Are you debating whether to remain a landlord or sell your investment property to simplify life? This post will help you with your decision using my own example.
Back in 2017, I had to decide on whether to remain a landlord or sell. Here was my thought process back then. I’ll then share what I ended up doing.
Remain A Landlord Or Sell
Remember how I was saying in a previous post that I thought there would be a two or three-year slowdown in SF real estate starting in 4Q2015 before its off to the races after Airbnb or Uber IPO? Well, I was wrong!
2016 was a relatively mild year with low single digit returns partly due to an influx of new condo construction saturating the market. However, 2017 has turned out to be very strong with the median single family home price surging to $1.5M, an all-time high!
I’ve been very fortunate to ride this SF real estate bonanza since 2003. But after a recent bad tenant experience, I’m seriously debating if I should remain a landlord or sell.
What I realized after Googling “should I sell my rental property” is that I’ve been thinking about doing just that since 2013. One of my own posts showed up on the front page of search: Should I Sell My Rental Property And Simplify Life?
At the time, I was going through another annoying situation with a condo neighbor. It’s always a trip when your own stuff pops up in search that you forgot you wrote.
As fate would have it, just two weeks after my tenants vacated, I received an offer that might be too good to pass up. It’s never a good idea to make big decisions when emotions are high. Thus, I thought I’d lay the situation out on if I should remain a landlord or sell to gain some objective feedback. Let me first provide some background.
Housing Situation
To determine whether to remain a landlord or sell, let me share with you the details of the house.
* Bought a single family home in an established SF neighborhood for $1.52M in early 2005. Put down $304,000 (20%), which was everything I had at the time.
* Four years left on an $810,000, 5/1 ARM at only 2.375%. It would be a shame to let this rate go after fighting so hard for it.
* Have a written offer for $2.742M (+80% higher than the purchase price). The original offer was $2.6M, but I countered at $2.79M. After a couple back and forths we agreed to $2.742M plus a $10K credit I’d provide at closing.
* The buyer hasn’t released financing contingency yet, but said his bank is set to fund on June 19 or June 20. This gives me an out to cancel the deal before then if I find something better (buyer or renter) given I didn’t give him a financing contingency extension. I accepted his offer after he removed his inspection contingency.
* Was renting the home for $9,000 a month. After one month of searching, I haven’t found the ideal tenant for the price. I really don’t want to rent to 4-5 guys again. Hence, there’s a chance I may have to lower my asking price to find a more headache-free tenant.
* The 100X rule says that I should buy a $9,000/month rental property for $900,000 or less. Or, conversely sell a property once it starts trading for much more than 100X monthly rent. At $9,000/month, the property currently trades at 303X monthly rent (25.25X annual rent). At $8,500/month, the property trades at a 321X monthly rent (26.75X annual rent).
* With my mortgage, it cash flows about $48,000 a year after all expenses. Or roughly $67,200 if you include the principal pay down. If the mortgage is paid off, then the property will cash flow about $7,200/month because the property tax is $21,888 / year and forever rising. I planned to pay off the mortgage within 10 years.
Why I’m Reluctant To Sell
* Commissions. I got the rate down to 4.5% from the traditional 5% – 6%. But that’s still $123,000 in commissions. The longer I wait to sell, the lower commission rates will go.
* Property Transfer Tax = ~$25,000. What a waste of money to enrich our bloated city budget for doing nothing.
* Long term capital gains tax = At least $100,000 even after the $250K/$500K exclusion.
* A property for my child to live in. Once you’ve got your housing expense covered, you can afford to live comfortably in even the most expensive cities. I can’t imagine what rent will cost in SF in 23 years.
* Step up basis. When I die, my child inherits the property at the market value not my purchase price. If he decides to sell the property immediately, he’ll pay zero taxes.
* Proposition 13 means I’ll have an artificially low property tax rate the higher the market goes.
* Capital appreciation. I believe San Francisco is one of the cheapest international cities in the world. Uber, Airbnb, Pinterest, Dropbox will all go public in the next 3-5 years, unleashing billions of liquidity into the SF Bay Area ecosystem. I’m surprised Pinterest was able to recently raise $150 million at a $12 billion valuation. I thought the company was going backwards.
* I’ve got demand at $9,000/month from 4-5 guys and $10,500 if I dare rent to six guys.
Why I’m OK Selling My Investment Property
* My original plan of living off my passive and semi-passive income streams in retirement is no longer necessary because I found a way to make a livable online income stream. If I didn’t have an online income stream, I would never sell. Related: Ranking The Best Passive Income Streams
* I was willing to sell the property in 2012 for $1.7M, but no buyers were to be found. When I bought my current house in 2014, I was willing to sell my old house for $2.2M but I decided to take some extra risk and hold on. Before I got my offer for $2.742M, I told myself I would strongly consider selling for $2.6M.
* I’ll still be long a single family home and a condo in SF after I sell.
* I’ll be following my Debt Optimization Framework. When you’re done with the working world, it’s a good idea to minimize debt to minimize the risk of having to go back to work.
* If there is a tech correction / recession, it’ll be nice sitting on a lot of cash.
* I’ve got a bird in the hand. It may never return if I let go.
* Supposedly I can 1031 exchange any profits over the $250K/$500K exclusion, meaning that I can pay zero taxes. I’ll have to double check, but so far all my research says this is true. Please let me know if you think otherwise.
* The $250K/$500K tax-free profit exclusion will go away next year.
* I won’t have to eventually spend $10K – $15K replacing the roof, $10K changing some windows, $8K painting the back of the house, $8K on a new furnace, and $15K for staging if I were to list my home on the MLS.
Know Where The Proceeds Are Going
* I know exactly how I’ll reinvest the proceeds. Each investment should earn more than the current ~2.2% net rental yield (cap rate).
- $300,000 will go into Fundrise. If I can earn a 10% IRR over the next 5 years, then I’ll 100% match the rental income lost from the sale with much less capital required. My earlier investments have started to pay dividends, which I’ll write about in my 2Q2017 investment update.
- $300,000 will be invested in various national REITs for higher income.
- $500,000 will be invested in various tax-free California municipal bonds.
- $100,000 will be used to pay down my 4.25% vacation property mortgage. I should pay down more, but I just hate feeding a mistake.
- $100,000 will be invested in various equity structured notes with downside protection.
