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Is renting this out a good idea?

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  • Is renting this out a good idea?

    Bought a single family house in central California a year ago for $325,000, current value is around $400,000, was planning to stay for work initially but might be moving away to a different city a few hours away in a few months, was planning to rent it out. Potentially to people I know. Also not looking to buy property where I'm moving to.

    Currently on a 2.5% 15 year mortgage, has about $120,000 principle left.
    Monthly principle is $1200, interest is $300, Property tax and insurance is about $450. No HOA.
    Could probably rent it for around $2200.

    My question is, would this amount to positive cash flow? I assume the $300 interest and $450 tax and insurance is tax deductible. That leaves about $1450 of income (annual income around $350K) that will be taxed to pay $1200 of mortgage principle. Which sounds like I'll be paying additional every month on this property if I rent it out? Hasn't done this before so not too sure of the numbers.

  • #2
    Cap rate is a starting point to determine if a potential rental is worthwhile, and that is monthly rent divided by home price. You want that over 1%. You're is $2200/$400,000 or barely 0.5%. which is pretty terrible.

    The might be other reasons to hold it and thus rent it: avoiding a large capital gain; needing to come back to the house in a year and not wanting to pay transaction costs, for example.

    But on the surface this isn't a great rental (it's better than one of mine though, which rents for $1800 and whose value is now approaching $500k. But the house was only worth $190k when we bought it so we'd have huge amounts of taxes to pay to get out of it).

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    • #3
      Doesn't pass the 1% rule at 2200/month. You need to know actual rental comps for the area, not a guess. Also, will you manage the property yourself (take 10% from rent if not)? Assume 1mo/yr vacancy (in reality, you can get most stuff rented quickly in this market, but it's not unreasonable to think a month max vacancy). Also, what capex do you expect (how old is the roof, HVAC, etc).

      If you can do a cash out refinance and get the monthly payments lower that would be ideal. Could be a wash depending on what rate you get.

      Your insurance may be more expensive if you're not living in the home and renting it out.

      That's not to say you shouldn't do this. At the current juncture, it doesn't look like a profitable endeavor without moving some stuff around.

      -- I'd be wary of renting to people I know unless you know. You don't want to get into friendly agreements with people you rely on to pay a note. If you decide to do that, then I'd go through all the normal things of credit checks, deposits, etc- and even consider denying them if they don't measure up on paper. Just my .02 on that.

      Comment


      • #4
        Originally posted by FIREshrink View Post
        Cap rate is a starting point to determine if a potential rental is worthwhile, and that is monthly rent divided by home price. You want that over 1%. You're is $2200/$400,000 or barely 0.5%. which is pretty terrible.

        The might be other reasons to hold it and thus rent it: avoiding a large capital gain; needing to come back to the house in a year and not wanting to pay transaction costs, for example.

        But on the surface this isn't a great rental (it's better than one of mine though, which rents for $1800 and whose value is now approaching $500k. But the house was only worth $190k when we bought it so we'd have huge amounts of taxes to pay to get out of it).
        1031 or cash out refinance? I'm impressed with the appreciation.

        Comment


        • #5
          Yea not looking to sell right now due to uncertainty of situation.
          My main question is assuming there is no vacancy, I manage the property myself, and no significant maintenance cost (bought as a new build), would I be making positive cash flow based the numbers?

          " I assume the $300 interest and $450 tax and insurance is tax deductible. That leaves about $1450 of income (annual salary around $350K) that will be taxed to pay $1200 of mortgage principle. Which sounds like I'll be paying additional every month on this property if I rent it out?"

          Comment


          • #6
            Something looks off on your numbers. You mention $1200 going to principal, there’s 14 years left on the mortgage, and a$120K balance left. That part doesn’t add up. But moving beyond that assume your monthly carrying cost is $1950 and your rent is $2200 That leaves a delta of $250. There may be maintenance although it’s a new build, vacancies, turnover costs between vacancies etc....Even so in this market,it’s not bad and should be close to break even. Don’t forget depreciation when you figure taxes. You can only depreciate the house not the land. So on a $325k purchase the house could be $250k which you depreciate over 27 years. So given that you’d write off against the rental income about another $9000/year. This looks to be about a break even on cash flow not including taxes if you self manage. The tax burden will be low. In 14 years you’ll own the house free an clear. Assuming conservatively the house appreciates 3%/year and rents do the same you’ll own a $600k asset that the tenants paid off for you and rents will be $3300/month. This doesn’t look too bad. I like RE because it’s a diversifier and keeps up with inflation. If inflation is higher you’d do even better The 2.5% loan is golden and will be paid back with cheaper dollars. Owning RE directly is more work for sure than index funds, but not bad if you have the right mindset. Forget about the 1% rule mentioned above, you won’t find a property that meets it in CA and don’t necessarily need to. Cap Rate is the purchase price/by net income. In your example that’s 325k divided by $17600 or north of 5%. Maintenance costs and vacancies will drive that number down. Still if your cap rate is greater than your interest rate that’s good and even a cap rate of 4% is good for sfh that are not in flyover country. So if you want to try out the landlord thing this may not be a bad one to start with.

            Comment


            • #7
              You will be technically be cash flow positive, but it would be a poor long term investment, which is what all the commenters have said so far. I've held on to worse, and it only gets worse. It doesn't take much to wipe away 200 dollar per month income. SALT taxes are capped at 10k/year so you probably won't get to deduct the 450.

