materialize. In fact, since I left work pretty much all my passive income has either been saved or reinvested.
Then starting in 2014, I rented out my old house because I downsized to a fixer in a quieter neighborhood. With two rental properties to manage plus a vacation property, I became even less satisfied with landlording.
Although I have a lot of free time, landlording started feeling like a job, which is completely opposite of why I wanted to retire early! And what bums me out most is tenants agreeing to lease terms and then breaking the lease terms. Why can’t everybody just do what they promise?
Catalyst For Wanting To Sell
The final thing that’s really made me consider selling is the unexpected growth of my online business. I’m having so much fun being an entrepreneur, that I’m finding I don’t really want to bother with real estate anymore. I’ve always preferred having fun and making money on the side rather than making money and eking out some fun.
My layoff strategy guide alone makes around the same amount as my rental property. Further, the book requires no maintenance or ongoing tax on its value. It’s about as passive an income stream there is. I’ve got a pretty fun post in the pipeline which compares real estate and an internet business you won’t want to miss.
But the real reason why I thought about the sell or rent out my home question was because we were having our first child in 2017!
The last thing I wanted to do as a new father was manage tenants and maintenance issues. As a result, I ended up selling our home.
Always Do The Math When Deciding To Sell Or Rent
To determine whether to sell or rent your home, always do the math.
Now that I’ve shared my subjective feelings, I’d like to focus on objective numbers. At the end of the day, an asset’s value is based on the cash flow it can provide.
Not continuing to rent out the property means roughly $36,000 in lost income. Due to depreciation, the taxable income is actually much less. Not all is lost, however, because selling the property would yield proceeds that can be reinvested.
Nobody knows exactly what they will get for their property until they finally get some offers. But you can make educated guesses about a price range you will likely receive by comparing the comps that recently sold based on price/sqft and using cap rates.
Analyze The Comps
My property is 1,000 square feet. Recent comps have sold for $980 – $1,500/sqft in the Pacific Heights neighborhood. Therefore, the range is $980,000 – $1,500,000. Anything above $1,300/sqft is a prime property that has been remodeled.
The only thing that has been remodeled in my condo is a bathroom. Everything else is original since 1980. But, I’ve got an amazing dead on view of the park. Therefore, my educated guess is somewhere around $1,100 – $1,200 / sqft, or $1.1M – $1.2M.
Please don’t get hung up about the price of property here in San Francisco. It’s expensive here. Focus on the methodology.
Use A Realistic Cap Rate
Now turn into an investor and use a capitalization rate (cap rate) to value your property. Take your annual Net Operating Income (gross rents minus property taxes, maintenance, HOAs, etc) and divide it by a cap rate in your region. Think about a cap rate as the required rate of annual return on the property or the rate of return buyers in your area are willing to accept.
For example, if you accept a low cap rate of 2%, you believe the property is in a rock solid area and has a strong chance of appreciating. Therefore, income is a secondary consideration to appreciation. If you accept a high cap rate of 10%, it means there’s probably little chance of strong capital appreciation, so you want higher income now.
In San Francisco, the cap rate is currently around 3.8%. That’s 2% higher than the 10-year bond yield, also known as the risk free rate of return.
If I want to drill down even further, I need to calculate the cap rates in Pacific Heights. If SF’s cap rate is 3.8%, then Pacific Heights’ cap rate must be between 3% – 3.7% in my opinion.
Related: How To Properly Analyze And Evaluate A Rental Property
Find Out Where The Two Values Intersect
To determine whether to sell or rent a home, take your annual Net Operating Income and divide it by your area’s estimated cap rate. In my case, I would take $36,000 / 3% – 3.7% = $973,000 – $1,200,000. I can take the average and get $1,086,500.
Now I compare the cap rate calculation value to the comps and focus on the overlap. The realistic selling price is therefore around $1.1M. Anything more than $1.1M should be considered a win. Anything less requires more deliberation.
