Rent or sell?

[MSooner]

We've still got about 3 years to make this decision before training is over, but my husband and I are starting to mull this over now.

We bought our home in medical school for $175k in 2012. We put little down (I think just 3.5% with an FHA loan) and have been very fortunate to buy at the beginning of a very strong real estate market--DFW area. In 2014 the home appraised for $230k and we were able to refinance and get rid of PMI. At the time, we figured we would sell when training was over, so we went for a 5/1 ARM in order to keep the interest rate low. Now, I estimate the home to (conservatively) be worth about $250k.

The "plan" has been to stay in the home for 1-2 years into attendinghood if we end up in this area long term (big possibility) in order to save money and pay off student loans (100K). If we moved elsewhere, we would sell. The profits would go towards a down payment on a bigger home or paying off the loans.

Now we are really starting to wonder if we should keep it as a rental. Whether or not we stay in the area would factor heavily in this decision, but if we stay, the idea is starting to seem very attractive. We chose the suburb we are in because it is the closest to downtown (and the med center) with good schools--needless to say, it is very popular. It has always had a strong rental market, even in downturns. In fact, a lot of the homes on our street are rentals.

The monthly payment is $1350. It would demand $1800-2100 monthly on the rental market. I do expect our monthly payment to go up over the next 3-5 years due to property taxes (Texas isn't cheap in this regard and it will slowly catch up to the value of the home) and of course, the ARM. Still, I think it could be a relatively self-sustaining deal, assuming we kept the "profit" to do maintenance and cover for any time the home was vacant.

This area is also attractive to residents/fellows with families for the same reasons we moved here--I think with enough networking I could manage to get a medical family in here without having to list it on the market. Not that a medical family=good renter, but I think there is a better chance than your average renter. Even if we had to list it, rentals move quickly.

The biggest downside I can think of is the management aspect--it would fall to me. I don't work anymore and wouldn't mind the challenge of being a landlord, but I do believe it could be painful to see the home I brought babies home to be potentially abused by renters.

The biggest upside would be having a nice, paid off asset with a modest income stream right about the time my kids hit college and potentially start getting married (weddings).

What are we missing?

[ENT Doc]

You have a lot of things to consider.  Good news is you have 3 years-ish to decide.  But good to be thinking about this now.  You'll have a much better idea in another 1-2 years if you'll stay in that area I imagine, which will make your decision a little easier.

1. Consider refinancing to get out of that 5/1 ARM if you're not going to sell.  I'm not a fan of things unpredictable.  I've learned that the government is very good at wasting money, and tax increases should be expected.  You don't want to see that on two fronts, the other being the rising interest rate.  You may see that nice payment to rental gap narrow quite a bit.  Your refinance decision will also be based in rates at the time.  If you refinance do it BEFORE you leave the home.  Your rates will be much lower since the bank still sees it as a primary residence.  The good news here is your current principal - it seems manageable.  A 15 year mortgage will probably cost you $5000 extra a year (based on some educated guesses), which isn't something to laugh at, but is this really going to be the difference between you saving for a down payment on a home or paying off loans, especially if you're only going to stay for 1-2 years after residency?  The benefits of this, of course, is faster pay off.  But it seems like with the differential you're talking about someone else is going to be paying this off anyway.  You just miss out on the 5K cash flow for those first 15 years, but get cash flow back in years 16-30.

 

2.  If you decide to rent, everything changes.  You now have to go through the painful task of being a landlord.  The learning curve on the first go around can be steep.  You have to demonstrate equal opportunity, save your applications for years to help prove that, be prepared to deal with the random call about something breaking, etc.  I suggest aggressively screening your tenants.  I demanded good credit, preferred married couples, talked to their previous landlords/references, did background checks.  I have been very pleased with my renters for 6 years because of this.  The most valuable thing here is the underlying asset - your home.  Emphasize how important the place is to you to your renters.  No smoking, take shoes off, etc.  Don't let a management company do any of this.  It's your home.  They are motivated to put *someone* in the home and collect their 10%.  You will do a far better job of putting someone in your home who will take care of it.  I have seen far too many homes fall into disrepair because of the management company nonsense.