              Better decision would be to keep it as your primary residence for a few more months and sell without capital gains

              Comment


              • #8
                Originally posted by Alex2022 View Post
                Yea not looking to sell right now due to uncertainty of situation.
                My main question is assuming there is no vacancy, I manage the property myself, and no significant maintenance cost (bought as a new build), would I be making positive cash flow based the numbers?

                " I assume the $300 interest and $450 tax and insurance is tax deductible. That leaves about $1450 of income (annual salary around $350K) that will be taxed to pay $1200 of mortgage principle. Which sounds like I'll be paying additional every month on this property if I rent it out?"
                See my post above and to directly answer your question. With depreciation The $1450 will be reduced to $750/month $250 is in cash so you’d pay tax on $6000 a year or a cost of $2000 to you. But you are gaining ~15k in that year that the tenant is paying for principal and if the house appreciates 3% that’s another $12k. Some RE investors say not to count appreciation but generally it should at least mirror inflation.

                The SALT limits mentioned above does not apply to rental properties. But I’d take those that tell you it’s a poor investment with a grain of salt and I’m not telling you it’s a good one. Rather in RE you need to do your own analysis and that just takes some basic math.

                Comment


                • #9
                  Originally posted by pit.alumni View Post
                  Something looks off on your numbers. You mention $1200 going to principal, there’s 14 years left on the mortgage, and a$120K balance left. That part doesn’t add up. But moving beyond that assume your monthly carrying cost is $1950 and your rent is $2200 That leaves a delta of $250. There may be maintenance although it’s a new build, vacancies, turnover costs between vacancies etc....Even so in this market,it’s not bad and should be close to break even. Don’t forget depreciation when you figure taxes. You can only depreciate the house not the land. So on a $325k purchase the house could be $250k which you depreciate over 27 years. So given that you’d write off against the rental income about another $9000/year. This looks to be about a break even on cash flow not including taxes if you self manage. The tax burden will be low. In 14 years you’ll own the house free an clear. Assuming conservatively the house appreciates 3%/year and rents do the same you’ll own a $600k asset that the tenants paid off for you and rents will be $3300/month. This doesn’t look too bad. I like RE because it’s a diversifier and keeps up with inflation. If inflation is higher you’d do even better The 2.5% loan is golden and will be paid back with cheaper dollars. Owning RE directly is more work for sure than index funds, but not bad if you have the right mindset. Forget about the 1% rule mentioned above, you won’t find a property that meets it in CA and don’t necessarily need to. Cap Rate is the purchase price/by net income. In your example that’s 325k divided by $17600 or north of 5%. Maintenance costs and vacancies will drive that number down. Still if your cap rate is greater than your interest rate that’s good and even a cap rate of 4% is good for sfh that are not in flyover country. So if you want to try out the landlord thing this may not be a bad one to start with.
                  Thank you for the response, the reason the numbers don't add up is that I made some extra payments (about $50K over the past year, probably wasn't a good idea but was initially thinking it was going to be my main residence and wanted to pay off the mortgage)

                  My only predicament is that I'll be about 6 months away from having lived in it for 2 years, if I rent it out it won't meet the requirement to sell without capital gains tax

                  Comment


                  • #10
                    My opinion is the low cash flow is not worth the hassle of being a long distance landlord, especially with the anti-landlord legal climate in CA.

                    Comment


                    • #11
                      Originally posted by Brains428 View Post

                      1031 or cash out refinance? I'm impressed with the appreciation.
                      Thought about 1031 but all property around here is similar. Don't really want to have a long distance rental.

                      If I cash out refi the interest is not tax deductible right? But I only owe $50k on the property so it would be nice to get some of that cash out and put to work somewhere.

                      Comment


                      • #12
                        If you cash out refinance, the money you receive is not taxable income as it is a loan. The interest that you will pay is considered interest on an investment, so it is deductible. The rules for deduction of business interest are different than the rules on deductions for interest on a personal residence. Also, there is no SALT limitation on business property taxes. The property tax is fully deductible for all investment property, no limits at all.

                        Comment


                        • #13
                          Originally posted by Alex2022 View Post
                          My main question is assuming there is no vacancy, I manage the property myself, and no significant maintenance cost (bought as a new build), would I be making positive cash flow based the numbers?
                          Two of three assumptions you make are unwise to base any decision off of.

                          Reevaluate these assumptions and recalculate.

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                          • #14
                            Here is a link to a rental property calculator. It will remind you to account for all expenses. And it will give you an idea of potential returns.

                            When evaluating investing in real estate, it is best to compare the estimated returns with the estimated returns you will receive on alternate investments.

                            https://www.calculator.net/rental-pr...alculator.html

                            Comment


                            • #15
                              Originally posted by White.Beard.Doc View Post
                              Here is a link to a rental property calculator. It will remind you to account for all expenses. And it will give you an idea of potential returns.

                              When evaluating investing in real estate, it is best to compare the estimated returns with the estimated returns you will receive on alternate investments.

                              https://www.calculator.net/rental-pr...alculator.html

                              One of the reasons I'm thinking of renting this out is to diversify since all my money is in stocks and bonds right now. Maxed out 401k and roth, have some cash but I'm putting it in the stock market gradually. If I sold this place I would probably just sit on the money for a while...

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