Enough Wealth asks:
When you say “I am underwater on my mortgage. I cannot possibly sell my condo right now. Renting is my best option.” Is that simply because you would make a loss by selling up (eg. have to take out a personal loan to settle the mortgage balance)?
If so, think through the option of taking a known loss now by selling up, and compare it to what may well happen if you hold onto the property and rent it out. What would you [sic] situation be like in five years time if the property value is down another 10% from here, and rents also drop during the recession while your mortgage repayments stay constant?
Imagine that you didn’t already own the house – would you want to buy it at the current price as an investment rental property? If not, the why keep it now? The money already lost is a ’sunk cost’ and shouldn’t be allowed to influence your decision making.
Making rational investment decisions where a loss would be crystalised is one of the hardest things to do as an investor.
Interesting questions.
1. I live near Washington, DC. While property values are down, I am actually in an area that has been targeted for development. I believe in 5-10 years my property will return to its original purchase price, if not be more valuable, so I’m not interested in locking in the losses now. To answer the question of buying my apartment now at the current market price, yes, I would be interested in buying it for the $85-95K it is worth now.
2. Rents in DC are softening, but not dropping hard. DC has inelastic real estate demand in the city center. I am in a good area with a reasonable commute to downtown as well as outlying suburbs where government agencies are relocating post-9/11. If I could get rid of my 2nd trust, the prevailing market rent would cover all of my monthly recurring costs. (But not the renovation.)
3. On balance, after running the numbers, I believe I get a reasonable return by taking a tax loss for the next 5 years. That will allow me to:
A. Ride out the down real estate market.
B. Wait for the city to do its development/planning mojo.
C. Confirm plans for a new light rail within blocks of my apartment.
D. Keep building equity.
If I sell now and take the loss, I’ll have no upside whatsoever except a one-time tax refund that won’t cover the interest I’ll be paying on a personal loan to cover the loss (the “selling up” to which he refers). Therefore it really is better to rent out the condo for the moment. Either way I’d have to renovate and losing the opportunity to recoup the cost really bugs me.
One thing to keep in mind is that I bought close to the peak of the market in 2004 in an underappreciated neighborhood. I bought my unit fairly cheaply compared to my other neighbors who purchased later. I actually had quite a lot of room to fall because there was 20% appreciation by the time the peak of the market came around in 2007. What shocks me are the foreclosures and short sales for similar condos which now show me at a -25% loss over my original sale price. I’m inclined to ride out the market because I think there are very good prospects in the future.
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