This past year a family I know was looking to downsize, and with the market at such a high water mark in their area, they thought now might be the best time to make their next move. They found a house they loved, made an offer, and it was accepted. As that process ramped up, they were considering their options: rent their old home or sell it to the highest bidder.
As they got a variety of input from friends, family and their realtor – they struggled with being able to look at the problem objectively, though there were a number of ‘softer’ points to be considered as well.
With these facts in mind, I built a model to help them evaluate the options available to them. Initially, this started as just sell vs. rent; but we ended up running a third trial where the family would take some debt out on the house, and invest the proceeds. They were fortunate enough to have already paid off their mortgage, making this option more interesting to them. While this leverage changes the risk profile considerably, it gives them more exposure to the stock market – as they were feeling over-allocated to real estate if they kept both homes.
When doing some research for this project (and a couple of other modeling exercises), I was disappointed in the templates available online. While there are obvious benefits to creating your own model from scratch – it can also be helpful to have a jumping off point. With that in mind, here is a public version of the model I created:
Walking through the model briefly, the first 30 or so lines are the assumptions that define the outcome. Most of the calculators out there have similar inputs, and they should be fairly self-explanatory. Tax rate info is shown at the federal level, but state-specific information can simply be added on top. The IRS includes an exclusion when selling your primary residence ($250,000 for individuals and $500,000 for couples), I am not a tax expert and recommend reading the tax law if you’re interested:
The model then breaks down into three sections: Sell Now, Rent (No Debt), and Rent (Debt).
Sell Now: The simplest version. You sell your home and invest the proceeds. Investing growth drives this portion.
Rent (No Debt): Gross income from the property is reduced by a variety of typical expenses. You pay taxes on the income and invest the proceeds into the market. At some defined point in the future, you sell your home through a similar process above. Rent and cost appreciation drive this section
Rent (Debt): This option involves taking debt out against your 2nd home, and investing the proceeds. While this is a risky maneuver, the results are interesting. After inputting the value of debt, that value continues to grow as an investment. Depending on the rent levels and loan, you may run an operating loss. This loss will be accounted for in the sell year, but may present cash flow issues in the interim. If the rental does turn a profit, those proceeds will grow as an investment. This section is driven by the delta between investing and real estate appreciation, as well as debt levels.
Good luck! If you have any questions, feel free to send me an email.
Though it should be obvious, it is worth saying: any use of this model is at your own risk.
TD // 8/2/16