Identify The Special Features Of Your Property
Every property has its intangibles that might sway people to bid much higher than the numbers dictate. I place a premium on properties with views.
This property has fantastic park views. I would have happily paid at least $50,000 more for the property when I first stumbled across it for $580,000 back in 2003.
But some people like to face other buildings and would never pay a premium for having their eyeballs massaged after work everyday. You just need to find that one buyer who places a premium on what your property offers to get top dollar.
It’s very easy to get biased about our own properties. Selling this condo is like selling my baby since it was the first property I bought as a 25 year old.
Being delusional about your property’s shortfalls is hazardous when it’s finally time to negotiate a selling price. Remember to treat your assets as a means to an end. My end has always been happiness and freedom.
Future Income On Sale Proceeds
Let’s say this property sells for $1,120,000. After fees and taxes, I’m left with around $1,000,000 since there is no mortgage on the place. What can $1,000,000 generate based on what I want to invest in? Here are some reinvestment ideas after a home sale.
1) 5-year CD at 2%: $20,000 a year. Shortfall to existing income generation: $12,000.
2) California muni bonds at 2.5%: $25,000 a year tax free. Shortfall: $11,000. Don’t think California will default.
3) High Yield Dividend ETF (DVY): $36,000 a year in dividend income. No shortfall, but potentially lots of principal risk.
4) Venture Debt fund with target IRR of 16%: $120,000 a year for a total return of $840,000 over seven years if I assume a more modest 12% IRR. But there’s probably a 30% chance of losing $200,000 at the end of the fund.
5) Automatic investing: I could choose a very conservative risk tolerance and have a robo-advisor automatically invest a lump sum or new funds every month into a 50/50 equities and bond portfolio with a 2.5% yield to generate $25,000 a year in gross income.
6) Diversify into real estate crowdfunding. One of the best ways to make passive income is by investing in publicly traded REITs or less volatile private REITs offered by Fundrise. Fundrise offers a very diversified portfolio of eREITs or eFUNDs so investors can invest in real estate across the nation. It’s free to sign up and explore.
As a father of two kids now, investing in real estate crowdfunding has been a great alternative. I now earn real estate income 100% passively, which is what I want since time is so precious nowadays.
Another great platform if you want to invest in individual commercial real estate deals and are an accredited investor is CrowdStreet. CrowdStreet focuses on individual deals in 18-hour cities, where valuations are lower and cap rates are higher.
The Final Question To Ask Before Selling Or Renting Out Your Home
Deciding on whether to sell or rent out your home is tough.
I believe everybody should own property for as long as possible. The 5% commission rate and the taxes on profit are economic leaks. Given inflation is almost always up and to the right, your property should keep up over the long run. You want to build as much passive income as possible for financial freedom.
But if you just can’t take landlording anymore, don’t want to hire a property manager, and believe the timing is right, then selling is a good solution.
The final question you should ask yourself before selling is, “Will I be kicking myself 20 years from now for selling today?” If you’re over the age of 60 with a pension that provides for all your needs, who cares? Life expectancy is only about 84. You might gain a great deal by simplifying the remaining 24 years of your life.
If you’re still working towards your financial nut, don’t have any other income streams, don’t really like your job, and aren’t willing to start a side business, your property might be one of the few things keeping your hopes alive. It often takes several years of losses before finally breaking even. Be patient enough to let inflation make you whole.
The other thing to think about is what will your children in the future think of your decisions today? In 30 years from now, will they think you were smart or dumb for selling a home today?
If history is any guide, chances are high that in 30 years, our children will be impressed you bought real assets today. If you didn’t buy, then at least you held on.
Latest Passive Income Chart
Below is my latest passive income chart that enables my wife and I to be stay at home parents to our two little ones. We plan to continue building our portfolio so we can remain financially free.
I ultimately decided to keep my SF rental condo. It’s paid off and generates $4,200 a month. The condo faces a park in Pacific Heights and is a great passive income source.