 

3.  Financially speaking a lot changes too.  The property taxes aren't deductible any more (if you itemize) - they're an expense.  A whole lot can be deducted as an expense:  https://www.irs.gov/publications/p527/ch01.html

Obviously, the excess (profit) will hit your income - unearned income.  This will hit your marginal rate in the future but no FICA taxes are paid.  Another expense to note is the required depreciation expense.  You end up dividing the home value by 27.5 and deducting this amount every year (as a requirement).  This affects your basis, which matters if/when you sell.  That brings me to another interesting twist with a rental - the capital gains taxes on the sale (assuming you do at some point).  This article highlights the issues quite well:

http://www.nolo.com/legal-encyclopedia/avoid-capital-gains-tax-selling-home-29901.html

Point is, you'll get hit with cap gains if you don't live there 2 out of the 5 years before the sale.  There are exceptions to this.  If you sell within a few years of leaving the place and renting you'll be sheltered from $500K of capital gains.  The way to get around this is, in a way, is with "like kind" purchases at time of sale.  This gets more complicated but essentially commits you to more real estate purchases and tax deferral.  If you're interested in building up real estate assets to diversify your portfolio this might be the way to go.

 

4.  Passive income.  I like having real estate to diversify away from the traditional investments.  This property seems like it will generate $30K of passive income a year in the not-too-distant future.  This a great insurance policy against income losses for whatever reason - disability, death, early retirement.  I have a rental right now but in a city far from where I live.  It's where I trained and my wife's family is still there.  They can help to manage in a pinch but otherwise I've made trips there at least yearly (which we would do anyway with her family being there).  Still got a few years to see where I'll end up (in the military now) but if we don't end up going back there we're going to sell it.  Too painful to manage something far away.  But I'll be looking to buy property for rentals wherever I go.  It's also a great asset to hand down to your children - which is another way of avoiding capital gains taxes (estate planning).

 

Anyhow, best of luck with your decision.  Hope this helped you.

[resident_1]

We are in same situation as you are (except finished training) and ended up renting. Read this forum.

https://www.whitecoatinvestor.com/forums/topic/refinancing-an-arm-to-higher-fixed-rate-on-a-rental-property/

The biggest issue is the 5-1ARM.  Refinancing will increase your rate. Also keep in mind that refinancing a mortgage with intention to then turn property into a rental may not be legal (and can get into mortgage fraud issues). So possibly refinance this year to a fixed mortgage.

 

 

[MSooner]

Ha, and here I was thinking I was getting ahead of myself thinking 3 years out!

Thank you both for your very informative posts. Excellent points on the ARM and refinancing as an investment. I'm sort of kicking my self for the ARM now, but at the time we were convinced we would sell. I'm going to need to look into this more. I'm hesitant to commit us to a higher monthly payment right now and pay refinance fees again, but I see how it would be well worth it in the long run.

It does look like rates are going to go up at this point--given this, it seems like a 15 year fixed mortgage would be the wisest setup for our situation. While I know it would be best to do it now before rates go up, I think we need to wait. In 2.5 years we will start the job search and will hopefully have something lined up 3 years from now. If we are moving, I'm going to be hesitant to rent it. I agree that I need to be the one (aggressively) managing the property and I don't think I can do that from far away. My parents live here, but that isn't a burden I'm willing to stick them with.

If we are staying in the area, we will almost certainly stay living in it for another 1-3 years from the "contract signed" point. It seems to be the more reasonable time to make the refinance decision, even if we lose some on the interest rate in the interim years. My husband also has much better moonlighting opportunities during the last year of residency + fellowship, so I'm not as concerned about covering an increased mortgage cost during those years. I do have two concerns about this:

1. Could refinancing in that time period hurt our ability to get a mortgage on our "doctor home" 1-2 years later?

2. Is that enough time to hold the home as our primary residence and then rent it out without getting into the fraud issues mentioned? I'm guessing it depends on the specific loan?