I bought a 2,100 SF single family home at the beginning of 2022 for $600k (about 10% under market at the time). The goal was to renovate (very cosmetically challenged), rent it out at close to breakeven, and capture the appreciation that I was betting on for my market.
Well, I got a little crazy with the upgrades and, needless to say, it looks great right now. For the past few months I've been renting it for $2,850/month with an NOI of about $1,800/month, after RE insurance, RE taxes, and a 10% PM fee on the base rental income (that I pay myself!).
I locked in a 5% interest rate when rates were surging, and with 25% down ($150k) for a 30-yr amortization, I pay a monthly mortgage of $2,400. So my cash flow after financing is negative $500/month, which I'm making up via my W2. After accounting for the monthly principal paydown, I'm growing my wealth at a rate of $100/month, or $1,200/year on a cost basis of $275k. That's a yield on cost of less than 1%...
I won't be able to sell the house for more than probably $685k in this current market environment, so I would walk away down $40k + $35k sale commissions + interest paid, from my initial $275k equity investment. I would then have the opportunity to earn 5-6% (HYSA, investment in public market, etc.) on the ~235k I would receive after loan payoff ($150k + ~$85k).
The alternative is that I keep the house and continue to go cash flow negative (which I don't mind) but grow my equity by $200/month without home appreciation, ramping up to $300 in Year 3, $400 in Year 4, etc. I anticipate that in the next 7-10 years, due to the explosion in my market's demographics and economy, the house could be worth $900k-$1.1M, at which point it might make sense to sell. Rough math says that a $900k exit in 7 years would yield a simple annual rate of return of 8-9%, not factoring in equity buildup. By following this path, not only would I not realize any losses, I could make decent returns. In this scenario, I would earn 8% on $275k as opposed to 5% on $235k from the previous scenario.
What would you do in my shoes - sell it or hold it? Anything you see that I should be factoring into this analysis?
How much did you spend to renovate?
Do you mean you pay yourself a 10% fee to PM it or you are paying a 3rd party PM 10% out of your own pocket? If it is the latter, can you cut out this expense? What is the PM service providing you for the 10% besides collecting rent for you and taking tenant calls? It's a SFH, not an apartment building. If shit breaks, you could spend that 10% on actually repairs.
How much are your taxes? Does your municipality offer homeowner exemption where the RE tax is discounted for homeowners? If so, just say that you live there to get the exemption. How much is your insurance? I think maybe your first goal is to try to reduce your expenses to break even. You are only $500 off so maybe by cutting some expenses in combination with increasing the rent next year, you can break even.
Try to sell it yourself first instead of using an agent. $35k savings is huge
In my experience, for a $600k SFH that is renovated to only increase in value by ~50% in 7-10 years is dog shit. Properties in the right market can double even triple in value in that time.
I think this mainly depends on 1.) do you have capital to do another deal and 2.) are there better opportunities? If you still have dry powder, then if you are able to get the property to break even each month, then maybe sell it 1-2 years down the road yourself and hopefully break even then you dont need to take a loss. But if this is all the money you have, then it kind of depends on what you think your opportunity cost is. If you are just bleeding money every month and it will take a while for prices to appreciate to a point that you break even, then maybe its worth considering cutting your losses and investing your capital in other assets that will perform better.
Sorry - I meant to specify! $125k for the upgrades (moving walls, kitchen island, carpet, interior & exterior paint, all new finishes, new appliances, full frontyard & backyard makeover). That's how I get my YoC of $275k.
The 10% PM fee is what I pay myself to manage it. I consider this an expense to keep things realistic (the labor should cost, whether it's me or someone else). But it goes into the same pot (mine) and it's minimal work, so I'm fine assuming it's a zero cost. Removing that $285 would bring my NOI up to $2,100/month, my CF shortfall to $220/month, and my equity buildup to about $300/month. Surprisingly, this change alone 3x's the rate I build equity.
Taxes are 1.1% per year of 100% assessed value. So on $600k that's about $550/month on taxes. I assume there aren't any RE tax breaks for investment homeowners. I already have a primary residence, so I doubt I can get any of those tax breaks. Insurance is reasonable at only $100/month.
I definitely will sell myself. Just left it in to be conservative because I'll probably have to split a broker/brokerage house to hang my license up with them to do the sale.
I arrived at my future sale price simply based on how high I think similar product in my market could go, so I very well could be off base (it could be higher). I just don't see anyone paying much more than $1M for a 2,100 SF house that'll be 50 years old by then, no matter how saturated my market gets (I don't think I'm sitting on the next Bay Area market). I'm hoping I've underestimated the combination of house appreciation/inflation and market appreciation. But a $600k property renovated and now worth $700k is, 10 years down the road at 5% appreciation, only worth $1.15M. Hard to see it much better economics than that in my situation, unfortunately. Oh well, learning experience.
I do have dry powder and no real investment prospects. I'm growing that money 5% a year in a HYSA, which is better than what this house can return in its current state (annualized); that's what I'm mostly comparing to - sell, realize the loss but collect the cash, and put it in a HYSA or even brokerage account and at least save myself on the opportunity cost. My thought is that it will take some time to get this house cash flow positive (~3 years assuming $0 PM fee), but it can be done, so that would take care of the bleeding part; the more difficult issue is the second part of your criteria, which is breakeven. I put so much money into this house ($275k total cost) that breakeven seems likely in the near-term only through significant appreciation, which I think will also take time given the market (5+ years).
Feels like a rock and a hard place right now...
- Only benefit to selling seems to be that you get cash in your pocket today. Do you need it or just want it?
- It sounds like you bought at 600 (in for 150), put in 125, and want to sell for 685 (before taxes/fees). To me, that's bad math (685-450 = 235, but you put in 275...so you're underwater).
I would hold it
I think the best way to think about it is that you have bought a stable/low-risk business, that is slow-moving and yields some cash every month. Your goal should not be cash-on-cash returns, but equity appreciation. Over time, the principal paydown + equity appreciation can act in two ways: as a financial safety net, and/or as a asset to leverage. In your 10-year example, where the house is now worth $1.15m, you should be able to refinance to ~65% easily, which equals ~$750k less the existing loan of $350 (a guess) = $400k in equity. That $400k is two 20% downpayments on similar houses.
Principally, you spent too much money on renos, and you're not getting a lot in rent. Market has turned a bit and now you have a bit of a stinker.
Any chance you could get a second tenant?
Realize that the majority of value creation comes from picking the right asset with the right business plan.
If the value creation was there as you planned - you’d see it by now. The market is telling you it didn’t work. Cut your losses and find a better place to put your money.
Thanks man, buying right and operating properly - two high level concepts that flew over my head, haha.
the point is, you're past the stage at which that value would have materialized.
it hasn't materialized - so cut your losses and find a better target for your time and money.
Bump
Hard to say honestly, I would recommend getting a property manager and keeping (you can probably get away with 6-8% of gross), but losing money isn't a great business plan. If you think you can start hiking rents in the next year or two, might be worth keeping, but otherwise might make sense to sell. RE investing isn't quite as easy as it looks, especially in the single family market.
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