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Sell or Rent Out my Home?

I mentioned before that my wife and I are considering moving this spring/summer. If we were to purchase another home, we now have the dilemma of either selling or renting out our current home. Lets weigh in the options:

Sell our Home:

The Positives:

  • This option would give us the equity in our home immediately which is approximately $50,000. This would equate to a larger down payment on the next home and a larger HELOC balance to start the Smith Manoeuvre.
  • Don’t need to worry about tenants/repairs/landlord issues

The Negatives:

  • Missing out on a cash flow and future appreciation opportunity.

Rent Out our Home:

The good:

  • Cashflow!
  • Market rent: $995/month
  • Current Mortgage: $700/month
  • Cashflow: $295/month
  • Future appreciation

The Bad:

  • Landlord issues.
  • Equity trapped in home. I can get some of the equity out with a HELOC, and use this to invest/repairs. This way, it will keep the total debt on the rental property deductible.

It seems after weighing out the options, renting out my current home would be the financially aggressive way to go. I don’t need the equity in the home to meet the 20% down payment requirement on my next home, I can use my savings/portfolio for that.

The only issue being that I wanted to start the Smith Manoeuvre which would will be challenging with a small initial HELOC balance on my new home. Perhaps I can tap into the equity in my existing home with a HELOC, and use that to invest. Hmm.. time to do some more thinking.

Any thoughts?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 31 comments… add one }
  • Mike May 2, 2007, 9:01 am

    If you opt to keep two homes then you always have the option of selling the rental if things aren’t working out as planned. My wife & I were going to keep her old house as a rental but then we spent too much on renos on the new place so we ended up selling it.

    Another thing – rather than lock yourself into a high-cost Smith Maneuvere with an FA – why not just use the HELOC on the new home to leverage investments as you see fit? That you can control the amount of leverage and financial risk you undertake.

  • Financially Motivated May 2, 2007, 10:07 am

    Hi FT

    I may be missing something – but I think given that you will have two mortgages (essentially leveraged investments)you are basically on your way to doing the SM with either option except instead of investing in the stock market, you are investing in real estate.

    Then you need to ask yourself – would you be able to get more than $295.00/month by investing the same money in a different investment?

    What do you think?

    Financially Motivated
    http://www.financiallymotivated.com

  • Investoid May 2, 2007, 10:13 am

    Financially the renting option seems to be a strong choice. However you need to be willing to put the time in to do the ‘landlord’ gig, which in my opinion is more of a lifestyle option than anything. It comes down to personal choice, but as Mike said you can probably sell later if you end up not liking the renting option (provided you’re in a relatively strong market).

  • FrugalTrader May 2, 2007, 10:15 am

    Mike: What did you mean by “high-cost SM with a FA?”. I don’t think I mentioned using a FA?

    FM: That is an interesting way to look at it. I’ve actually considered using the HELOC to purchase more rental properties. So $295/mo x 12/$50k = 7% annual return.

    Investoid:  Good point, but since I already own an investment property, I know what i’m getting into..  sorta. :)

  • bakeapples May 2, 2007, 10:31 am

    So $295/mo x 12/$50k = 7% annual return.

    What about taxes, insurance, maintenance, etc? Got to figure in those expenses.

    The best part of renting is someone reducing your liability at their expense. Once the liability is gone, then your talking cashflow.

  • FrugalTrader May 2, 2007, 10:35 am

    bakeapples: taxes and insurance are already accounted for in the calcuations, but not maintenance. Is there a standard figure that landlords use to account for maintenance?

  • Canadian Capitalist May 2, 2007, 10:37 am

    FT: I’ve never invested in rental real estate mainly because mostly I cannot see the benefits. Take your situation:

    You can get a yield of 7% on your $50,000 investment. Sounds good. But it is gross, not net. You still have to pay property taxes, maintenance and probability that the property is vacant and my guess is you’d be lucky to clear 3%.

    Or you can put it towards your personal residence and save mortgage interest (or earn 5% guaranteed and after-tax). Sounds like a no-brainer to me! If you are so inclined, like Mike says, you can get a secured line of credit to do leveraged investing (with caution).