- $50,000 will be used to speculate in individual equity names.
- $300,000 will just sit in the bank as I patiently wait for a stock market or real estate market correction that may never come.
- $150,000 will be earmarked for long-term capital gains tax if I don’t do a 1031 exchange.
Related: What Every Home Seller Should Do Before Listing A House
Would You Remain A Landlord Or Sell?
Now that I’ve providing you all the pros and cons of keeping the investment property or selling, I’d love to hear your thoughts. Would you remain a landlord or sell?
When I bought the house in 2005 for $1.52M, I felt strongly the house could easily be worth $2M in a short period of time. As a result, I invested everything I had and lived very frugally for years after.
If you want to experience financial fear, get a $1.2M mortgage at the age of 28 on top of a $460K mortgage you already took out two years prior for a condo with nothing left in savings! It takes iron balls to take this type of risk. Ah, to be young, stupid, and full of courage again.
Unfortunately, the financial crisis hit several years later, delaying my beliefs and giving me all sorts of ulcers. There was definitely a point between 2008-2010 when I thought I’d have to start all over again. It was a very humbling time period, but I kept the faith, partly thanks to this site and many of you.
Almost Lost A Lot Of Money
When you sidestep a bomb in 2008 – 2010 and then dodge a bullet in 2012 after not being able to find a buyer, you begin to wonder when will your luck run out.
I took a similarly sized risk in 2014 by buying my current single family home with close to a $1M mortgage while already having a $900K mortgage on the home I’m considering selling today.
When you don’t have a steady paycheck, this is a risky move! But due to this decision, I’ve experienced double appreciation with leverage.
They say you can never lose if you lock in a gain. At the same time, I feel strongly San Francisco home prices will be much higher 10 – 20 years from now. What would you do?
Gut it out as a landlord, hire a property manager despite the already low yield, do a 1031 exchange, or sell and reinvest the proceeds in various higher yielding, lower maintenance assets?
I feel I’ve reached a clearing price where I’m somewhat ambivalent with either outcome. But I know I’m missing something since it’s hard to be completely emotionally detached from a home I spent 10 years of my life in. Heck, Financial Samurai was born in this house!
What I Ended Up Doing
I ended up selling my SF rental house for $2,740,000 and reinvesting all the proceeds in 100% passive investments. For the first year, I felt some regret. I felt like a failure for letting the property go because I had owned it for almost 13 years.
However, today, I am so much happier not having to maintain this house now that I’m a father. Truly, managing rental properties is a young person’s game!
And if you are under 40, you probably should buy rental properties. The value of rental income has gone way up because interest rates have come way down. It takes a lot more capital to generate the same amount of risk-adjusted income.
For me, I will continue to keep my three rental properties and one vacation property. Before we move to Hawaii, I will probably sell one or two to simplify life.
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Why is a source of stress bad? It keeps you mentally active and thinking.
Please do not sell.
Learn and grow from keeping it.
Try to remember when you were younger, with more energy and vigor. You did put everything you had in mortgage. Why chicken out now?
Sooner or later, 10-20-30-40 years from now, you’d be rewarded for this so-called-stress.
My 2 cents.
Thanks for sharing your opinion. How many rental properties do you have and how did you deal with the stress? Thanks
We have 6 rentals. We have found that once we set up processes to follow, stress was considerably reduced. We know exactly what to do and when. No thinking or re-thinking. Just follow the process. We screen tenants well and make sure to get previous landlord references – very important. With new tenants, we visit the property a few months after they move in. You will usually know by then if you have a problem tenant. We have at least one visit a year after that. We do smoke detector and water leak checks (safety and maintenance) – gets us into every room. We also take care of any minor maintenance issues then. If there is any significant tenant caused damage, we deduct from security deposit for repair costs with 30 days to replenish. Of course, all of this depends on your lease and your state’s landlord tenant law. We also incorporate uniform standards and guidelines for housekeeping similar to that used by the state housing authority. We don’t usually need to do inspections and corrections, but it’s all there and the process is explained if needed. The tenants are well aware of our expectations. Train you tenants from the start, or they will train you.
I follow Jom Rickards and Josh Crumb for their gold analysis. Have you considered converting some of your dollars to physical gold to protect your purchasing power?
Your initial purchase price of $1.52m would have been worth approx. 3551 oz. of gold in March of 2005 ($428/oz. as of March 31 2005). That same amount of gold would be worth $4.44m today ($1250/oz.).
You’ve used you’re financial leverage to acquire an appreciating asset and now would be a good time to store some of that fiat currency to sound money, gold. House price has virtually not changed much since the 80s if you paid in gold. As long as the central bank continues to increase the money supply, the dollars purchasing power will decline and the price of gold will increase over the long term.
Love the analysis Sam, both sides have their pros and cons but I’d like to factor in your point about SF being a cheap place to live internationally.
The Median Family Income is $77k in SF, but to make the analysis look more palatable let’s round it up to the Average Household Income to $105k. That puts the median price divided by the mean price (overly generous) at a staggering 14.3 — not cheap, by any stretch of the imagination, anywhere.
Moreover, the argument that prices should be going up due to a “housing shortage” doesn’t seem to hold water. Sure if there are a shortage of homes and people can afford them then yes, housing should go up. But there is currently a shortage because there isn’t enough low to middle income housing, these people could never afford to buy your home in multiple lifetimes… but somehow their desire to own a home drives up the high end property market? To quote Shakespeare “Something is rotten in the state of Denmark.”
Given how the market outlook with inflation (there wouldn’t be any if it weren’t for energy and housing prices), interest rates going up and the lack of a major cash influx outside of Uber and Airbnb (and who knows when they will ever go public, and seriously who else is getting an influx of cash? In today’s marketplace only companies who can be total monopolies get major funding — where is the anti-trust law enforcement when you actually need them), it’s just hard to justify not selling (what I believe to be) at or near the peak.
Hi Ryan, thanks for sharing her thoughts. It’s true, valuations in San Francisco and other coastal city markets are much more expensive. The same goes for growth stocks versus dividend paying stocks. You pay up for capital appreciation which may continue or it may reverse itself. That is the camo one takes one being a higher price: Growth.
You’ll enjoy my next post on this topic.