However, in 2017, I did end up selling my SF rental house for 30X annual gross rent ($2,740,000) to simplify life. I didn’t want to deal with tenants who kept throwing parties and breaking things. As a first time father in 2017, I was happy to sell my home.
I reinvested $550,000 of the proceeds in real estate crowdfunding and the rest in stocks and municipal bonds. It feels so much better to passively earn income.
Recommendation
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.
For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Refinance your mortgage: Check out Credible, my favorite mortgage marketplace where prequalified lenders compete for your business. You can get competitive, real quotes in under three minutes for free. Mortgage rates are down to all-time lows! When banks compete, you win.
If you can refinance your mortgage and lower your carrying cost, it makes owning a home that much easier. I refinanced in 2019 to 2.625% for a 7/1 ARM and rented out the home in 2020. In 2020, I decided to take advantage of softness in higher-end property and buy a new home. I got a 7/1 jumbo ARM for under 2.35%.
I read with great interest the decision strategy by Vicki a few minutes ago, and now have curiosity to know what Sam decided to do? Sell or keep the home (property)?
I set up a race between a real estate agent friend of mine trying to sell and me, trying to find a renter.
Check it out! Create A Win-Win Scenario To Never Lose
You have a good nose for real estate. I was wondering what your opinion is on northern Colorado. Seems to be one of the hotter real estate markets. Seems like there is an argument that prices will level out or maybe even retract? Is this wishful thinking? We currently rent, and are waiting for the right time to buy a house. We then may turn it into a rental 3-5 years down the road.
The fed is indicating that they will raise the fed rate 3 times in 2017. What does that mean to the market? Will realestate slow down? Will there be a frenzy before rates really rise? Are the values in Northern Co way overvalued. From what I can tell from my random research. Prices seems to be 10-15% over fair value. However we all know “fair value” doesnt mean squat. It could be 50% over in a year or two if things continue.
Lastly, I found that in the past, real estate doesn’t go down when rates go up…unless its a quick spike. It seems that suppy and demand trump the cost of borrowing money.
Great blog much appreciated.
Hi Arik,
Check out these posts:
Should I buy a home in a rising real estate environment – this one should help you think about things more
Buy real estate as young as you possible can
Prices are softening in coastal cities, and slowing down in places like Denver. I don’t think there is any rush. There’s ALWAYS another great property to be had if you miss one.
In the meantime, I’m investing more surgically in the heartland of America (South, Midwest), where returns are greater, through a real estate crowdsourcing platform called RealtyShares. I just made a $25,000 investment in Austin, Texas this weekend, and plan to do more.
Sam
hey Sam, when you say you have close to $200k passive income, what is the actual net amount?
You have a few properties which have mortgages I assume. You rent out your SF house for $9k/month, that’s about $100k per year.
With all housing related costs (mortgage, insurance, taxes etc…) it’s very different from earning say $10k in dividends which is mostly tax free.
200k no doubt is a very impressive number, just that it’s skewed because of operating costs.
Here’s a post with a snapshot of my latest passive income streams. $108K/year is gross rental income. My net is about $64,000 a year if you include the $24,000 a year in principal I’m paying down through my monthly mortgage payment. I’ve got to do a 2017 update soon.
I just sold my triplex that I bought at 26, circumstances were a little different but I made the call to lock in the win. I’m a realtor in Southern California and I think we’ve definitely got the economic speed wobbles. I’m betting on the next crash being super bad and think that having the cash on hand to take advantage is worth paying the capital gains tax (still feels like the government is mugging me though). That being said, it sucks just sitting on the money for now, but I want it liquid just in case. Also, been reading your stuff for a couple of years now, really love the site! Thanks for all the great ideas and analysis!
