Our Rental Property – Should We Sell?
Case Study Key Takeaways:
– The folks in this case own two homes: their primary residence
– The rental property has $125,000 equity and $310,000 value
– They make $90,000 gross income per year and live month-to-month with $5,000 monthly expenses
– They have $200,000 in retirement savings in a 401(k) and are 59 years old
– They project to receive $4,650 in monthly Social Security income at full retirement age
– They have $50,000 in credit card debt
– The rental property breaks even when rented, but requires dipping into savings when vacant
– The person may need to address spending habits that led to the credit card debt.
– A financial planner might be helpful.
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Our Rental Property – Should We Sell – Transcript
Sell Our Rental Property?
Case Study Transcript
Tim, Tom, thanks for hopping on. We’ve got another case study here. So I am going to do a lot of talking again upfront and spell it out for you guys, and then we can discuss our thoughts on this person’s situation.
This person owns two houses: a primary residence and a rental property. They have $125,000 worth of equity in the rental property. It is valued at $310,000. They currently have renters in there that pay $2,500 a month, and that covers the mortgage payment and the homeowner’s fees associated with the property, but they are not making any money on the property.
It’s rented now, but when it’s not rented, they have to dip into savings to cover the costs. Outside of the rental property, this person makes $90,000 of gross income per year and they’re living month to month. Their expenses are about $5,000 per month. They have $200,000 in retirement savings in a 401(k). I believe they’re 59 years old.
This person projects to receive $3,100 a month in Social Security at full retirement age. His wife gets 50% of that. So you’re at about $4,650 of retirement income when that time comes, and they have $50,000 of credit card debt. So what jumps off the page at you guys here? First thing that jumps off the page for me is when someone says that they have $125,000 in equity and that the value of the property is $310,000.
According to who? These are squishy numbers, and not to be believed. Really, the only way you can tell what something is worth is when you get an offer in hand to buy an asset from you. That’s the only time you’re really going to know for sure what the value of something actually is.
It really comes down to what someone will pay for it. Doesn’t matter if we’re talking about individual bonds or if we’re talking about real estate or raw land. It really comes down to what kind of offer do you have in hand. Otherwise, we’re all just speculating about what the value is. And if you have to guess on what the value is, then you’re only guessing on what the equity is. So yeah, guessing. Maybe there’s some sort of online estimator or Zillow.
All these different real estate sites give you your projected value there. Maybe there was an appraisal done. We’re not sure how this person’s valuing their rental property, but you’re right in the sense that you don’t know until you get an offer on that. One of the benefits and also one of the downsides is you’re not watching the value of your house increase or decrease every day like you do in the markets. But then when it comes time to sell it, you’re not exactly sure how to value that because that price discovery function isn’t there like it is for stocks or ETFs.
I think one of the things for me going back to this situation that jumps off the page is the fact that when they’re not renting the place, they’re dipping into their own savings to cover the costs. Especially if they’re thinking about retiring at some point, having to do something like that in retirement makes it even worse because then you’re dipping into your savings and you’re not earning income from your regular job too. So it’s kind of a double whammy at that point.
It sounds like from a monthly perspective with Social Security, the two sources combined, their income is gonna cover a lot of what they have to cover in retirement. But just looking at going through the process at least of trying to figure out what the value of the house might be, what the rental property might be, then you can really get more firm in terms of the amount of what if you were to sell the house, what you might be able to then add back into your overall retirement portfolio.
Like you were saying, you don’t really know what the price is gonna be until you list it. But when you list it, you can see if offers are coming in, see if they’re lower, see if they’re higher. No one’s forcing you to sell the house at that point. They could just take that for what it’s worth and then have the information to say is this something we actually wanna do, is the offers in the ballpark, the ranges of what we are looking to get for the house.
But I think adding a big chunk of money to that retirement balance could benefit them in retirement, especially if they’re having to dip into savings to cover costs in retirement. That doesn’t sound like a great idea to me.
I think I’d wanna know more about the purpose for owning the rental property. Like, is it just because you wanted to own property because that’s the investment you know, like property goes up in value over time like it has, or is it, you know, a lot of the time when you have a rental property, the idea is you’re getting passive income. You’re getting some amount of income each month that’s coming in you don’t really have to work for.
But in this case, it sounds like they’re not earning anything above and beyond the expenses that it’s costing them to finance the house and maintain the property. So I’m not sure the value there. It doesn’t sound like there’s a lot of value there from an income perspective. So I’d wanna understand more about that.
Sometimes for people, we run into a handful of situations where it’s not all just dollars and cents value for people. Like it’s a vacation home that they use for three weeks out of the year and then they rent it. But they really enjoy taking those family vacations there. So that again, we don’t have that information. So there could be some sort of emotional tie to this house.