I think it boils down to cash flow/ liquidity requirements vs holding an asset/ other opportunities
1. Cash: Do you need the cash? Why do you need the cash?
2. IRR: Can you generate better yields than what you have now.
I know very generic views. But I’d also say count your blessings, many people would love to have your difficult decision.
1) Don’t need the cash now. But in 2-4 years when I move back to Hawaii, I would like to have the cash to buy a nice home there. It’s easier to sell on the way up, than on the way down where vultures come out w/ lowball offers.
2) Yes. At a ~2.4% net yield, the hurdle rate is low. Hard to say what property prices will do after the Airbnb and Uber IPO in the next couple of years (probably up). But I don’t see prices rising by more than 4-5% a year.
I’m definitely counting my blessings often. Especially the one where I didn’t sell in 2012!
I agree with a previous comment….keep this asset in your family (hopefully in perpetuity). I lived in Asia also and my time there made an impact on my view of housing. I live in Vancouver and there appears many parallels between the SF and YVR housing markets…the least being rapid price increases over last 5 years. Sadly our median incomes are not as beefy as our SF friends. We own a detached home in Vancouver suburb and then part owner in farmland outside the city. We purchased a duplex a couple years ago, 5 minutes from our downtown core in a gentrifying area with the explicit purpose of securing future housing for our young girls. There are definitely better investments out there, but we are future use-buying. Vancouver is locked in by the ocean and the mountains…nowhere to build. The girls may or may not live there in the future (and we may or may not provide housing for them…based on their work ethic and attitude), but it will be there for them when or if the time comes. Added benefit….this is insurance they are not living with me forever! Good luck with your decision.
What happens to SF property if a natural disaster like an Earthquake occur? It happened in Christchurch New Zealand several years ago, people can’t sell for half of what they paid previously. Businesses have still not recovered and young people left in droves, rental is dirt cheap now. Property is never a guarantee of rising prices! If you’re ok with that risk and you didn’t overpay initially by all means hold it but nobody knows what can happen 30-50 years down the track.
Is it really that tough in Christchurch? If you have an article about this situation, I’d love to read it.
Yes, SF is near a fault line. And yes, there was a big earthquake in 1989, almost 30 years ago. I spoke to my neighbors (70+) who owned and were present during the quake. They said nothing happened to their buildings, just a little rattling.
There were areas in the Marina that didn’t do well, but they’ve ALL been retrofitted since as required by the law.
You have done a great job with the money side of the equation-it seems pretty balanced and either way is not terrible. Have you considered the time implications? If you don’t have to do the upkeep/manage tenants, what will you do with your extra time? A big part of FIRE for me is having the time to do things I enjoy (enjoy even more than work, which I never hated…but still). I personally would sell if it is the least enjoyable of your income-producing assets.
Hi Sam,
I am actually having the same problem with a house I own. My solution is if I have to ask if I should sell I am not ready. So don’t sell!!! You will regret it big time!
I can feel the anxiety in your writing. :)
Best from LA
Gary
Interesting analysis!
But I like to weigh the pros and cons for everything, even the much smaller decisions.
(1) The capital gains exclusion is only available to your primary residence, not to rental properties.
(2) The 1031 exchange requires finding another qualifying property within 180 days.
(3) Query whether the transfer tax apply if you conveyed the property to a SPV and conveyed your interest in the SPV, rather than the underlying property.
I have additional thoughts if they are of interest.
Thanks for the interesting post. I voted sell. If you don’t need the income, which you confirmed based on online income, then the issues of being a multiple units landlord combined with the attractive offer that meets your terms seem to tilt to sell. the god news is if the deal doesn’t pan out, you are still in a good position cash flow wise (by lowering the rent), so this isn’t a fire sale.
Talk to your wife. She knows you better than we, and as the the closest people usually see us more accurately than we see ourselves she probably has many insights. This is based on the appearance that you are past worrying about money for survival and are currently trying to optimise for happiness.
She notices that the only time I’m stressed is when I have a property issue to deal with. I am seldom ever stressed anymore. So she is tilting me towards selling to have a happier life. Because you know how the saying goes:
Happy husband, household nirvana awaits.
I just made that up.
Hey Sam! I’m a long time reader, but first time commenter. Thanks for putting together this great blog!
I voted to sell the property, but after thinking it over for a while I have a follow up question. Do you plan on buying a third property in SF again if you sell? If so and you sell, you’ll have to make the difficult decision of timing the market bottom as well. You are going through the painstaking decision of trying to top the market right now and it’ll be just as hard in a few years to buy the dip at the right time. If you are confident that the SF property market will be higher in 20 years, just stay long your great property because making two timing decisions is unlikely to put you in a better place.
I only plan to buy another property in SF IF I feel there is a smoking good deal like I felt in the Golden Gate Heights neighborhood in early 2014. Now prices are up literally 30% – 35% in 3 years and I’m getting outbid (I bid on two properties this year). So I’ve got to find my new GGH neighborhood.
To sell, and then buy within a short period of time isn’t very efficient due to transaction costs.
So if I sell, I’d use the proceeds to buy a home in Honolulu, where I ultimately want to end up raising my child and taking care of my parents.
Hi Sam!
I think the choice is also defined by alternatives. So if you sell, where will you put the proceeds?
I made the choice recently to sell my flat to take advantage of capital gains tax exemption. My choice was also affected by experiencing a slowdown of growth in the equity in the flat.
I decided to move the equity to stocks because:
– Buy/Hold/Sell costs: The costs to acquire, maintain and sell stocks is much lower than property.
– Leverage: can be much more easily and cheaply added/removed via margin/options/futures
– Liquid: If you require funds, you can quickly sell part of your portfolio. With a property you either sell the entire property, or attempt to renegotiate the loan. Again, costly and slow.
– Tax advantage: I live in a country (UK) that provides a yearly capital gains tax exemption. You can take advantage of this with stocks, but the allowance would be too small for a property.
Sorry my post is so long. It is the right answer to consider before selling anything significant.
But here is your answer from my post:
* I know exactly how I’ll reinvest the proceeds. Each investment should earn more than the current ~2.2% net rental yield (cap rate).
* $300,000 will go into RealtyShares, making my total investment $560,000. If I can earn a 10% IRR over the next 5 years, then I’ll 100% match the rental income lost from the sale with much less capital required. My earlier investments have started to pay dividends, which I’ll write about in my 2Q2017 investment update.
