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Cutting Losses in Real Estate

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THE SCENARIO A friend of mine, Jim, bought a house in California for $450,000 in December 2004, which was not too long before the real estate implosion that happened at the end of 2007. The loan on that house is adjustable, meaning that as rates rise over time, the payments will get more and more expensive. Because he bought the house near the top of the market, and because the crash was so deep, the house was worth less than he bought it for until very recently. Now, he's considering selling it, because he thinks the market is near its peak again in the area in which the house is located. Jim lived in the house for four years, and has been renting it to tenants since he moved out in 2008. During the entire time he's owned it, the property has averaged breaking even* on a month-to-month basis. The question: If Jim sells the house in June 2018 for $525,000, and pays 10% (in agent commissions and other costs) to sell the house, what would his return on investment be? Assume Jim put down 20% to buy the house, and ignore things like capital gains taxes and depreciation recapture. To simplify the question, ignore the amortization that has occurred and assume that Jim only walks away from the sale with his original down payment as well as any profit from the appreciation of the house. * The reality of the month-to-month cash flow is a bit more complicated that this. The house has really cost Jim about $800 per month, but the mortgage has been amortizing about $800 per month, meaning that that money isn't really lost, rather Jim's been on something of a forced savings plan. Still, as the saying goes, 'you can't eat equity', so Jim would rather not send that money away every month anymore if he can avoid it.

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THE SOLUTION This one is pretty straightforward. Before we solve it, though, we need to know:

1. how long Jim has owned the house
2. his down payment amount
3. his proceeds from the sale
4. how much he walks away with after the sale

In that order:

1. Jim bought the house in December 2004, and sold it in June 2018. That's 13 years and 6 months, or 12 x 13 + 6 = 162 months.
2. Jim's down payment is $450,000 x 20% = $90,000.
3. The proceeds from the sale are $525,000 - ($525,000 x 10%) = $525,000 - $52,500 = $472,500.
4. Therefore, Jim's profit on the sale is $472,500 - $450,000 = $22,500. Since Jim gets back his down payment when he sells the house, he walks away from the sale with $22,500 + $90,000 = $112,500.

Now to solve the problem. First things first, make sure the calculator is using 12 Payments per Year. N: 162 (Jim has owned the house for 13½ years) I/YR: (This is what I'm trying to find) PV: -90,000 (Jim put down $90,000 when he bought the house) PMT: 0 (The house 'breaks even' every month) FV: 112,500 (Jim gets his $90,000 down payment back, as well as the $22,500 in profit)

Jim's return on his $90,000 down payment is 1.65% per year.

A 1.65% annualized return is pretty weak. In fact, that's an understatement - it stinks. It doesn't even beat inflation. That's why this Money Blog post is called 'cutting losses'. Jim is paying down the loan by nearly $10K per year, but that's money he can't do anything else with, and since he thinks the house is near the top of the market, he's pondering biting the bullet, taking the lackluster return, and seeing if he can do anything better with his $90K down payment (plus the meager profit). He's also eager to no longer have to pay the $800 per month into the house, freeing that money up to do more profitable things (or maybe to relax his lifestyle a bit).

What do you think? Should Jim sell the house, cutting his losses, recouping his down payment with a little bit of profit and stopping his $800 per month 'bleed'? Or should he stick it out, paying the house off entirely in 16½ more years, at which point the bleeding will definitely stop? What would you do? Why? Let us know in the comments!