to sell current house or turning it into renal property?

[662drsdn]

Here is my situation, current house value, aprox $180,000-200,000
amount owing is $97,000

Im looking to upgrade to a bit bigger house, budget im thinking i can afford around $350,000 without too much trouble

I found a house that i like and am thinking about putting in an offer and its actually lower than what i was budgeting, its priced around 300,000

Originally i was planning on simply selling my current house and using the equity i have in it as a down-payment on a new place
but i got to thinking that maybe i should keep my current house as a rental property
but how would it work (or would it) if i wanted to buy a new place and keeping my current house. Since i was planning on using my equity as the down-payment and don't really have anything else saved for a down-payment would i be screwed with nothing down on the new place?
or could i refinance my current place for say 140,000ish and use that extra cash as a down-payment? (my current mortgage is up for renewal in a little over a month)


Current house:

Mortgage - $620 month
Taxes - $100
Insurance - $50

(shouldn't have an issue renting it out for $1000 a month maybe a bit more)



New house:

Mortgage - $1200 (estimating)
Taxes - 190
Insurance - $70 (guestimate)

only other debt i have is a 320 (160 bi weekly) car payment but its 0% financing that hardly counts! lol

im single, in my late 20's making around 70,000 a year, not sure if im crazy thinking of renting out the current place and maybe i should just sell, take my equity and use it as a down-payment, then the new mortgage payments would be even lower, but the way house prices have been going up, holding on to my current place kinda seems like a good idea.

the other thing if i do put in an offer on the new place, and decide to sell my current house financially i could carry the 2 places for a while just not sure how the banks would like that. I wasn't really planning on buying this soon but i happened to find a place i really like while casually browsing. haha


I have an appointment to go talk to a mortgage broker next week to go through my options, just looking for some feedback to see what other people think of my situation and if it would be a good/bad move to rent

Thanks guys, been a long time lurker of the personal finance area and always love the discussions in here!

[Mark77]

So you have a $190,000 house that gives you a rental yield of $1000/month.

From that $1000/month, $150 comes straight off the top for insurance + property taxes. So $850/month. 12 months/year = 5.4% yield prior to maintenance items.

Figure on a $190k property you're gonna have around $2k/year of maintenance expense. So that reduces your yield to 4.3%. And at a 32% tax rate, the after-tax yield on such a property is around 2.9%.

And thats before even paying yourself a dime for management expense, vacancy allowance, etc.

Currently, one can go out and buy XIU, an exchange-traded fund with 60 of Canada's largest stocks, at an after-tax earnings yield of 7% (source), and a cash yield of around 3%.

So this deal, of holding onto this property to rent at the stated specs, doesn't even interest me in the least. Especially when its trivial to purchase a diversified portfolio of investments (60 of Canada's largest companies....versus one property) at such a greater after-tax, after-items yield.

Plus the stocks tend to grow faster over the long run than real estate. Real estate tends to grow at the rate of inflation, give or take a percent. Stocks tend to grow alongside GDP growth which is usually 2-3% in addition to inflation.

[kenchar]

I would definately keep it and rent it out. With positive cash flow I don't think you can go wrong. With your income and lack of debt you should have no problems with the financing. With you current mortgage expiring I would contact a good mortgage broker and work with them to find a solution that works best for you.

Personally I would take the maximum amount of equity out of the rental property and use it for buying the new house. Since the rental property is now an investment you should be able to write off the interest against the rental income. (check with an accountant though but I am pretty sure you can do that.)

That way you are in effect writing off some of the interest on your new house.

There will be a minimum amount of equity that you will have to have in each property to satisfy the lender. Just maximize the amount you can borrow on the rental.

I sold my house to buy the next one. Looking back I sure wish I had kept it and rented it out. After 25 years of home ownership I could have had a nice income to retire on as well as the old house.

Just my 2 cents....

[glemlin]

Even ignoring what Mark77 mentioned of maintenance and stuff, looking at it from an ideal world situation and ignoring potential increase/decrease in value it doesn't even sound great.

Looking at it as though you put the $180,000 towards your new mortgage you'd save more. If it were rented at 1000/month you'd net $2760 after the bills (you'd actually get a bit more after tax deductions, but you'd also not always have a tenant and have excess expenses Mark77 mentioned as well). Assuming an overly low rate around 3% your old house's $180,000 could save you $5400 in interest per year, $2640 more than the rent with a lot less hassle. Granted that number would decrease annually it needs to be below $92,000 before it's better at 3% and by then the interest rate will probably be higher anyway. This is just using it towards your mortgage to save interest, not even considering other options that may make more off the same sum.

[kenchar]

So you have a $190,000 house that gives you a rental yield of $1000/month.

From that $1000/month, $150 comes straight off the top for insurance + property taxes. So $850/month. 12 months/year = 5.4% yield prior to maintenance items.

Figure on a $190k property you're gonna have around $2k/year of maintenance expense. So that reduces your yield to 4.3%. And at a 32% tax rate, the after-tax yield on such a property is around 2.9%.

And thats before even paying yourself a dime for management expense, vacancy allowance, etc.

Currently, one can go out and buy XIU, an exchange-traded fund with 60 of Canada's largest stocks, at an after-tax earnings yield of 7% (source), and a cash yield of around 3%.

So this deal, of holding onto this property to rent at the stated specs, doesn't even interest me in the least. Especially when its trivial to purchase a diversified portfolio of investments (60 of Canada's largest companies....versus one property) at such a greater after-tax, after-items yield.

Plus the stocks tend to grow faster over the long run than real estate. Real estate tends to grow at the rate of inflation, give or take a percent. Stocks tend to grow alongside GDP growth which is usually 2-3% in addition to inflation.