* $300,000 will be invested in various national REITs for higher income.
* $500,000 will be invested in various tax-free California municipal bonds.
* $100,000 will be used to pay down my 4.25% vacation property mortgage. I should pay down more, but I just hate feeding a mistake.
* $100,000 will be invested in various equity structured notes with downside protection. $50,000 will be used to speculate in individual equity names.
* $300,000 will just sit in the bank as I patiently wait for a stock market or real estate market correction that may never come.
* $150,000 will be earmarked for long-term capital gains tax if I don’t do a 1031 exchange.
Cheers
Interesting decision.
I think the first consideration needs to be your current return on equity. If the return on existing equity is poor, that is a good indicator that selling now would be a good move. I like your allocation of fu da in the event of a sale, and I’d like to agree that in 1-3 years you can re enter the real estate market with another good buy. I’d also suggest investing in first deeds of trusts if you do sell. There are some great lending opportunities in real estate just beyond banks conventional underwriting. Typical yields are 6-8.5, safe LTV, responsible borrowers and very good asset qualit
However…you are fortunate to own a good asset in one of the most desirable areas in the US and one of the most expensive markets to enter into. I don’t see value dropping off considerably…building new supply is very difficult. My vote was to hire a manager.
Management is a $50-$100/hour job. There are numerous professional, competent managers in the sf market. Hire one, manage them and let your tenant continue to pay down your mortgage at the ridiculously low rate. You’ll getyour time back….I’ve done this with a group of properties in the north bay and don’t regret hiring management for a second.
Good luck. Nick
I hear you on the property manager. I found one for a fixed cost of only $125/month. That’s damn good value on $8,500 or more/ month in rent. I’m really leaning towards canceling the deal and going that way.
There’s an old adage about “you get what you pay for”.
$125/month seems way too cheap. They likely cannot provide you sufficient service at that rate, and something will suffer….mostly likely they won’t re responsive when it’s needed. Even at 5% that’s $425/month. You no longer will need to manage venders, and the general unease that comes when you start to enjoy your Friday evening before it’s interrupted by an “emergency”. In my opinion, the cost far out ways the peace of mind and getting my time back. I find I am way more present at home with my kids and family than when I was managing this stuff myself.
That is a good saying. Yes, the leasing agent/property manager isn’t very responsive on text. $125/month sounds too good to be true. But maybe I can get their “premium service” for $225/month! lol
They will probably run interference at least
Deferred sales trust?
Sam,
You would be silly to sell that property in SF….I agree that prices are only going to continue going up. Keep the property and rent it out again. Just because your last experience with renters was crummy does not mean your next renters won’t be awesome. Put your big boy pants on, stop crying about your first world problem and get that place rented…! BTW, Love the website…
One other consideration. If you can find a significantly better tenant that is likely to create far fewer headaches – e.g., a young family – and it only costs you $500/mo in lost rent, isn’t that worth the peace of mind?
My uncle just passed away and I think his life serves as a lesson to sam. He owned 2 buildings in Manhattan and sold them for 1 million in the mid 90s. 1 million was an astronomical amount of money back then. 5 years later it traded for 5m, 20 ywars later they are worth 20 million. He bought a condo and some stocks and his estate is wort about 1 to 2million now. Ask any old real estate professional, and they all say the same thing, they have regretted every sale they made in the past. Sam, don’t sell, and your kids’ kids will thank you. I’m sure his kids would love the extra 20 million now!
That’s amazing. Is it possible though that he earned only has 0% to 100% return on his condo and stocks over the next 20+ years? The stock market is up a lot since then. But I do believe his buildings in NYC are worth a fortune now!
“Ask any old real estate professional, and they all say the same thing, they have regretted every sale they made in the past.”
My mom’s house sold $160k in the 1960’s, now worth $7m. Around a 7.5% IRR excluding leverage.
Now my dominant money script is that I CAN’T sell real estate. When my wife gets mad at me, she says “I’m going to sell all your real estate when you die!” :)
Omg, hilarious!!! Funny thing is, our wives will likely outlive us Since women live longer than men!
depends on where you live. my neighbor bought his home in the Chicago suburbs in 1999 for 1,050,000. Today he is entertaining offers in the 750k-800k range.
What happened? I thought the Chicago economy was pretty strong? Was 1999 a particularly frothy year where he bought at a peak?
I remember the stock market, specifically Internet stocks were trading like crazy in 1999, but not so much real estate.
Interesting. I did not know the $250K/$500K capital gains exclusion was going away next year. I can’t find anything that says this is true. Do you have a source?
I looked into doing a 1031 exchange when I was renting properties. I never did one, but I do remember there are very specific steps that have to be followed. I think one of those was that the new property has to be identified before the sale of the property is final. If I recall, multiple properties could be identified as potential new properties, so you aren’t locked into a specific, but you have to have some idea of a property you will be rolling your investment into. So if you decide to go this route, be sure to check this out thoroughly.
It’s not for everybody, it’s just for me because you have to live in your house for two out of the past five years. Next year I will have only lived in the house for one year out of the past five years. So I can just go back and live in the house today.
Check with your tax guy. I think it is progressive now. You might be able to take only 3/5 of the exclusion.
1031 has to be a similar (rental) property of equal or higher value and costs $5k for the escrow. Could totally do that but then you are stuck with another rental, commissions, and all you did was ding yourself again.
The 3/5 years rule applies to the 250-500k protection.
Of course neither of these protect you from the nefarious 4.5% which is much worse.
Sounds like the tenants are your worst problem which is fixable. BUT given that you have several properties I’d for sure pivot to considering a potential contraction in the market. I think this cycle is mature.
Housing affordability ratio is at the same level as 2008 when the bubble burst and we’ve been bumping along there miraculously for 3 years. Everyone along with you thought 2016 was it but it is STILL growing probably due to Trump exuberance. If we get new money minted with a bunch of IPOs MAYBE that allows this to continue, but I’m pretty concerned about the downside.
For shizzle if I were you I’d cash out and hedge. Seems like 61% of ppl agree!
I only have one property so I’m all in or all out, and I’m about to try to get all out.
Actually, 78% of the people agree! You forgot to add the percentage of people who agree to sell and do a 1031 exchange.
