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The Question of Selling or Renting Out, Part 2: The Math

Contributed by mm | June 26, 2005 6:51 AM PST

Thank you for all the feedback and suggestions after I posted the situation I am in. As one reader suggested, let me go back to my financial analysis roots and run the math. I'll evaluate two options: Option 1 being selling the house now, and reinvest the home equity I can cash out; Option 2 being becoming an absentee landlord for the next two years, and selling the house afterwards in anticipation for some more price appreciation.

Since the housing price trend in the next two years is a big variable, I'll lock in the rest of the model while trying to calculate the break-even appreciation that makes both options equally attractive.

Option 1: Sell

The financial consequences of selling is easy to quantify. I will be able to cash out my home equity of $146,600, and assuming an annual after-tax return of 5%, we will end up with $15,000 in investment income after two years.

Option 2: Rent Out for Two Years and Sell Afterwards

The math for Option 2 is quite complex. Below is the pro forma P&L I anticipated (some explanations follow):

Monthly P&L   
[1] Rental Income  $     1,700
[2] Lapse Between Renters (7%)  $      (119)
[3] Gross Rental Income  $     1,581
[4] Property Management Fee (10%)  $      (158)
[5] Net Rental Income  $     1,423
[7] Mortage Payment (Interest)  $      (700)
[8] Property Insurance  $        (40)
[9] Property Tax  $      (280)
[10] HOA Fee  $        (25)
[11] Maintenance  $      (150)
[12] Net Income  $        228
[14] Absentee Landlord's Pain  $      (200)
[15] Economic Income  $          28
After Two Years  
[19] Total Economic Income  $        670
[20] Closing Cost at Sale (5%)  $  (19,500)
[21] Appreciation Needed To Break Even  $   18,830
[22] Annual Appreciation Needed 2.4%
[24] Appreciation Needed To Make $15,000 Profit  $   33,857
[25] Annual Appreciation Needed 4.3%

Line 2/Lapse Between Renters: This is to assume the home will be idle for 25 days every year between renters (with no rental income).

Line 4/Property Management Fee: Based on my preliminary research, local property management company like this one can offer full-service management at a fee of 5-10% rental income. 10% is used for modeling purposes here.

Line 7/Mortage Payment (Interest): Only the mortgage interest portion is included. I consider this as an economic impact exercise instead of a cashflow exercise, and since any principal payment will be returned to be after the eventual sale, the economic impact is minimal (little investment income on $400/month, which can be ignored.)

Line 11/Maintenance: Some maintenance cost is budgeted -- the house is relatively new and in the last two years, it only costs me less than $400/year for upkeep.

Line 14/Absentee Landlord's Pain: This line monetizes the hassle/pain/pressure as an absentee landlord. In other words, if someone pays me $2,400 a year, I will be happy to put some hours to be an absentee landlord (with the full-service property management company covering my base).

The monthly P&L analysis ends up with an economic profit of $28 a month. To complete the full model that considers the impact after selling in two years, I need to include the closing cost of sale as 5% of the total property price (line 22). I didn't use the 7%, or $30,000 number because if I have to pay the closing cost, I would consider For Sale By Owner (FSBO) to save some commission. (As a side note, I didn't include the tax impact, which will be some tax benefits in the first two years when I claim some property depreciation, only to be recaptured in the tax year when I sell the home. This makes the tax consequences almost only a cash flow concern.)

So, it all comes down to the guess of whether/how much my home will appreciate in value in the next two years. With an annual appreciation of 2.4%, Option 2 is a break-even plan by itself, but if the appreciation goes to 4.3%/year, it will make Option 2 as attractive as Option 1.

Still, it is not an easy decision after running the math. The same property appreciates at 12% a year in the last two years, but it does not indicate the future will be as bright or as half bright. Therefore, in the next part, I will explore different assessments of the current housing market, and make an educated guess.

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This Post Has Received 4 Comments. Share Your Opinions Too.

Mike Commented on June 26, 2005

Don't forget that you can get a deduction on your income tax for depreciation. On a house as expensive as yours, you can save a lot of money on taxes.

ctjs Commented on July 3, 2005

What are your feelings about a situation where the rental market does not bear a monthly rental price equal to the mortgage? This may be the case these days considering low interest rates (people buy instead of rent)and depending upon who your target renters are (elderly couples or young couples starting off)

Do you hold on for multiple years in anticipation of yearly appreciation? Or is it better just to punt and put the money toward some better option (even if you lose some money in the sale)?

How would you judge break even? If additional monies (maintenance and extra $$ to make up the mortgage shortage)sunk into the project equaled the appreciation?

Do you consider tax consequences when attempting to make a judgment? I noticed you added no benefit in for that in your analysis.


tmil67 Commented on September 25, 2005

Aside from the cost of repairs/maintenance/management fees, I don't see how to lose in renting property. I am contemplating the conversion of my primary residence into rental property in the spring of 2006, and with a monthly payment of only $850 on a house currently valued at $166,000, I should have at least a $300 margin above my monthly PITI. My house if only 6 yrs old, so this margin should more than cover my repairs and mgmt fees. As much as I've run the numbers and tried to beat the idea of being a landlord into the ground, I can't get past the basic principle that someone else is paying both the interest and principal on a piece of real estate for me. I realize that you're working with only a 2-yr time frame, which does make a difference...but in principal, real estate is one of the few investment vehicles where you can have someone else pay for your leveraged asset, while it also appreciates in value. That seems to me to be worth a certain amount of headache.

kaih23 Commented on October 17, 2005

Well, if you're basing your decision on your numbers, I would totally go for renting it out. Especially, if you plan to move back in 2 years. The probability of real estate sales dropping from 12% to 2% appreciation is zero to none. Check out the history of real estate markets. Something drastic would have to happen for real estate market in your area to drop from 12% to 2%. I'm actually, in the same situation, except, I'm not sure if I'm moving for good for for 4 years and my house appreciation is about 29% annaually. 2 years is nothing. I predict my house will appreciate minimally 10% for the next two to 5 years due to extensive development in the area. But I'm concerned with damages to the house and then the cost for remodeling. I think I am going to rent my house out. I'm currently making $1350 from renting it and living in it as well, which basically means I'm paying like $500 a month to live in my house and I still own it. I hope this helps.

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