I understand your point but am wondering where the money to invest in this fund comes from?

[glemlin]

I understand your point but am wondering where the money to invest in this fund comes from?

Whatever is made off the sale of the existing house..

[Mark77]

I understand your point but am wondering where the money to invest in this fund comes from?

Where does the money come from to invest in the house? The same place. From savings or from borrowing.

The example didn't propose a solution, but rather, pointed out the absurdity of an asset class (the house) trading at an earnings yield of 2.9% (conservatively calculated), while the much-faster-growing stock market trades at an earnings yield of 7%. One could conclude that housing is either 150-200% overvalued, or the stock market is due for a 150-200% rise. Or something in-between.

[kenchar]

Whatever is made off the sale of the existing house..

OK, I see what you are saying. So after fees etc the net is $80k, some of that will have to be used as a down payment. If the op invests the rest of the money in the suggested fund how much would he have after say 20 years. If he rented it out and paid off the mortgage in that amount of time and assuming no change in house value he would have a $200k house earning whatever the rent would be.

Perhaps the killing I took in the dot com bust has changed my investing views or it could be my prairie heritage...but owning property seems to be my bias.

[Mark77]

OK, I see what you are saying. So after fees etc the net is $80k, some of that will have to be used as a down payment. If the op invests the rest of the money in the suggested fund how much would he have after say 20 years. If he rented it out and paid off the mortgage in that amount of time and assuming no change in house value he would have a $200k house earning whatever the rent would be.

This really can't be answered easily. If we return to historic norms for interest rates on mortgages, the rate would be approximately 7-8%. And a long-term historical trendline of the TSX stock market index has us around 22,000-23,000 (currently ~12,000).

Obviously historic norms for interest rates would probably make it very difficult to pay off the mortgage in that timeframe without additional funds paid in by the landlord. As just the interest alone on a $190k mortgage is >$1000/month.

A return to historic norms would also bring up the question -- is the landlord (ie: the OP) prepared to take $200-$400/month of his own money, to subsidize a renter? Or will he sell the property at what probably would be a substantially lower price? Imagine that -- owning a house that not only is dropping in value, but also, every month, asks you to pony up cash to subsidize someone else living in it.

but owning property seems to be my bias.

Not a great bias to have....

[kenchar]

Where does the money come from to invest in the house? The same place. From savings or from borrowing.

The example didn't propose a solution, but rather, pointed out the absurdity of an asset class (the house) trading at an earnings yield of 2.9% (conservatively calculated), while the much-faster-growing stock market trades at an earnings yield of 7%. One could conclude that housing is either 150-200% overvalued, or the stock market is due for a 150-200% rise. Or something in-between.

Sorry to be dense but what replaces the income the renter pays. Doesn't that money pay for the house eventually so you end up with the house free and clear as well as the future rent.

[Mark77]

Sorry to be dense but what replaces the income the renter pays.

Does the renter really provide any net income after expenses? Even at today's all-time lows for interest rates, this investment is barely even cash-flow positive.

Of course, if the landlord does no maintenance, doesn't pay the taxes, etc., -- those items simply pile up and become cumulatively worse to the point where the property's value (ie: ability to earn rent) is severely impaired.

Doesn't that money pay for the house eventually so you end up with the house free and clear as well as the future rent.

Not at the prices involved, and a realistic assessment of long-term interest rates, maintenance costs, etc.

[sods]

Does the renter really provide any net income after expenses? Even at today's all-time lows for interest rates, this investment is barely even cash-flow positive.

Of course, if the landlord does no maintenance, doesn't pay the taxes, etc., -- those items simply pile up and become cumulatively worse to the point where the property's value (ie: ability to earn rent) is severely impaired.



Not at the prices involved, and a realistic assessment of long-term interest rates, maintenance costs, etc.

Mark, what you are really missing is the fact that OP would never qualify for a 190k investment loan... but the banks will give as mortgage assuming normal criteria. So seeing as though you will probably want 25% equity to avoid cmhc fees, after down pmt and fees for lawyers and agents, he probably has 10- 15k to invest. So 2% on 190k is alot higher th a n 7% of 10k. There is a point to be made for the hassles of being landlord vs passive income. I would bet most landlords make minimum wage if they took profit/hours worked.

[662drsdn]

its good to see both sides, im really not thinking i would make a ton of money on it monthly just more so looking to break even yearly and i would be happy, i was looking at it as an investment that someone else is paying the mortgage and at the end i have a free house to sell. But the part im not totally sure about is do i really want the headache of trying to find descent renters, looking after 2 houses and all the hassles of being a landlord.
Thanks for the discussion and feedback, its a really big decision im struggling to make!

[Buy Low]

Mark, what you are really missing is ...

Yes, as well as the fact that OP did not ask for advice on stock market investments.

And also that each person's situation is unique. For example, real estate may be an important method of diversifying a portfolio. Or it may have other attractions for the individual.

Also, what about XIU's considerable volatility?

Besides, in the subject line the OP is considering turning the house into renal property - a Freudian slip that may have provided the answer.

[Mark77]

Yes, as well as the fact that OP did not ask for advice on stock market investments.

Discussing just real estate without discussing alternatives, isn't exactly appropriate. By definition, when discussing real estate, one has to discuss fixed income investments (ie: mortgage bonds), unless the purchase contemplated is going to be 100% cash (which isn't the case here). Because a debt against a house, is an asset to someone else.

Also, what about XIU's considerable volatility?

Housing has volatility as well. Especially when purchased on credit.

edit: I didn't tell anyone to buy XIU. But XIU is a good reference for the Canadian stock market, as the most liquid and investible instrument that one can gain exposure. Being that its not only Canada's largest fund that's available to the public, but also the least expensive from a management fee point of view.