If you only own one property and live in it, I wouldn’t so. You’ve got a live somewhere, and even if the market goes down 20%, your life doesn’t change because your payments are the same. It’s all man when you feel your job is at risk or your income is at risk when you should consider liquefying.
Since only about 500 or so properties trade at any given time in San Francisco, thousands of new multi millionaires will really make a difference in the property market in my opinion.
I currently have a contract on two properties (8 units) for $450k – not in SF, obviously. Gross rents are $8,200/mo. Goes without saying that expenses are substantially higher to operate than a single family but it should still have a cap rate around 10-11%, including management fees. Everyone has their own idea of “normal” from the unique real estate market in which they exist so it’s crazy to me to consider holding on to an asset earning 2.2%, even worse that someone would buy it. That being said, single family and 2-3 unit buildings in wealthy urban areas are often terrible from a cash-flow perspective because the typical buyer is an occupant and doesn’t care about ROI. The only reason to hold the property is if you can bull doze it some day soon and build more units or other more intensive use. Otherwise, almost every investment that could be made will have a better return; seeing real estate prices rise and depositing that rent check does FEEL more satisfying but the most boring option is typically the best. I’m not familiar with your site/writing and stumbled on this article but you seem like a circumspect and rational fellow. Your solicitation reminds me of a quote I have above my desk: “Advice is what we ask for when we already know the answer but wish we didn’t.”
Merrill Lynch (I’m not a Merrill shill – trust me) has an interesting product – a loan management account (LMA). The LMA is an overlay on an account that will allow you to leave the underlying investments alone while being able to use a line of credit against the assets. Could be any assets from cash to securities to a note, etc. Could be worth considering as a place to park your proceeds to earn something while still giving you the flexibility and access to cash if some other deal arises. It’s a good product for real estate investors who want to be diversified without committing to permanently sideline funds that could have been used to seize a buying opportunity. I’m sure other brokerages have similar products but ML is the only one I am familiar with personally.
I understand your dilemma.
I think it makes sense to sell.
But (and that’s a big butted but!) you obviously don’t need either the income, nor gains.
Exchanging an appreciating asset for a cash flowing one has tax implications at your income level. I don’t know that it’s worth it. Especially if you don’t plan on retiring.
In 30 years we both know prices will be 10x higher. Your future kids will be priced out unless you help them. (Nothing wrong with that).
I would encourage you to hire a property manager and keep it.
I’m not sure of the property will be worth $27.5 million in 30 years. But if you really believe that is true, then I should deathly not sell!
How much was it worth 30 years ago?
Do you think the person who sold it ever thought it would be worth this much today?
Great question. I only see a 1996 sales price for $600,000. So that’s a 355% appreciation after 21 years. Not bad! But not 10X higher after 30 years… maybe 5X higher.
But DAMN! 5X higher than $2,732,500 = $13,662,500 if the pace continues. I don’t think the pace will, but maybe.
After doing this quick exercise (thanks for suggesting it), I have no doubts the house will be a $5M house in 20 years time = 83% gain = 3.5% a year increase on average. Doable, but takes maintenance and taxes.
I had a discussion with the Chief Economist of a major tech company several months ago.
She thinks housing in major cities in the US will eventually become similar to housing in major cities in Asia – unaffordable, and this will cause it to become a multi-generational asset.
I would assume this is more likely to happen in areas like SF and Manhattan which face geographical constraints against growth.
While it’s likely to be extremely volatile, I think 5-6% average annual growth rate over 20 years is quite possible for SF real estate.
As a landlord of rental properties in the midwest, and a SoCal resident, I can’t imagine trading in my California property for a minority interest in someone else’s deal in the midwest.
I wouldn’t either in that situation!!
Definitely not an easy decision. Some of the numbers make sense to sell, and the fundamentals behind your other ideas make sense too. Never easy to sell something your attached to emotionally, and the idea of using it to help out your kids makes it even tougher to pull the trigger.
I think you could probably find good tenants again decreasing some of the headache. But if you can take the money and re-invest it into better opportunities you are doing yourself a disservice if you don’t.
Really looking forward to the decision you make Sam. Thanks for sharing this with everyone.
Your son will most likely will want to do his own thing when he’s older and may not even be interested in the house.
What do your folks and wife think? Make sure the decision is beneficial to your family.
This is a diversification question, imo.
My personal rule of thumb is no more than 10% in any real estate deal and only 1/3rd of NW in real estate (excluding primary residence and privately-held businesses).
If I had $30-50m+ net worth, I would keep it. If I had less, I would sell it and scatter the proceeds amongst 10-20 syndicate real estate deals earning 8-15% or so in different areas.
Also, I don’t believe in owning real estate and managing it personally. I feel that the time is unproductive and better handled by a manager, even at 8-10% of gross rent. If a deal doesn’t cash flow properly after paying the manager, I won’t do it.
If it was me, I would sell simply because I’m highly allergic to tenants. Especially since I’ve seen pics of the property. That place is way too nice to risk tenants destroying it.
But I voted other. I think you should remove your kid’s future from the list because that’s way too far in to the future and focus on your own.
I think what you should really consider is that rental income, although a pain, is cold hard cash. From what I read in the post and comments, it seems that the market is at or almost at the tipping point. (There’s a lot of financial terminology that’s way over my head :) ) So if the market tanks, will your investments survive? Will you be able to continue your FIRE lifestyle without this rental income?
If so, sell, take the tax breaks and simplify life. If not, keep it and gut it out with tenants. After all, having a steady income during a financial crisis will help you sleep at night.
A wise man once told me how paying off a house equals peace of mind. If I’m not mistaken, I remember writing it on an index card back in September 2016.
Involuntary renting equals lack of peace of mind.
Sam, I would sell the property. This month I sold a similar property on a much smaller scale in Chicagoland that I had purchased in 2014 for 275k.
I put 66k in the property for downpayment + repairs(it was financed on a 15 year fixed) and sold on June 7th for 363k. The property was purchased solely for investment and was rented for the past 3 years to the same guy and his son who were there for the school district. I ended up clearing 180k on the settlement and am in the process of doing a 1031 exchange. I will be purchasing more rental property in Texas but this time with a property manager.