But yeah, just from a dollars and cents perspective, if you’re hardly breaking even, I would like to know as well, you know, how often is it rented? You said when they’re not renting it, they have to dip into their savings. Is that like four weeks out of the year or is that six months out of the year it’s not rented? You know, how often do they have to do that? Or is it something where it’s consistently being filled with renters ten, eleven months out of the year? All those things I think would factor into the viability of keeping it for the long term or deciding to move on.
So I think again we need more information, but you just reminded me, Tim, when you talked about how long is it rented for. They have to be mindful of the Augusta rule, where they have I think it’s a fourteen-day limit, something like that. The other part of the question that I think I would follow up on is this: maybe this is a retirement home that you plan to retire to at some point down the road.
That’s a good point too. This may be why they’re keeping it. It seems like a struggle. The other point in the details – we got limited details on this – but they reported a $90,000 gross income. And I know the both of you, the first thing that we do when we’re crunching the numbers is we break that down into a monthly gross number and then we start looking at okay, how much tax are they paying on this?
And let’s try to get to a monthly net number and then apply the expenses that we know about before we can help them make a decision about whether this is something they should keep or something they should hang on to.
Yeah, I think something that’s fine on another radar here is the $50k in credit card debt. To me, that suggests that they’re probably spending more than they’re making. I don’t know if that’s related to the rental property or not. But one idea is you sell the rental property. You take the net proceeds from that and pay off credit card debt, maybe pad the retirement savings like you said, Tim.
I do wanna point out that since, you know, if they do sell a rental property, it’s not their primary residence so that will have taxes. They will have the full capital gains tax on there because they won’t qualify for the primary residence exclusion for married couples that is $500,000, right? $250 per person.
I feel like a lot of times it’s almost definitely gonna be worth it to pay off the credit card debt because the interest rates you see on a lot of credit cards are most of the time pushing 20% or more. So you’d have to really outperform in the market to break even on that.
The trap in that is that people are now starting to get these zero percent interest offers. And I’ve been around long enough where people have actually called me over the years, years ago, and said, “Hey, I can borrow money on my credit card for six months or twelve months at zero percent. What can we do?” And honestly, I wanna just hang up when they ask me that.
And then that gets into some of the behavioral issues of how you got to the credit card balance in the first place. And then if you’re paying it off with a lump sum, you’re not really addressing the issue. You’re kind of just wiping the slate clean and then the habits that got you into trouble in the first place are still there. But that’s a different video we could do all on that alone.
And $50 grand is not a little amount. It’s, you know, for someone who reports a gross income of $90,000, more than half of your income is what you have on a credit card. It’s a lot. But it’s gonna take years to dig out of that. I mean, this person’s 59. I think their full retirement age is gonna be 67. So, outside of taking a lump sum to pay off the credit card debt, it’s gonna take maybe until retirement to make these credit card payments, and not adding anything on top of that is gonna be difficult in this situation.
If they don’t sell, yeah. I don’t wanna say that the lump sum is a bad idea. Like, they should still do that while they have the option to do it. It’s just underneath or after you pay off the lump sum, maybe just kind of sit back and reflect on how you got there.
I think the Dave Ramsey instant fix answer to this question would be it’s easy: sell the property. Take that $125,000 in equity, get rid of the credit card debt, put some money into an emergency savings account, and for goodness’ sake, change your habits in terms of spending, or find ways to make more money to match it.
So, yeah, those are all good ideas. I think, you know, this person they’ve got a ways to go until retirement, but couple big decisions for them to come up, to make sooner rather than later hopefully and not let that credit card debt spiral any further out of control.
Does this person need a financial planner?
I think they do. I don’t know if they need one in the way that we work with people in an ongoing capacity. They might not need somebody in that sense, but I think maybe trying to find an hourly planner you can run all of this by them and maybe get an hour or two of their time and just to bounce the questions off of.
But I think they could definitely benefit. I think it’s something that they might be able to figure out on their own. But you know, it couldn’t hurt to get some expertise there, but I don’t know if they need to engage in an ongoing relationship with a planner and investment management or anything like that.
I feel the same way. Don’t wanna layer on any more costs. I think it could, you know, I think the fact that this person is writing in and asking this question, they probably have some inclinations as to what the answers are to their questions. They just maybe want confirmation that they’re thinking along the right lines.
I don’t know if that’s necessarily worth it to pay someone for. I think, you know, it’s… I don’t wanna say it’s self-evident or self-explanatory when you’re in credit card debt like that. It is hard to dig out and you might not see paths out of it, but I think the answer is simple. It’s not easy. I think the answer is you know, live below your means and make some cuts or make some more money.
Like I said, they’re simple solutions but they’re not easy to do.
But I’ll also say simple for us because we’re on the outside looking in and this is what we do. Right. So, I mean, we just rattled off a number of different considerations that didn’t come up in the questions that they were asking. So there are things that we think of as professionals that they might not even consider, that could really impact things. So it could be worth the time.
To be fair, we’ve had people come in and meet with us who are in situations like this. And they wanna know how can they improve the performance of their 401(k). You’re asking the wrong questions, not even on the same planet.