  • Canadian Capitalist May 2, 2007, 10:40 am

    FT: Just saw your comment. You still have to figure in 1%-2% in maintenance (of entire property value, not just the down payment) and the probability that the property is vacant (say 5%. I made up that number as it depends on demand in your area).

  • FrugalTrader May 2, 2007, 10:46 am

    Good points CC. These comments definitely put a new light into my evaluation. Thanks!

  • S. B. May 2, 2007, 11:42 am

    I generally agree with CC. I’ve run the numbers on many, many properties in my area. In all cases, after you factor in P&I, taxes, insurance, maintenance cost, and vacancy rate, the returns are extremely unimpressive. Compared to the average property in my area, you would definitely be better off with equities or even a CD. The only way to make the numbers work out favorably is to assume the property will appreciate substantially — something I’m not willing to assume after the run-up of the last 10 years. And frankly, if you’re that certain about real estate appreciation in an area, you might just want to invest in a good REIT that specializes in that region. It would be a lot less hassle and a lot more liquid.

    Anyway, after having said all that about the average piece of property here, I agree that real estate markets are not that efficient, and so, yes, there will always be the chance to get a good deal on a particular piece of property if you look long enough…but that’s not my cup of tea. From an opportunity cost standpoint, I would probably be better off spending all that time trying to increase my returns on my equities portfolio or to increase my pay at work.

    And of course, not every region is as overheated as the U.S. coasts currently are…

  • David May 2, 2007, 12:05 pm

    We passed up a well-priced opportunity to purchase a rental in our neighbourhood, due to the concerns addressed above. We are now kicking ourselves, as it seems to have come together for the ultimate purchaser. They found an excellent tenant who was looking for a child-friendly neighbourhood, and RE has taken off since. Thus, IM(not so)HO, it depends very much on how risk averse you are.

    I’m still trying to determine how to invest retroactively in the markets, so I can apply my 20/20 hindsight!

  • Mike May 2, 2007, 12:11 pm

    Sorry FT, I shouldn’t have assumed you would be using a FA for the SM. You are way too smart for that!

    I guess the big risk with any leveraged investing (houses or equities) is interest rate risk. If the rates go up substantially then it’s safe to say that the equities and/or house values will go down which means you have to be able to handle the potential negative cash flow since selling won’t be a good option.

  • Blain Reinkensmeyer May 2, 2007, 12:27 pm

    I don’t know how the market is there, but here it is horrible and it doesn’t matter how bad you want to sell your house, you probably aren’t going to get it sold! Which in such case it would be better to lease it out for a year or two and take the cashflow.

  • FinancialJungle.com May 2, 2007, 1:52 pm

    Although I’m not a fan of real estate investing, the numbers look pretty good. Note that the 7% is cash flow before appreciation. I understand the 7% is based on the down payment instead of the whole house, but in Vancouver, leveraging will decrease your yield because mortgage rates are greater than rental yields for most houses. The more you leverage, the less cash flow you get.

    The yield is there, but question is what’s is the rate of growth when compared to infation? When you buy dividend paying stocks, you get the tax credits, and can expect 6-10% dividend growth.

    By the way, the rule of thumb I use for all expenses (tax, maintenance, insurance, etc) is 33% of the rent, but that will differ depending on the neighbourhood.

  • The Hubby May 2, 2007, 2:23 pm

    I think it really depends on your situation. If you pay a lot of taxes, and you get more benefit from the smith manoveure, then sell your house and put the money in investing. I wouldn’t use a heloc to do trading. I’m currently doing that. My Heloc interest rate is at 8%, so I have to invest pretty aggressively to try to beat that. There’s a lot of stress involved. Using a heloc for trading cuts into your emergency money because once you put the money into some investments, sometimes, when you need to liquidate your investments, it is not the right time to sell, like when a stock is down, and you’re waiting for it to go back up. If you have multiple houses, it is also harder to qualify for more mortgages because debt to income ratio increases.