The house that I sold will be torn down. It’s in a wealthy suburb where all the 1960s houses are being torn down and the new homes built are selling for 1.2 to 1.5 million. I have no regrets on selling because I believe Texas at its current valuation with a property manager in place will yield 6 to 6.3 percent non leveraged. And with leverage it goes to 9 to 10 percent when you factor in principal paydown. I am not as debt averse as others on this site but I do appreciate how getting out of 800k of debt feels great.
I think the reason to sell is because of the poor yield on your potential 2.74 million and if you were to lose your property tax exemption for whatever reason you return would be that much worse. If you decide to hold you are betting on appreciation. The problem with that is you will never see the appreciation unless you sell it. It’s kind of a funny paradox. And in terms of the 1031 exchange I am using Assett Preservation which seems to be run well and isn’t too pricey as a qualified intermediary. Realize you should have it set up prior to close for everything to work which sounds like it could be next week.
It’s a good problem to have.
Congrats on your sale!
May I ask how you cleared $180K on the property if you bought it for $275,000 and sold it for $363,000? That difference is $88,000 before fees and transfer tax. Are you talking about the three years of rental income + original downpayment + the profits?
Hi Sam,
To answer your question, essentially yes. The property was on a 15yr fixed mortgage which meant there was a whole lot of principal paydown but no cash flow on a month to month basis (the rent payment was 30 dollars less than the taxes/insurance/mortgage). It was like a zero coupon bond. When I sold the place, the mortgage had been paid down from at the start 226k down to 172k over 3 years. So 363-172 is 191k. But 10k went to tax proration and other closing costs. I didn’t pay any real estate commission as I used a flat fee realtor no service but get your listing on the MLS Realtor. That cost me $600.
Look into what duplex properties are selling for in your area. I can’t imagine any less than $4,000,000. Senate Bill 1069 that passed earlier this year was an absolute gift to single family landlords in high cost of living areas. You can currently divide your existing single family home into two units, up to a 50/50 split. I would absolutely add that 700 square feet, and distribute the square footage in a way that is going to maximize your rental return. Your problem right now is that you have a bunch of bedrooms to be filled and limited prospects that need to rent a single family home of that size. By splitting the property in half, you are going to vastly increase the rent per square foot, and open up your new smaller units to a much larger pool of renters (like established families, couples, etc.) Instead of one $9,000 a month rental you could end up with two $7,500 per month rentals. You are going to see a massive increase in value as well, because smaller units are valued at a higher ppsf than larger single family homes in the same location. One day your child can live in one unit and rent the other, a very responsible outcome. This second unit is known as an accessory dwelling unit, and the state law supersedes any local zoning restrictions. You do not have to add any off street parking if the property is within a half mile of mass transit (virtually all of SF), and the city has to issue a ministerial permit for its construction, meaning no special commission or committee reviews. The city also cannot charge special utility hookup fees and you can run the entire property off of one gas/electric/water meter which saves a fortune on remodel costs. Renters will pay a premium to live in these units because they are located in less dense more desirable single family zoned neighborhood.
Don’t let a buyer come in and arbitrage this opportunity from you. At a minimum you should look into 1031 this property into multiple single family homes in SF that are good candidates for conversion into ADU duplexes. Once the City catches on they will amend their municipal code to place more restrictions on the current State law. There is maybe a 6 month opportunity to obtain permits to convert these properties before the new restrictions kick in. The beach communities in my area of Socal are exploding with ADU contruction right now, the attraction of creating legal rentals that can be rented short term is too good to pass up.
303x monthly rent = I’d sell and laugh all the way to the bank (before you reinvest passively).
I remember when 70x monthly rent was a general rule of thumb, followed by 100x and 120x and then I lost track. SF is obviously one of two extreme outliers in North America, but I don’t see the current appreciation rate as sustainable.
Sam,
You had a good run on the property and made a good profit, sell! Remember the rules “Buy low, sell high”?! Don’t be greedy – bulls and bears make money, Pigs get slaughtered!
I believe Property Booms and Busts occur every 7-10 years. The Bust should be
coming, you’re still young(what 40’s?) and if you still have the itch, atleast you’ll
have the dough ready for it.
Regarding the cycles… yes 7-10 years, so we have 2-5 years left in the boom. Hmmm. I’m 40 this year. I no longer have the itch.
Even when I started this site in 2009, I wrote in my About page that I was no longer motivated to make a lot more money. I just wanted to be absolutely free.
I think I should sell. 78% of the voters say sell!
Since when does Sam shy away from a little hard work. And by hard work I mean just a few calls a year max from a property manager.
You say yourself san fran is a cheap city compared globally. You are going to kick yourself for selling for peanuts today. I promise!!
I hope you don’t sell. But if you do… I look forward to seeing your regret post in 10 years.
;)
Definitely. Who doesn’t love a good schadenfreude. Taking Joy in the misery and suffering of others is a national past time! :)
Tell me about yourself and your rental property situation. How long have you owned and how has your yield and tenant situation been? Where are you looking to buy more?
If time is money and you want hassle free $, sell and invest proceeds as per your plan. If you are happy being a landlord and think you have a great asset, god bless you! if you want more creative change, here’s another idea, you take a longer haul on properties. How about you sell (great! Cash is king), but find other properties to buy (section 1031), at least you defer the tax piece. Looks like a massive house is complicated to rent, buy 2-3 condos (1 or 2 bedrooms?) that you can rent to couples.
No need to handle 4-5 guys and couple stay longer. Have had great tenants for past 10 years (got lucky though!).
In any case, great problem to have in life. Well done!
I’d love to have a great tenant who stays for 10 years in a row. That would be a dream come true! I can only get that if I get a family. 4-5 guys is impossible sadly. The most they’ll stay is perhaps 2 years, and then I got to do this whole thing over again.
I suggest going with your gut :-)
You are already a landlord because you rent out your condos, but my impression is that doesn’t seem to bother you for those properties. Could you keep one of the condos for your child/ren?
I myself wouldn’t want to be a landlord unless I was making a good income stream…but there is still the unknown aspect of what type of tenants you will end up with. No matter what, renters do not take as good of care of a property as an owner.
In Seattle, it’s becoming increasingly difficult to be a landlord because of the new rules and regulations about first-come-first serve, capping rental deposits, payment plans for deposits, etc. etc. It’s becoming very high risk for the landlord in general and I’m not sure if thats the same thing in SF. There’s a new coalition within the City specifically for tenants rights and already as it is tenants have more rights than landlords. It just opens up a huge pile of risk on the landlord.