FS – Do you worry if something like this passed, it would put downward pressure on both rental pricing as well as purchase pricing in SF?
https://time.com/4388177/san-francisco-tech-tax-ballot/
The downward pressure has already begun! Lower rents are great for people will will have more disposable income to spend and help the economy. More workers would be hired as well, driving back prices. I do feel tech companies have been a boon for landlords, and if they can pay the same or more to help displaced residents find affordable housing, great. I just don’t know whether the money will be used as intended.
What do you think?
Probably on the margin I think it would hurt rental incomes – it probably depends on how many properties they actually build, how big the units are, and what they actual charge tenants for them. Probably would be more “pain” at the low end of the rental market than middle and higher end.
What about Capital Gains taxes due on the sale…How do sale proceeds on a long term investment that are $1,000,000 not get taxed?
Long term capital gains tax rate of 20% or no taxes w/ a 1031 exchange or reduced taxes if one moves in for 2 years for the last 5 years, but is now prorated.
Sam, hold on to the property and get a property manager if dealing with the tenants is too much. in the long term you will be happy with the decision.
That’s a pretty terrible ROI on rental property. I’m not sure I’d invest in rental properties in San Francisco.
I make $25,000/year on a $425k house. I have a few other properties as well. Generally I buy properties in the $125k range and clear about $10,000/year on them. Rent of $1350/mo – fees around $500 (HOA and taxes are just $400/mo and figure $1,000+ in maintenance). On $1.2M, I’d expect to earn upwards of $75k/year.
I guess the decision is really about where you want to live. Because you can do much better in a different area with real estate.
What I have done is link up with a few good professionals and services. Appliance goes out? I know exactly who to call. They schedule with tenant and deal with it. Tenant moving? My realtor knows what to do. My actual effort is minimal, maybe a phone call or two a month – and that’s with 5 properties.
Indeed. Cities like San Francisco, Manhattan, London, Hong Kong, etc have very low cap rates. Instead, people buy property for lifestyle and capital appreciation.
Prices are supposedly up about 68% since 2012. So if you have a $1M property in 2012, that’s a nice $680,000 + the $40,000 – $60,000 in gross rent you are making.
Where do you live and buy and how long have you owned?
I’ve been off/on reading your stuff. I really enjoy your writing. As my business has done so well, I’ve been looking for more financial strategies and ideas.
Anyways, you have seen a better ROI simply based on the property value in San Francisco. But that only works when you sell it. I would expect rents to go up accordingly, and always thought they did, but it’s interesting that it doesn’t seem to be the case when hearing about your experience.
I own property in South Florida. I’ve started acquiring property about 4 years ago as my business boomed. Not knowing the future, I wanted to own free and clear property for financial security. So I bought 3 properties in the $120k range, and that income paid the mortgage on my primary. Then business kept doing so well, I paid off the primary and moved up to a bigger primary. So now I have 4 rentals and a primary.
I’m not sure if it’s the best approach, but it works for me. I know that I have an amazing house, paid off, in a great area/school district (I have 2 young children), and the income from the other 3 rentals is enough where I technically wouldn’t have to work, but would live semi-frugally. It feels nice having that security. I’m only 32 and I have semi-financial security for my family. It eases anxiety and pressure, that’s for sure.
I think the “smart money” might say to sell in San Francisco and buy elsewhere with better returns. But as we both know, it doesn’t work that way. I’m sure you love where you are.
Sounds good to me.
For SF and these other “international cities” is that cap rates have been low e.g. 4% or less for a long, long time. At least since the late 90s when I first seriously started looking.
Being not having to work at age 32 is amazing. Congrats! I should have bought a Manhattan 2/2 condo in 2000. I might have been able to be financially independent by 32 too! The place was around $800,000 and is probably worth around $2.4M today.
Hi,
Long time reader. Thanks for your detailed practical advice and insight.
