Latest posts by FIRECracker (see all)
- Should the Government Mess with the Housing Market? - April 24, 2017
- Reader Case: Pay Off Debt or Invest - April 21, 2017
- Why You Should Let Your Kids Fail - April 17, 2017
Since it’s been FAR too long since I ranted about housing (aka 3 whole days), I’m going to break that dry spell with a case study from a reader in Montreal (post has been edited for brevity):
“I have been in the housing market for nearly a decade, moved from Edmonton to Montreal, and owned property in both cities. My employer recently threw down the gauntlet and said “hey, we need your skills at the mothership – please move to Toronto.” I am likely to move because the opportunity is interesting, and I am in the process of negotiating the package. The core of my dilemma is this.
I am virtually mortgage free in a downtown Montreal loft, living a car free existence, walking to work. If I move to Toronto, I have zero intention of buying property in that effing-ludicrous market. Assuming I move, I will rent in Toronto, and am struggling with what to do with my condo? Do I sell my condo and invest the 325K and enjoy both market appreciation and dividends, or do I become an absentee landlord, hire a property management company, and enjoy a passive income stream of rent (which is more than I could generate with dividends)?
Condo market value is 325K. The mortgage balance is 50K at 2.19%. I essentially consider it paid off because I have 56K in cash earning 1.75% in a TFSA. I know that’s not an optimal position to have all that cash, but I figured I was just going to pay the whole thing when it comes due next October. I struggled between having an emergency fund and paying off my mortgage faster, so I was willing to bear the opportunity cost of a 0.44% spread to have the best of both worlds.
Current costs are:
$254 per month condo fees
$187 per month property taxes
$42 per month school taxes
$36 per month owners insurance
$60 per month for hydro
My mortgage payment is $318 per month ($172 principal and $142 interest), and I max out all prepayment privileges every year.
When I had the assessment done, I was advised I could rent it for 1400 per month unfurnished or 1600 per month furnished.
What should I do?”
Well MD, I gotta admit that is some NICE debt murdering. You murdered the SHIT out of that debt. I would wager you are the MURDERIEST MURDERER who ever MURDERED a…
Aaaaand now the RCMP just emailed me saying we’re both on their watch list. Sorry about that, buddy.
Anyhoo, onto your question. To hold and rent or sell and invest? The age old question, which we shall answer by…
MATHING THIS SHIT UP!
Okay, so MD has 2 options to choose from:
1) Keep the condo and rent it out
2) Sell the condo, invest the proceeds
Scenario 1: Keep the condo and rent it out
Costs = $254 + $187 + $42 + $36 + $60 + $318 = $897/month
Wow! That’s as low as our rent was in Toronto. Pretty good deal right? Okay, let’s see what happens if he rents it out.
Rental income is $1400/month – $897/month = $503/month or $6036/year. And since the condo is worth $325,000 and his home equity is worth $275,000, that’s a return-on-equity of $6036/$275,000 = 2.19%
Yeesh. Considering the high interest rate savings account we’re currently using pays 2.25%, that’s pretty shitty. So if he actually SELLS the house now and shoves all his money into a savings account, he’d get better returns.
Now, we also know that he has $56K sitting in cash…enough to pay off the rest of the mortgage. So what happens if he does that?
Costs = $897 – $318 (principal + interest) = $579/month
Rental income = $1400 – $579 = $821/month or $9852/year.
Cap Rate = $9852/$325,000= 3.03%
So paying off the mortgage dropped his monthly cost by $318, pushing up his cap rate to 3%. But is that good? I mean that 3% would still get taxed as rental income, which isn’t taxed as favourable as investment income. And we haven’t even taken into account the cost of hiring a property manager! Which MD will need since he’ll be living in Toronto and won’t be around to deal with the tenant.
So already we’re looking at returns of 2.25% – 3% (depending on whether he pays off the mortgage) and we still have to subtract the costs of a property manager. Not good.
Let’s see what happens if MD invests instead.
Scenario 2: Sell the condo, invest the proceeds
If MD were to pay off the mortgage and sell it, he’ll need to subtract closing costs:
Real-estate agent: 0.05*$325,000= $16,250
Lawyer fee: $500
Closing costs: $16,750
Total earnings after fees would be $325,000- $16,750 = $308,250
Assuming a conservative average return of 6%, that would be $18,495/year. Comparing that to his rental income of $9862/year, that’s almost double!
Even if you were to ignore the capital appreciation and only focus on the dividends, his assumption of “enjoy a passive income stream of rent (which is more than I could generate with dividends)?” holds as much water as a submarine with a screen door.
At an ROE of only 2.25-3% from paying off the mortgage and renting the condo, that’s similar to the dividends generated by a 60/40 portfolio! And since you have to subtract the cost of a property manager, and dividend income is taxed more favourably than rental income, the spread is even bigger than you think.
So in MD’s case, I see no reason why he would want to keep the condo and rent it out at that rental price. I would need that rent to double to pique my interest, so unless he wants to have shitty returns just for the sake of owning something, I’m going with selling that sucker.
But those are my thoughts. What do you guys think? Chime in in the comments below.
UPDATE: Here’s what MD actually decided to do:
“Thanks for the thoughtful analysis FC. I reached the same conclusion as you, though your calculations are more accurate. I completely overlooked the return-on-investment component expressed as a percentage (duh).
For those that are in suspense as to my decision (yes, the world CLEARLY revolves around me), I have put my condo on the market. What I have had a harder time with (arguably), is the shift in mentality from being an “owner” to being a “renter”. While the numbers make more sense to me, I have become irrationally comfortable in having my equity tied up in a piece of real-estate, because I can live in it, touch it, and marvel at the exposed brick and roof top terrace with a downtown view. My financial psyche is still influenceable by emotions, even though I know that is anathema to financial success.
I have started focussing on some of the positives in making this choice:
– Blowing away that piddly mortgage I have means 0 debt. Period.
– Enjoying a Montreal-metric-shit-ton(ne) more flexibility than if I kept owning. I can pursue other opportunities – either with my company or along another venture – at my own pace with a lot of financial runway.
– Greater liquidity than with real-estate, which is important to me in case that Montreal-metric-ton(ne)-of-shit should hit the fan. The mental cushion of a relatively liquid portfolio is comforting.
I was also able to work out an equitable arrangement with my employer when it comes to relocation that keeps me whole, especially because they asked me to break up with the city I love. I know a lot of corporate cultures mistreat/underestimate their workforce, particularly millennials, but I count myself part of the lucky corporate whores out there: I am well treated, well compensated and am truly engaged in my work, all while building my portfolio. Yes, this is a business relationship and one day my employer and I may part ways (either voluntarily or involuntarily) – this emerging liquidity makes taking this career risk a lot easier to deal with despite moving to stoopid expensive Toronto.
Wish me luck guys!!”
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