Thanks for your delightful posts!
Haha, nice play on my title. Condo landlording is easy b/c my condo is only a 2/2. It’s attractive to a huge pool of people. And frankly, having a 2/2 condo in Pac Heights should be good enough for anybody for the first 10 years post college. Hence, one of the reasons why I’m OK letting go of this harder to manage rental house.
Landlord rules are very stringent here in SF as well. I really, really try to vet carefully and build a good relationship to save myself future hassle.
Thanks for sharing your thoughts!
Sam you should sell. My belief, from being a big elon musk and ray kurzweil fan, is that there’s a reasonable chance that real estate prices might flatten in the next 10-15 years. Especially on the higher end. Because of the rise in the 5th mode of transportation (hyperloop) and because of automated vehicles making commutes a moot issue. The biggest factor that makes some of these HCOL areas expensive is because of the jobs. But again, if the commute because a non-factor, then house prices, especially in the hottest areas, will come down. I am pretty sure of this. Might not happen tomorrow. But will happen within the next 10-15 years for sure. Something to chew on.
Tim, this is an excellent observation that I don’t think is getting enough attention – how tech disruption (especially transportation) will affect the long-term growth and feasibility of owning real estate as an investment.
I personally own a 4-unit apartment building in DC that cashflows nicely (~$8k / mo against ~$4k / mo expenses), but have contemplated when / if I should exit because of the potential disruption in our pretty near future (my opinion in 5-10 years), and dump the profit into non-long term real estate investments.
Not only would this make the property itself worth less, but also there will be less appeal to living in the city and therefore depress rents too.
Sam (and Tim), it would be great to get a discussion and maybe a post around this topic!
Transportation disruption is actually definitely one of the reasons why I bought on the western side of San Francisco. It used to cost $28 to take a taxi downtown. No it can cost as little as four dollars with UberPool.
As a result, locations further away from downtown have seen a massive uptick in demand.
See: https://www.financialsamurai.com/how-to-get-rich-practice-predicting-the-future/
And the other posts linked in that post.
My current house in Golden Gate Heights is in the Red hot center zone for demand right now where prices are appreciating the fastest.
I would sell it and bank it. 100% freedom and 0% stress. My pal refuses to sell for $1mm a home he bought for $500,000 only 4 yrs ago. The main reason was he would miss the neighborhood community, shops, restaurants, kids’ schools, amenities in his great location, and be forced to downgrade to a more rural location.
You don’t control the government who could write policy, the builders who build new condo buildings. Do you think they will turn in ur favor or not in the coming 2-3 years? You should drive the township regularly then and the instant when you see new construction of apartment homes you rush a sale.
I don’t get why you don’t have MULTIPLE potential renters all come the same day in 30 min intervals to examine ur home before YOU DECIDE who to rent it out to. I do this. You can actually control the renters. Look at the neighborhood. What type are the majority of people, is often the identical people who will end up renting. Wrong people = lots of work. Right people before they buy their own home = almost no work.
“I don’t get why you don’t have MULTIPLE potential renters all come the same day in 30 min intervals to examine ur home before YOU DECIDE who to rent it out to.”
It’s because the demand pool for $9,000/month is not that big. They are out there, but they are pickier and go through relocation agents and leasing agents.
I do this w/ my 2/2 condo I rent out for $4,200/month. A much larger pool… maybe 10X larger actually, so much easier to pick and choose.
Your friend has good reasons for holding on. I wouldn’t sell if this was my only residence in SF.
There are merits to both, but if you house is worth 300x monthly rent, it sounds like real estate is a renter’s market! Why would anyone want to buy a house in SF when rent is so much cheaper in comparison!
If the answer to that is future asset appreciation, then the right financial move is to buy a property in the midwest as you have said many times, and rent in SF assuming emotions is completely taken out of the equation when it comes to home purchasing, which we all know is difficult.
Charleston. This is exactly right. I’ve got a post coming on this topic.
Perfect, eagerly waiting for the new post. Keep up the good work.
Hi Sam, do you currently use the depreciation on your rental property to offset income taxes?
And would selling therefore adversely affect your tax situation and also result in higher capital gains due to the depreciation recapture?
Depreciation always happens whether you need it or not. Depreciation recapture will lower your cost basis, thereby increasing your taxable gains. But, that would be offset by the tax savings you had on the rental income. I don’t have much recapture b/c I haven’t rented it out for that long. .
Sam, I’ve been reading your blog for the past few years. You opened my eyes to financial independence, and I’m grateful that you’ve taught me so many things along the way.
You are sitting on a fantastic offer that will significantly simplify your life. Selling this property will mean less stress and worry, less time managing your property, and less time checking up on your tenants. This is extremely valuable because you get to spend more time with your family. We’ve all got a finite amount of time. Sell your property, decrease stress, and spend more time with your family.
Good luck.
Hi Dave,
You’re right in that time gets MORE valuable the older you get b/c you have less of it. Pretty logical stuff.
Thanks!
You asked if you forgot something in your analysis. I believe you forgot the non-financial aspects such as reduced stress and time commitment. Getting rid of the property would free up a lot more of your attention, which you could dedicate to other endeavors whether they be family, personal, or entrepreneurial.
You also missed a big non-financial/financial collision in your analysis. Maybe I’m being a complainypants here, but did you really just say you’re going to let your kid live in the property, and (from my interpretation of your writing) let them live in it rent free? This lack of rent for an unspecified amount of time should be included in your analysis. And what if your child wanted to buy the property from you? Would you be willing to give it to them for cheap, and possibly a loss on your end?
After all your posts about how you hate/despise privileged millennial children…I guess I’m just confused by your reasoning on this issue. I’m trying to figure out if you are being hypocritical when your own children are the millennials who could benefit from riding on their parents’ success.
Sara, excellent observation about being a crutch for our children. Nobody else pointed this out. I have an upcoming post dedicated to this topic about how NOT to be a crutch to our children and my thoughts on secretly being the bank of last reserve for the people we love the most.
My plan is for my child/children to pay me market rent instead of a stranger. I’ll teach him with a real life example of how to be a good tenant, how to build relationships, the pros and cons of renting, the pros and cons of owning, and taking responsibility as a master tenant and managing other housemates.