    Landlording is hard work. You have to worry about people trashing your place. Sometimes, the tenant won’t pay rent, and you have to evict them. Chances are you will not break even by renting. Worse case scenario is 3 months of vacancy. And I notice you didn’t put maintenance costs and property tax and insurance as expenses.
    Assign a cost to the amount time and work you have to maintain the property and collect rent. You’ll be looking at negative income.

    Do Canadians get a tax deductions from passive activity loss just like us Americans? Are all expenses for rental property deductible? If that’s the case, then that might be an important factor in your decision.

    You also must look at the appreciation rates of your property. If your property values have a high appreciation rate, like 16%. Then definitely worth it to keep it. The appreciation makes up for all the expenses even if you take a loss every month. But if the appreciation rates is really not that good, then sell the house, and rebalance your portfolio so that you have more investments that are earning you more money.

  • FrugalTrader May 2, 2007, 3:18 pm

    As a general tone of the comments, it seems that most feel it would be better to pour my money into equities than to use the same cash for real estate. Interesting.

    Hubby: To answer your questions about Canadian taxation, yes, we get tax deductions for investment interest expenses and rental expenses. Do you have a rental property portfolio?

  • Canadian Dream May 2, 2007, 3:47 pm

    FT,

    Sounds like you thinking about going with equities anyways, but here my thoughts.

    First a few questions for you. How much of your total money is already in real estate? (If I recall correctly a fair amount) Do you really want to increase that in your local real estate market or not?

    I find most people like the idea of renting out a second property, but reality tends to be a bit different. I agree with SB’s idea. Get a REIT if you want a real estate investment. A lot less work and a lot easier to get out of.

    CD

  • ThickenMyWallet May 2, 2007, 5:32 pm

    I agree with Hubby’s first point and Financial Jungle- what will rental income, even after tax deductions, do to your income tax situation?

    Would you not be better off investing into dividend stocks and taking advantage of the tax credits plus superior ROI?

  • NWTInvestor May 2, 2007, 8:49 pm

    I just recently sold my rental property in Paradise, NL which is close to you as I understand it. The property also had positive cashflow on paper as you’ve suggested, but you have to really take a hard look at it.

    The rental market in St. John’s area is going down the tubes with the various mortgage options out there recently. You’ll have no trouble renting a basement apartment, but the upstairs can be a nightmare. Add in vacancies, appliance and other repairs/replacements, taxes, etc. and it isn’t worth your trouble IMO.

    I have several friends and relatives in the same situation. Despite having 1 year leases, tenants seldom even stay longer than a year, many much less.

    Good luck.

  • QCLandlord May 2, 2007, 10:07 pm

    I’m surprised that nobody has mentioned yet that if you rent your house, the rent amount is added to your income and is taxable. Sure you can deduct various expenses (taxes, utilities, insurance, interest payment on your mortgage but NOT the capital, etc..), but still you might easily end up with a negative cash flow…

  • Q Cash May 3, 2007, 8:14 am

    FT

    I made a lot of my net worth through rental properties and real estate. While I was in my 20s, being a landlord was not easy, but I had the time and energy to deal with most of the issues. Now, I think RE is a PITA.

    I still have a couple of rental properties, but I am holding on to them to do some future development, not because I enjoy being a landlord.

    However, there is one thing that some of people above looking at the annual rate of return are missing and that is the gain in value.

    If you can cash flow a rental property in a good area where property values are jumping, it can be a good long term investment.

    If, however, you are just scraping by, I would buy into a REIT rather than an individual property. Returns plus capital gains, plus no PITA, plus better diversified than just one area/property.

    My $Q.02

    Q

    PS One final thing, if you are thinking of starting a family, don’t do rentals. Tenants seem to have no problem calling you in the middle of the night when the toilet is clogged.

  • Warren May 3, 2007, 12:41 pm

    As a landlord I’ll add my 2 cents:

    Obviously property appreciation is important. Most urban markets in Canada look high and the downside risk is large. But I think you’re in a smaller town right? You’d know best about your own market.

    I own a relatively new apartment in a large tower. There is a standard maintenance fee, and very little requires my intervention. This is much more ideal than renting out an older single family home, which may be fine for months, then suddenly have more serious problems (flood, roof, furnace breakdown, etc.)

