Here’s an awesome question from Bob in New York…
“I own a condo and am looking to buy a second home here in the near future. That being said, I would love to keep the condo, and rent it out as a second form of income.
After doing some research about the renting market in my area, I found that I would only make a few hundred dollars a month from a potential renter.
Simply put, my mortgage and taxes would account for approximately 90% of what a potential renter would be paying. Only leaving me about 10% profit margins each month.
So my question is this… What do you think the minimum required profit margins are when taking on the risk of renting out a property?”
Matt & Joel’s response: I like the way you’re thinking! Renting out that condo certainly could be a money making endeavor. But not every property is created equal and there’s no rule of thumb for minimum cash flow.
Let’s get into some important factors that affect rental property profitability…
Mortgage term and interest rate
The first thing we’d want to know is the length of your mortgage. Is it a 15 or 30 year mortgage term? And what is the interest rate? That would shed a lot of light on the situation.
Yes, the rental would be less profitable on an ongoing monthly basis with a 15-year note. But if you’ve got a great rate, you’ll pay off the mortgage 1.5 decades sooner and still be cash flowing. That’s a potential reason to keep it!
A few hundred a month might not sound like a ton now. But once it’s paid off, you can pocket all that extra cash that would have been going to the mortgage payment. In retirement, that could be a massive amount (not to mention, rents will be higher in the future too).
So, consider how long until it’s paid off and what this investment might produce from a cash flow perspective then.
Maintenance & expenses
Another unknown is the cost of maintenance. That 10% gap you mentioned between your mortgage and the rent amount doesn’t quite tell the whole story. And what about HOA fees?
There will be a lot of months where you won’t be pocketing that gap. In fact, you’ll pocket a fraction of it. Or worse, some months you’ll be in the negative.
Owning a rental property comes with a bunch of costs people never think about. Like vacancy, repairs, and general maintenance. A few hundred dollars doesn’t stretch very far if you’ve got an unexpected plumbing repair or a busted appliance that needs replacing.
You might experience little to no vacancy, which would be great! And maybe you’ll have zero maintenance issues, although that’s unlikely.
Make sure you plan for a potential lull and regular maintenance. It’s far better to plan for the worst than assume things will always run perfectly. That way you’ll have the cash on hand to deal with those issues as they arise.
Cash flow vs. appreciation
Cash flow is certainly important for rentals, and a 10% gap is actually pretty solid. But another crucial factor to think about is the potential for appreciation.
Is your condo in an up and coming neighborhood where you stand to reap outsized returns?
If so, you might make peanuts each year in cash flow over the next decade. But you stand to reap a huge windfall at that point in time if the value rises significantly.
Do you think your condo could realistically grow in value by say, $10,000 a year? If so, that’s an average of ~$800 a month in value you could add to your calculations.
Even though you can’t use that potential profit immediately or live off it like you would with cash flow, it eventually turns into real dollars when it comes time to sell down the road.
As long as your finances can handle waiting for that reward, it could still be a smart move to hold onto this condo.
Time and effort considerations
Do you want to be a landlord? Wrestle with that for a moment.
Owning a rental property is more of a part time job than the “passive income” that most people expect.
Since this is a condo, it’ll likely be a little easier to manage than a single family home. The HOA is typically responsible for exterior repairs, lawn maintenance, etc. So that’s a lot of hassle that won’t be on your plate.
I’d also do some soul searching about your potential ownership timeline.
The cool thing about rental real estate is that the numbers tend to get better over time as rents increase and your mortgage stays roughly the same.
And if you want to hold forever and let someone else inherit this condo when you die, there are some meaningful tax breaks for your beneficiaries because they’ll inherit this property with a stepped-up basis post mortem.
It’s one of the best tax maneuvers ever, but that’s also a LONG time from now. And it involves you dying, which is kind of depressing. Tax breaks shouldn’t guide your decision, but It’s good to know.
Alternative options
Lastly, think about this: “what would you do with the money if you sold the condo?”
Would you hurl it into your Roth IRA and a taxable brokerage account? That’ll be the easy route. Although it’s impossible to predict whether the stock market will be as lucrative as real estate in the coming years. Nobody knows!
By the sounds of your question, it seems like you can afford to buy the new house without selling the old one. But, given the current interest rates, maybe you’d want to sell the condo and use all those proceeds as a huge down payment on the new house?
Putting more down on the new property would mean borrowing less, and having a smaller monthly payment. This would also free up cash flow in your budget to invest regularly.
The Bottom Line:
If you like the idea of becoming a landlord, which it sounds like you do, keeping the condo will be a great first step into real estate investing. Condos are easier than houses, so you’ve got that going for you.
And if you believe in the neighborhood where your condo is located and see meaningful upside, holding onto it can deliver outsized returns in the years to come.
All in all, we’ve got no slam dunk recommendation for your situation. But we’re leaning towards holding onto the condo and seeing how it goes. You can always change your mind next year and sell, or in a couple years. Good luck!
For the full version of this discussion, check out Podcast Episode #874 (it’s the 2nd question in the episode)
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