I find it much more effective SHOWING people the way with real examples instead of just telling.
I am interested in the dichotomy of having your child live in the income house and pay you rent. On one side, it doesn’t seem much different from what many parents do in letting their children live at home. Granted in your scenario they get and maintain their own separate space, and they are paying full rent, but your kid will still have that family support system. I definitely agree that a real-life example would be very educational.
On the other hand, I could see major tensions developing. Namely those potential tensions such as raising the rent in high-demand markets, intimately knowing each other’s financial situations, and the overall lack of independence (at least in my opinion) in addition to having to “manage” potential friends in the housemates (who would know the familial relationship with the landlord).
Then there is the serious intermingling of family finances. If your child loses their job, you lose a tenant/income. Conversely, if you needed additional income and raised rent, your child would have less present income (although from your plan it sounds like this would only benefit their future inheritance). Wouldn’t you ultimately be relying on each other as “banks”?
I hope Financial Samurai is around when all this happens as I am extremely interested in hearing how all of this plays out. Both in the financial and non-financial categories. I’m also really looking forward to reading that post about being a bank for loved ones!
I feel strongly that I will never need my child’s market rate rental money if he were to ever lose his job. I know this because I don’t need the rental income now, and have considered keeping the house empty and using it as a pitstop and parking spot.
There is no doubt I will probably treat my son well as a tenant, as I treat all tenants. But I get excited thinking about getting to visit him sometimes, thereby enjoying the property as well and seeing what he’s up to. These are dreams of a father/parent.
I don’t think having my child pay close to market rent by himself and with housemates the same as living at home in my house and not paying rent.
I love creating financial buffers for my financial buffers. I know I will always be there for my son whenever you falls.
It is awesome that you will be there for your son. I am just playing devil’s advocate. I love these kind of thought experiments and analyses.
First, I did not say rent free. The reason I say having him “rent” the house is like having him live at home is because some parents charge their children a discounted rent while they are living at home (which is what I intended to be interpreted from my earlier statement). And this is usually accompanied by having them buy their own supplies or contribute their fair share to the household budget. The parents have full reign of the house, and they may have a set of rules that need to be followed.
Your son will be growing up learning about your real estate empire (if you intend to keep it, of course). I’m sure you will teach him and take him to these houses. I wouldn’t doubt if he continued to feel like the house was still your property even while he was renting it. He would buy his own supplies and have his own budget, but you would ultimately be the ruler of the house. He would still need to go to you if he wanted to make changes to the house, and the tenant policy would essentially be the set of rules he has to adhere to.
I see no difference with an adult child living at home (and paying discounted rent) versus your plan except that he might have some housemates, especially considering that you intend to visit him regularly.
Cool. Tell me about yourself and your philosophies on raising your child (children). I’m always curious to know do you want to share so much of my own voice. It would be great if readers shared their own. How old are your kids?
I’m actually looking for guest posts on readers on this topic if you are interested!
I am flattered you suggested I write a guest post. However, I feel obligated to inform you that I am not a parent, but the child in this situation. I am living with my single mother while I pay off over $100,000 in student debt in three years. I am not a blogger, but I would be willing to share my point of view as the child if you are interested. In the same token, I would understand if you are miffed by this situation. Please know that I did not intend to insult you. I was honest when I said I enjoy discussing thought experiments.
I have been reading your new posts and archives for approximately a year and this was the first post I had the courage to comment on. However this works out, know that I will continue to be a fan of your site and read your posts. I look forward to hearing from you. Have a great Wednesday!
Hello Sam,
Think about an economic crisis, when it comes all the investments will take a hit and you will have that directly translated into a huge loss for the moment. While having a house, it will still depreciate but you won’t fell as bad for that. Considering that in the past 5 years you had such a huge growth, keeping this asset will seem a way better investment for a period of another 10 years at least. Even if you don’t keep tenants… but it’s going to get even better in case you keep them.
Yes, it will require some extra work, but you have always gone for extra hustle…
What do you think about this approach?
It’s hard to use past results to extrapolate future results.
I’m 90% certain the next five years won’t be as fast as the past five years.
In the worst case scenario, in the next financial crisis what will hurt more for you, to see a money loss or to have the house depreciate with the market. After all, I think it’s a matter of the risk level you are willing to take, either way you’ll be fine.
Please give us another post on what you plan :)
It’s a no-brained, sell then put proceeds in the various allocations you mentioned.
I recommend you NOT to sell for two reasons.
1. You will forever lose on property gains and future leverage on the house. If you don’t sell, you can always refinance, continue to rent, keep as vacation home, etc. If you decide to sell later, you’ll still capitalize on the gains. Having previously bad tenants may have steered you towards the selling route, but it sounds like you’re not ready to give up the property. In this case, just rent it out and hire a property manager. You might make a little less, but the ideal tenant will come and the property will still be yours to keep. No one can predict the future, but I think you already know where the future is headed in the bay. I believe you’ll have less regret holding even if the market slightly dips.
2. 2.5% commissions are way too high in the bay area. I’m actually more shocked that the listing agent is not taking less…It’s a competitive market out there for seller’s agents and they really should take less. From my experience, it’s it’s not hard to sell a house for a good price using an agent who will do a listing for 1-1.5%. These agents who rebate commission, of course, are generally less famous, but still work hard and will do anything to make a deal and take credit. Of course your agent will tell you he/she is the best and get you the most money. :) It’s usually harder to decline a 2.5% commission to a buyer’s agent, since they will initially be less financially motivated to bring a buyer to see the house. Some spend months finding a house for their buyer before offer is accepted or buyers move on completely.
Indeed. May I ask about your landlord history and what solutions you’ve used to deal with tenants? thx
I just passed on selling to a private buyer. It was very tempting. In the end I felt the property would increase in value as the area in South Berkeley that I purchased the property is rapidly gentrifying. I also wasn’t sure what to do with the proceeds. I tend to think 1031 exchanges have limited value. They just defer your gain and your buying in to the market you’re selling so good luck finding any sort of value in any most metropolitan areas. Your depreciation goes with you also. If you do sell, bite the bullet and cash out; don’t exchange. Good luck!
Sell. Take the profits and buy yourself something nice, like Pez! Or just save it. Next dip is coming soon?