    Rental property works for me, but I think a lot of that has to do with little work on my part and an accurate estimation of expenses (maint fees, taxes, little else).

  • SavingsJourney May 7, 2007, 9:00 am

    I think you need to consider it from a long term perspective for it to work to your maximum benefit. Consider that you’re also profiting from inflation – your mortgage principle never increases due to inflation, but your rental fees do! You perhaps pay costs that rise due to inflation such as maintenance & repairs, water / heat, electricity, but the more stuff like that your tenant pays for the more you can in theory profit from inflation. Wasn’t sure if the #’s above take this into account.

  • FinancialJungle.com May 7, 2007, 1:04 pm

    The mortgage principal does increase faster than inflation, only that the homeowner keeps paying it off with new money. In a normal market, rents are less than ownership expenses; therefore renters who are discipline can invest the difference, which produces income to partly offset their rents. I belong to the second group, because Vancouver is hopelessly overpriced.

  • Frank July 18, 2007, 3:19 am

    If you are turning a profit monthly and not using the SM, then you also have to consider the thousands that are being paid off your principle each year by the tenants. That actually works out to a much better return on investment than the $295/month profit he is mentioning. I have a rental property with around $400/month positive income, on top of the fact that over $4000 of the principle on my mortgage is also paid off yearly. In this case it’s money I can’t really touch, but it seems to work fine for me. I just like to consider my rental property as a savings account.

  • Andrew September 18, 2007, 2:05 am

    I decided to rent my condo when I bought a house. I went through a lot of analysis and developed a spreadsheet model to help. This model will give you before and after tax NPV, IRR, Cash yield, cashflow, and income forecasted 25 years in a nice graphical form. All of the numbers update automatically based on your input data. My condo flows negative cashflow for the first couple of years and then starts to go positive, however it gets about an 10 to 12% IRR in the first 5 years. Not a bad investment if you ask me, considering that I am leveraging a $70,000 down payment for a $280,000 condo investment. Can’t do that with stocks. If you’re interested in the spreadsheet email me at ajmccaus(at)gmail.com

  • gene October 29, 2007, 10:42 am

    I’ve done some RE investing and I can tell you that 295 positive cash flow will actually be zero or negative. My humble suggestion is to sell. The debate should be whether it’s best for you to increase your down payment with the proceeds or send part/all of proceeds to alternative investments….and that’s very difficult to answer. if you are young-ish and have investor mentality, comfort with leverage, and decent credit, it’s quite possible you’d be better off borrowing more.

  • Katherine November 20, 2007, 5:41 pm

    Reading your different perspectives and about your comfort levels has been interesting. In this real estate market some of you have overlooked the ‘VALUE’ of the investment. In all my research and reading; it is important to look at ‘VALUE’.
    I purchased an investment condo 6 years ago for 200,000. In today’s market (just like a stock) it is valued at $650,000. That’s an increase of $400,000 or $66,000 a year. The rents have covered my expenses thus that works out to about 33% a year.
    Call it luck, the market, timing. Even after capital gains and taxes I will be much further ahead in an area I am comfortable and familiar with. Plus I feel have more control over this investment than a stock I am unfamiliar with.

  • Matt March 10, 2008, 1:52 pm

    Seems I am late to this conversation…

    One thing I note with many of the naysayers to rental properties is the increase in taxable income. While this is true what I do with a good chunk of my monthly cashflow is invest in my RRSP. This helps cancel the tax bill and usually ends up being a substantial refund at the end of the year due to all the other expenses of rental properties.

  • patty moore September 24, 2012, 8:44 pm

    I own a home in Peterbough that used to be my principal residence, Ontario and my principal residence in Toronto where I now live used to be my income property.

    I can afford to keep both …but not sure if the income properties would appreciate in Peterborough…have lower my asking price by 30K

    please help with any insight.

    patty

  • Avtar December 4, 2012, 8:43 am

    Hi.I just moved out from Canada and I have my house in canada so can any one help me what should I do (sell it or rent it) because selling market is down so if some one know about any agent who can help in renting because may be after 2years I will be back to Canada. Thanks

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