During my morning Twitter check-in, I ran across a cost/benefit analysis shared by heartlandonfire.com as part of his process for deciding whether to sell his rental (previously primary home). It was a great analysis and inspired me to share mine.
I purchased my home in 2004. Not quite the top of the market, but close.
It’s situated across from a river at the mouth of a canyon on 1/2 acre. It has a rural feel but isn’t that far from suburban convenience, within 30 minutes of 3 ski resorts and a state capitol. The home itself began its life in the 50s as a small cabin. 30 years and four additions later it had become a full-fledged 2000 sq.ft. home. Eclectic is a good description and one reason I love it. Like Mr. Heartland I had no intention of ever selling it and never considered how its idiosyncrasies and location would affect its future marketability.
I began renting the property 5 years ago when I moved in with my partner and started traveling more. I’ve never had problems renting it, but in terms of income it doesn’t even come close to reaching the 1% Rule (rental amount is 1% of total purchase price). In fact, with a purchase price of $395,000 and a monthly rental value of $1,700 it will never even be in the ballpark.
The rent on the property barely covers the mortgage payment and taxes.
Add maintenance costs to this scenario and you end up with a negative cash flow. More depressing, the market value of the home is now less than what I paid for it. Add to this wear and tear and emotional costs associated with tenant issues (rarely, but it happens) and it quickly becomes a bottomless pit.
Mr. Heartland’s thoughtful analysis includes a side-by-side comparison of the proceeds and investment potential of the cash realized from the sale of his home versus the equity he would realize from its continued rental. My assumptions and situation create a much different outcome than his.
Here is my cost analysis:
He assumes 6% equity growth each year over the 15-year period. While that may be a reasonable assumption in his location, I am not as optimistic in mine. Why would I say such a thing?
I live 15 minutes from the Nevada state line. Real estate is booming there fueled by California transplants tired of overpriced real estate and no end to the legislation inspired by political correctness financed by ever increasing tax rates.
California is hemorrhaging. While the sales of luxury housing in and around large metropolitan areas continue to rise, sales in rural areas are falling as the former middle class abandon ship and Silicon Valley is quickly following suit. Great subject for another post, another time.
What about appreciation?
At the bottom of the market in 2009, the estimated market value of my home was $260,000. ($135,000 or 34% less). Today, the market value is approx. $360,000, which works out to an annual return rate of only 3.31%. Here is a handy calculator. I think this is a fair expectation for the future of the market in my area.
Predicting the future is always a sketchy business and you should carefully analyze the housing trends in your area before picking your “number”.
Taking this a step further, the interest rate on my “modified” adjustable rate loan is stepping up with a ceiling of 5%. With the feds raising interest rates, it won’t be long before the interest on the loan exceeds my appreciation estimates.
Assuming the house appreciates at 3.31%. I’d break-even on the original cost of the home in 3 years. That’s a huge assumption though considering we are already over 7 years into a rising real estate market. According to the Cato Institute “except for World War II, the peak of most real estate cycles is roughly 18 years” with some cycles as short as 8. We are on year 10.”
My break-even point on the purchase price would be year 13 of this cycle. In the immortal words of Dirty Harry (you won’t get it if you’re under 40) – “Are you feeling lucky punk?”.
There are always options.
My friends keep telling me to turn it into an Airbnb. Truthfully, I think it’s more trouble than it’s worth. I’m cutting my loses and finding other investments I can enjoy more. Like a tiny house in Hawaii. What do you think?
And, while we are on the subject, you might want to think about how this property works into your estate plan. More specifically, will be a burden or a hinderance for your kids? Regardless, make sure it has been properly transfered into your Trust. I wrote more on this in a recent post “Can Your Kids Afford to Inherit Your House?”.
Many thanks to Mr. Heartland. I love your blog and followed.