Reading the comments to my blog posts over the weeks has been amusing, infuriating and sometimes enlightening. The most commonly repeated advice to me is that if I can’t recognize how fortunate I am to own a rental property in the District, then I should sell it. I won’t lie; selling has certainly crossed my mind many times and writing this blog has accelerated my thinking about the wisdom of my apartment as an investment.
The timing certainly seems right. The current tenants probably will only stay one year, two at the most, so I would not have to worry about displacing the tenants.
And the real estate market is heating up in the District again. It may not reach the heights of 2006, but the value of my Dupont Circle condominium is probably close to its peak.
Moreover, the risk entailed by waiting is growing. If one believes the reports in The Post, many more apartments are coming on line in the next several years to meet the demand for rentals so supply will be robust. And on the demand side, rock-bottom interest rates and a restored faith in the housing market may drive more people to buy homes and cease being renters. If this scenario plays out, rents certainly could stagnate — if not decline — in Washington.
As I have stated before, it is a hassle to manage one’s rental. I don’t particularly enjoy it and living more than 1,000 miles away compounds the difficulty. Being able to shed the responsibility and worry of management would certainly make my life easier.
Moreover, selling would give me a way to fully tap the equity in the property. I bought the apartment in 1992, and I’m confident that I can sell it for three or four times the price that I paid for it. Even after paying back the mortgage and capital gain taxes, I would come out with a healthy slug of cash. That would certainly come in handy as my girls will be going to college in the next few years.
In contrast, as an actual income-producing property, my apartment has not performed well. Blame the numerous refinancings and rising expenses for sapping cash flow, but the apartment is only earning a 5 percent return based on its current cap rate. (Real estate investors use a metric called the capitalization or “cap” rate, which is the annual net income divided by the value of the property. The metric tells you your rate of return on capital and helps measure real estate against other types of investments.) Even if you can only match the 5 percent return by buying Apple stock or Treasury bonds, it would still be advantageous to trade in the property because stocks and bonds are less risky and more liquid investments.
But there are strong reasons for wanting to hold onto it. The apartment fills one of the cardinal principles of investment: diversity. Not only does it give me exposure to real estate, but it also gives me exposure to a very different real estate market from where I live. Over the last dozen years since we bought our house here in Denver, the market has not experienced as severe a decline in housing prices that places such as Las Vegas and Miami suffered, however, it hasn’t appreciated much either. In contrast, the D.C. market was scorching hot in the 2000s and, even after the bubble burst, did not suffer declines on the scale of the rest of the country. I was fortunate to have this apartment as my parlay in the` real estate game.
Taxes also slow my impetus to sell. The downside of having a highly appreciated property is that when you sell, capital gains and other transfer taxes accrue. And as an investment property, none of the gain from the sale can be sheltered under the exemption for owner-occupied homes. While taxes do concern me somewhat, I do keep them in perspective. The tax on long term gains is fairly low (15 per cent) so it really should not be an overriding factor in my decision. And, if anything, capital gains taxes are going to rise in the future, given the government’s need to reduce the federal deficit, so holding on to the property to wait out a more favorable tax environment would be foolish.
These mundane dollars-and-cents calculations give way to more sentimental reasons for holding onto the apartment. This apartment was the first place of my own. It was where we experienced our first presidential inauguration — Bill Clinton’s. My wife and I spent our first happy years of marriage there. (I proposed to her atop the roof deck overlooking the city below.) Tenuous as it is, selling it would sever the final connection I have to D.C. As long as I own it, I can still uphold the pretense of being a Washingtonian and still hold out the possibility of returning to live there, or, if not me, for my daughters to someday make it their first home. I know sentimentality is probably the worst reason for keeping an investment, but when it comes to my apartment, it trumps all others.
A Colorado-based lawyer, Douglas Hsiao has rented out his Dupont Circle condo for 18 years. In his occasional column, he details his experiences as a long-distance landlord.