I recently consulted with a couple who are renting a home in Pasadena. They own a home in Tujunga, but instead of selling it when they moved last year, they decided to rent it out, even though it represented a negative cash flow of $500/month.
Why not wait to sell until the market ‘recovers?’
Their loan broker referred them to me when he realized what they were trying to accomplish would be impossible through conventional means.
Given the economy, and the fact that his wife was struggling to build a new business for herself, they wanted to refinance the home (now investment property) so they could pull out $20,000 to put in savings for a rainy day. It would also help subsidize the negative monthly cash flow.
They bought the home for $250,000 and refinanced to a loan amount of $315,000 when the value exceeded $600,000 at the top of the market.
Loans can be hard enough to get for owner occupied dwellings, but investment property cash outs are even harder. And, of paramount importance is the fact that the value had dropped to $450,000 . . . or so they told me.
When I did the comps, I came out with a market value of $350,000 . . . oops. Yes, there was one new construction that sold for $450K, but several REOs and individually owned properties were selling between $320K – $365,000.
If they put it on the market and sold at $350,000, they’d probably be able to pocket $10,000 and eradicate the $500 a month soak from their bank account.
But, ouch . . . selling at a ‘loss’ is hard to swallow, isn’t it? Wait, but they bought for $250K, so they’re actually up a hundred grand, right?
Nope, that’s not how they see it. In their minds, the property ‘should’ be worth $600K, so selling at $350K, they’d actually be taking a $250K ‘loss,’ which, of course, is unacceptable.
I ran some numbers and showed them how they could possibly inch the purchase price closer to $400K if they were willing to offer terms to the next buyer by leaving their (very attractive) existing financing in place.
Using that strategy, they could have pocketed the $20,000 they wanted, and they would have had a positive cash flow of $500 per month. They could also have created an equity sharing agreement that would have let them participate in any appreciation down the road.
In my mind, it made a lot of sense. Most people shouldn’t sustain unnecessary negative cash flow when they’re moving into uncertain economic times, personally and globally.
Ultimately, they decided to do nothing, partly because if they put the house on the market, the tenant might move out a month too early and cost them $1,700 in lost rent.
Hmmm . . . I must be bad at math.
And partly because they, like so many others, are determined to ride the market out until it ‘recovers’ so they don’t have to suffer the humiliation of a loss.
But let me ask you something . . .
When you’ve ‘recovered’ from a hangover after having too much to drink the night before, do you feel all tipsy and high, or do you just feel normal again?
Recovery is not the same thing as re-inflated bubble.
It’s highly probable that some time in the next 3 years this couple will find themselves under water, and not have any exit strategy (save a short sale) if they run out of money to subsidize their ‘investment.’ Bummer.
And even if the price comes back up to $450K, it’ll most likely be the result of inflation and won’t represent real appreciation, because by then they’ll be paying $19.50 for a cappuccino.
If you liked this, why not sign up for the feed?