Novice Investor at a Crossroads: Trade Up, Fix Up or Sell?

Q: I have rented a single-family house to the same tenant for 15 years. The tenant is moving out next month.

I owe $68,000 on the property, and it could sell for $280,000. It probably needs $25,000 in improvements to bring in that much.

I am a novice investor. However, I would like to eventually own an investment that gives me enough cash flow that I could go into partial retirement. This property nets $200 per month. I am trying to figure out if I should do a 1031 exchange and get a four- or five-unit apartment building (which would cost $400,000 to $500,000) or a commercial building. I do not know a lot about commercial property.

I could also fix up my house and rent it out again, or just sell it. If you were in my shoes, what would you do? -- Eric

A: DEAR ERIC: Not everyone can fit in the same shoes, so you have to decide what's best for you. Do you want to continue to be a landlord? Will your rental continue to appreciate in value, or is the neighborhood stagnant? If you decide to get a multi-unit building or a commercial property, will you be able to manage it, or will you have to hire professionals? Even if you go into partial retirement, will you have enough time to deal with the problems of rental properties?

Some people simply decide to sell their investment real estate, pay the capital gains tax and pocket the rest of the sales proceeds.

If you are comfortable with continuing as a landlord, I suggest that you discuss these issues with your financial advisers. Have them run the numbers on the various options, which include keeping your rental property, selling it outright and doing a 1031 exchange. Such an exchange allows you to defer capital gains tax by selling one investment property and obtaining another, following rules set by the Internal Revenue Service.

You should get all of the financial reports on the properties you are looking at. You will want to review the income and expense statements for at least the past three years. Keep in mind that just because that landlord may be making a profit does not necessarily mean you will. You will need to obtain a larger mortgage, which means your monthly debt service will be higher. You should also have a professional engineer inspect the property; for all you know, the landlord has deferred a lot of maintenance, which would mean that you will have to spend a lot of money to bring the property up to par.

You should also review the existing leases. Are the rent levels acceptable? Are you locked into long-term leases with low-rent tenants? Are there any delinquencies?

And finally, your lawyer should advise you on the local landlord-tenant laws. In some jurisdictions, such as in the District, the laws (and the courts) are heavily weighted in favor of tenants.

You say you are a novice. This does not mean you should shy away from investments. What it does mean, however, is that you must have competent professionals advising you. While real estate agents will be helpful, keep in mind that they want to sell you properties so they can make a commission. Your advisers must be independent.

I keep hearing that private mortgage insurance can now be deducted on your federal taxes, but certain dates and time frames must be met. I got my mortgage in January 2005. Can I use the PMI deduction? -- Wesley