Client Case Study: Selling vs. Renting Out a Home

May 22, 2019
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Recently, we shared an article about whether or not it makes sense to sell a home or hold onto it as a rental. Deciding between selling vs. renting definitely depends on numerous financial and lifestyle factors. Still, sometimes it helps to look at a real-world scenario and a case study from one of Illumination Wealth’s clients.

About the Client

This client lives in Minneapolis and is getting ready to move up and buy a new home. They currently live in a condo, but want to move up into a bigger home as their family has grown. After reviewing their financial situation, lifestyle goals and other considerations, they decided the best option was to sell their home. It simply didn’t make sense for them to keep the condo as a rental at this point in time.

Now let’s look at the facts and figures that led to this decision.

Equity Earned

First, they would be making good money on the sale of the condo. It was purchased 10 years ago for $390,000 and its current resale value is around $500,000. This was $120,000 of growth on an ~$80,0000 down payment (including principal paydown). The appreciation rate on their condo in that market was roughly 2.5% per year and that is not expected to go up dramatically in the coming years. Second, the new home they are buying is priced at $1.2 million, so that equity will go a long way towards a down payment on the new house.

Capital Gains & Mortgage Refinance

If they decided to keep the condo as a real estate investment, they would also lose out on approximately $20,000 in capital gains tax exclusions (unless they were to 1031 exchange at a later date). Another big step they would have to take to hold onto the property would be getting their mortgage refinanced. Their current principal balance is $300,000 and it’s an adjustable rate loan, so they’d want to lock in a better-fixed rate if possible. This would ensure more predictable cash flows when it is rented out.

Other Factors

Selling the condo was certainly a simpler solution and they would be able to use the equity they earned toward the new home and other expenses. To keep the condo as a rental, they would have a longer list of factors to consider:

  • Refinancing the mortgage (including closing costs around $3,000).
  • An additional commitment of time (or property management expenses) to manage the rental (which is at a premium due to their business and family commitments).
  • Forgo capital gains tax savings of $20,000.
  • Keeping it as an investment property would produce after-tax cash flow of $4,000 per year (equating to 2.3% on their $200,000 of equity on the home). This would result in an after-tax cash flow of $60,500 over 10 years.
  • If they held the property for 10 years at 2.5% appreciation per year, the total return would be approximately 8% pre-tax (coming from assumed appreciation and mortgage principal pay-down).
  • Not selling would increase the new mortgage balance on their home by $170,000. This would create additional interest payments of $69,000 that would not be tax deductible because their new mortgage balance will be over $750,000 limit.
  • They could put the money into other investments that could potentially produce more than 6-8% in pre-tax returns. For example, a standard 70/30 U.S. Stock & Bond portfolio has compounded at 9.3% a year since 1980. A 9.3% return on the $170,000 net proceeds equals $413,000 over 10 years compared to $298,000 (projected at 8%) net rental property gains.

The Right Decision

For this client, selling the property was the right choice from both a financial and lifestyles standpoint. However, that’s not the case for everyone. Oftentimes, it makes sense to hold onto a property if you can and rent it out for extra income. That’s why it always pays to work with an experienced financial advisor who understands real estate investments and can help you make wise financial decisions.

Contact Illumination Wealth today to learn more about our personalized investment advisement, retirement planning and wealth management services.