Tuesday, November 22, 2022

Do I Stay or Do I Go, Now?

When should you sell a property?  Maybe before now!

I recently got some correspondence from our condo association.  We bought this condo years ago so our cleaning lady would have a place to live.  She paid the condo fee and the insurance and it was a break-even deal, and quite a deal for her.  In retrospect, maybe too good a deal.  It was so cheap for her to live there that she delayed returning home to Mexico until she was almost invalid.  Hard to say, of course.  You try to do the right thing, but altruism is always suspect.

Anyway, once she left, we cleaned the place up, painted it, and rented it out.  Since we were not "on site" we hired a management company that wanted the first month's rent as a fee, plus about $100 a month to collect the rent and deposit it to our account.  They also handled maintenance and repairs, using their own selection of expensive plumbers and repairmen.   We made maybe a few thousand dollars one year and then lost as much the next.  At the end of each lease, the tenant would leave and they would suggest raising the rent, which meant the place was vacant for months at a time, leading to more losses.

Our last tenant had cats and smoked and the place was sort of a mess.  The manager guy wanted $5000 to clean it and spray-paint it (spray-and-wipe, I call it - they spray everything beige and then wipe off the overspray from light switches and whatnot - it looks like crap).  So we drove up there and two backbreaking weeks later, it was cleaned, repainted, and carpeted.  It looked crisp and new.  And we found a good tenant who wanted to rent for a year.

One reason we hung on to the place was that they finally decided to tear it down and build new medium-rise condos there.  There were systemic problems with the place as the buildings were sliding down the hill, slowly, due to marine clay, and the infrastructure was over 50 years old and poorly maintained.  Yes, Never Own A Condo!  Condo associations will slash maintenance budgets to get short-term gains at the expense of long-term costs.  And this is a prime example.

At least the buildings didn't collapse killing hundreds.  Well, one balcony collapsed - good thing no one was on it - or under it!  Anyway, they have this horrifically complicated deal going on, tearing down units in stages, selling off land parcels to different developers (there are 22 acres in all!) and some people want to stay to the bitter end, others want to "early out"and leave ASAP.  If your unit is slated to be torn down early and you want to stay, they will relocate you to a unit that someone else wanted to "early out" from.

Well, we thought about it and decided to stay until the end.  That was a few years ago.  Anyway, the condo association dithered and dawdled and the original plan expired and we had to vote on a new plan - and have another opportunity to "early out" - so we did.  In August of 2023, they should pay us about $160,000 for the unit and we walk away.  The tenant's lease expires in June, so that should not be an issue.

Since there are no real estate agent's fees, closing costs should be minimal, if non-existent.  However, if we decided to keep the money, the capital gains taxes would be about $27,000 in Federal taxes and $7800 in State Taxes (!!).  Plus, this would cause us to lose our Obamacare subsidy for at least one year, or another $16,800.  So if we "walked away" and took the cash, we would end up with $106,400.  This is assuming miscellaneous closing and other costs of about $2000.

Why sell?  Well for an asset worth $160,000, we are earning maybe $5000 on a good year, losing money on a bad year (like this one).  Over the last ten years, cumulative, it has been a break-even kind of deal - with no depreciation deduction.  We should have sold it a long time ago!   That money in the bank could have made us a lot of money over time.  Not sure what we were thinking, other than once the redevelopment started, it was kind of hard to sell.

Today, the majority of units are held by investors and as such, regular mortgages are hard to come by - only VA and portfolio-backed loans are available if the unit is less than 1/2 owner-occupiers.  Units that are selling are going for $155,000 or so, minus a 6% real estate agent fee.  So, veterans or cash buyers, basically.

One alternative to paying all those taxes is to do a 1031 or so-called 'Starker" deferred exchange.  After selling the unit, you have 45 days to "identify" a property and 180 days to close.  Your basis in the property is transferred to the new property and no capital gains taxes are due.  If you eventually move to that property and then declare it as a personal residence for three years out of five, you can then sell it and walk away paying no taxes at all.  Nice work if you can get it.

Timing markets is difficult.  But it seems with rising interest rates, real estate prices may drop off in the coming months.  Like I said before, there is a lot of hysteresis in the system, so people are still paying prices that made sense in an era of 3% mortgages, at a time when they are pushing 7%.  Some folks will end up in trouble, no doubt.

Timing markets is difficult, to be sure.  But I am going to take a gamble here that in 2023, $160,000 in cash will buy a nice property more locally to us.  We can rent it out and make a little money and be able to manage it ourselves (which would eliminate about $2500 in management fees every year).  And if it was something we could "downsize" to later in life, it might work out as a tax-free deal.  We could sell our existing house, tax-free at that time.

Worst case scenario, we walk away with a hundred grand in cash, which invested might yield $7,000 to $10,000 a year in income, or spent, would keep us afloat for another three years without having to tap into our IRA.   Or the money could be used to buy a "big ticket" item down the road, like a new roof for the house, or maybe a car someday, when the hamster finally wears out.

First world problems, I know.  But it is funny, looking back at our ownership of this condo, we really didn't "make out like a bandit" on it, as we broke even over the years on the rental income (this does not account for our labor, however!).  Yes, we end up with a capital gain of $160,000 (as we depreciated the original purchase price of $38,000 down to zero).  But if you look at that in terms gain over the 25 years we owned the place, it comes to about $6400 a year.  For an initial "investment" of $38,000, compounded for 25 years at 6%, that works out to about.... $160,000.   Nice steady growth, yes.  Obscene profits?  No.   Of course, the first 18 years were rented out at-cost.   Being "nice" is expensive!

Anyway, we'll see how it works out.  Maybe things will turn around next year and prices will go even higher - and $160,000 will buy you a Big Mac.  Who knows?

It is good to have such problems.