I ran into this article today that analyzes SF housing prices over the last 30 years and attempts to find factors to predict. I thought you might find it interesting.
https://medium.com/@andersem/a-guy-just-transcribed-30-years-of-for-rent-ads-heres-what-it-taught-us-about-sf-housing-prices-bd61fd0e4ef9
I saw that article. Good to see rent and prices have gone up 6.6% a year on average for 60 years. I’ll take that, b/c my goal is for a 4% net worth increase each year compared to inflation of around 2%.
You can’t build fast enough in SF due to zoning, so holding for the long term is generally a great idea. I’m leaning towards holding on and just leaving my place empty until I find the right tenant. No more need to rush to get 100% occupancy anymore.
I’ve been following the conversation and must jump in here to help solve your dilemma. Since you say the work involved in getting the place ready for another renter was the trigger event, and now you would just as soon leave it empty, I’d offer to condo sit and do the physical labor required just to get to leave yucky Houston and stay in a nice SF condo for FREE. I’m an artist and retired from public ed., which means I’ve been through an FBI clearance if that gives you any assurances I’d be an honest worker/tenant who would cost you zero dollars and leave the condo looking great. I’ve considered a trip to Italy in one of those free rent in exchange for farm labor arrangements but I’m actually more of a city girl. Just thought I’d throw out the idea. Now, I wouldn’t offer this for just any condo. I saw the photo at the beginning of the thread and if that’s the condo I’d fuss over every little detail of that beauty like it were my own and be there to show to prospective renters for at least a month…
I’ve been following the conversation and must jump in here to help solve your dilemma. Since you say the work involved in getting the place ready for another renter was the trigger event, and now you would just as soon leave it empty, I’d offer to condo sit and do the physical labor required just to get to leave yucky Houston and stay in a nice SF condo for FREE. I’m an artist and retired from public ed., which means I’ve been through an FBI clearance if that gives you any assurances I’d be an honest worker/tenant who would cost you zero dollars and leave the condo looking great. I’ve considered a trip to Italy in one of those free rent in exchange for farm labor arrangements but I’m actually more of a city girl. Just thought I’d throw out the idea. Now, I wouldn’t offer this for just any condo. I saw the photo at the beginning of the thread and if that’s the condo I’d fuss over every little detail of that beauty like it were my own and be there to show to prospective renters for at least a month…
I think one problem and asset you have is your financially at the finish line, where most readers are not. You got a lot of dough to maintain your life, but now your biggest problem is not screwing up what u already have.
Your relevant investment thinking and decisions and sharing those creatively is what keeps your fine edge samurai sword sharp and why people read and hopefully you enjoy doing it as much as we enjoy reading.
I think your biggest risk in the sf property is lack of diversification for such a large amount of $.
Your return is fairly low to compensate you for keeping your wealth in one place also sounds like you have another property in same geographic location. I would sell and put my money in pockets where I could not lose in one big swoop. Maybe buy real estate in different locations and that would still be all in real estate if you think that is the safest. New homes have less headaches. If you decide on property management I bet with your skill you could cut a solid deal that would make you more money, and less hassle.
I am sure you checked with your accountant too. I always try to live for 2 years in my home before selling. Yes you still have to pay back the depreciation you took renting, but sometimes still advantageous to move in and sell or sell primary property.
With no crystal ball no clear cut absolutes around for returns, the closest we have is that the feds can’t let housing or the stock market crash because it could be unrepairable. but low interest rates and helicopter money for long term seems to be what is easiest to give.
I’m exploring new reinvestment opportunities if I sell the condo, but will only sell the condo based on a minimum price. Otherwise, the rental market is so strong in SF that I’ll just keep the cash flow forever.
Here’s a new option I just wrote about: https://www.financialsamurai.com/real-estate-crowdsourcing-investing/
I believe we’re going to go in a 2 year existing home sales lull as incomes try and catch up to price increases.
What’s your story?
All I can say is wow.
Freedom is the ability to make these kinds of questions about whether or not to sell SF properties with park views.
You’ve made it!