Rental Property Conundrum
It’s been far too long since I’ve written an “Ask the Readers” article. Truth is, after almost 20 years of blogging, I feel like I have a very good handle on personal finance. When you combine that with an intimate knowledge of our own finances and goals, it doesn’t make much sense to put a scenario out to the general internet. However, this situation has me flummoxed*.
We have a condo in the Worcester, MA area. My wife bought it before we met for about $150,000. It’s worth around $300,000 now, and the mortgage will be paid off in about two years. We’ve been renting it out since we moved to San Francisco in 2006. The current rent is $1490. We have a long-time tenant in there who rarely says anything to us. The rent used to always be on time, but now it comes about 15 days late. My wife talks to the tenant, and she feels that it’s close to the maximum the tenant can pay.
Realistically, the property should rent for around $1,800. Unfortunately, there’s no way to bridge that gap, and the amount my wife is willing to raise the rent barely covers the increasing condo fee each year. I like being part of the low-cost home solution, but we’ve recently had to rehab our other rental property, and it cost $10,000 more than the most I had estimated. We were making a few hundred dollars a month in cash flow, but it will take a few years to recoup the cost of that renovation. That’s one reason why it’s not great to be way under market.
I’ve run the numbers a few times, and it seems like this property is just a poor asset. It’s way underperforming. What are our options to have it pull its own weight? We don’t want to work so that we can fund a property’s renovations. The property should be paying us, so we don’t have to work. Without the mortgage, this would surely happen, but it’s still not a lot of money for the value of the asset.
So I’m exploring some ideas:
1. Sell the property
If we sold it and invested the money in the stock market, we’d probably cash flow around $12,000 a year (assuming a 5% return). That’s more money than we get now, and it is completely passive. We’d have to pay taxes on it, but that’s not the worst thing in the world.
That said, I feel like the stock market is dangerously high now. I would be surprised if it dropped 25% in the next months. The real estate market is high too, but it seems less volatile. There’s still a housing shortage – at least in this area.
2. Do a 1031 Exchange for a Property in Newport, RI
A 1031 exchange is a way of selling one property and buying another in a different location. The advantage is that you don’t have to pay tax on the sale. The disadvantage is that you have a very limited time to buy. You can’t be extremely picky and look for the very best value.
The advantage of this plan is that we live in Newport and can be better landlords here. Also, we wouldn’t have to pay corporate tax and filing in MA, which is about a savings of $700 a year.
The downside is that there aren’t many properties here available for around $300,000. There are some fixer-uppers, but the pickings are slim in general. Most likely, we’d have to get a property around $450,000. That would require us to take out another mortgage. And that would delay us from earning the best cash flow.
On the plus side, the mortgage would be low, and the rents here are higher. However, in general, it’s better to rent here than buy. That means we still wouldn’t be getting a great value renting it out. If the stars align and the right duplex becomes available, that would work out, but we can’t gamble on that happening with the limited time we have during the 1031 exchange.
3. Do nothing
Doing nothing is an option, but it’s not great. It feels a little like a financial slow-motion time bomb. We’ll get a condo association assessment or need to make renovations at some point, and we’re not able to build up a fund for that.
We could also try to raise the rent, but that would likely mean a new tenant. We don’t want to manage a problem tenant that is a couple of hours away. Then the property isn’t working for us. We’re working for the property.
Final Thoughts
I’ve plugged all of this into ChatGPT and have tons of ratios, metrics, etc. The analytics help me figure out what’s a good deal. For comparison, the condo that we are close to rents for $2500 and is only valued at $325,000. It’s a better deal to get $1,000 more a month for the same $300K-ish asset. We’re not big fans of the condo complex of the one we have here, though. It has some issues and infrastructure problems. Otherwise, we could just repeat that.
One interesting idea that ChatGPT came up with is to do a 1031 exchange and buy a duplex in Providence. It’s not a terrible idea. The numbers work out well, but that’s still a little far for our support system down here to cover. It tried to find a duplex that’s close to us, but off the island. It admits that finding a property in those surrounding towns that is a good fit is almost impossible.
Part of the problem may be that I’m simply looking for something that doesn’t exist. Zillow recently put out a report about how home values are rising in half the country, falling in the other. We’re in a place where the values are rising, so I think it’s tougher to get the same value out of the rent.
So, internet, what do you think?
* Yes, I’m working with my son’s vocabulary in preparation for the SSAT upper level exam.