The Pain of Speculative Holding: An American Reader Writes In

March 28th, 2012 by Potato

Reader Rhea, from Seattle writes in:

We have a rental property in what was supposed to be an up-and-coming neighborhood near Downtown Seattle. We lived there for 2 years and loved it. It is on the top floor of what was a new condo (now 7 years old), and has amazing views of the water, mountains, and downtown. We paid $275,000 7 years ago. Then we moved and bought a house and rented it out for 4 years for $1500/mo. That tenant left and we tried to find another renter, but had a hard time at that price point, eventually renting it out for $1300. We pay about $2100/mo including HOD’s. We got into a bad mortgage deal, as was typical at the time. Zero down/Interest Only.

All condo sales in the building have been short sales, and estimation of condo [market value] is around 200k. Question is, do we re-finance, which would cost us 125k to get mortgage down an amount which renters would cover. Or short sell it?

Hi Rhea, thanks for the question.

I’ll start with a question of my own: why did you hold on to the condo after you bought a house? Is it because you planned on moving back in later, or because you loved the idea of becoming landlords, or was it purely an investment motivation?

The fact is, as an investment, the condo turned out to be a poor one. You’ve lost money on it, and the thing to realize is that the money is gone and you can’t get it back. You can realize the loss bit by bit as the rent falls short of the monthly costs, or you can face the loss all at once by paying down the mortgage deficiency now or doing a short sale, but no matter how you slice it, it’s not coming back.

With that realization, the most important thing to consider for your decision of what to do in the future is your motivation for holding on to this condo. If you just love being a landlord and would do it even if you had to pay for the privilege, just so you could speak with tenants and help put roofs over their heads, or if you plan on moving back in to this specific unit in the next few years, then one of the options for continuing to hold on to it would best suit you. If you don’t love being a landlord, and were just looking for an investment, then you might want to think about just taking your losses and selling it.

At a current value of $200,000 and current rent of $1300/mo, your price-to-rent is 154X, which is in the roughly break-even range. Continuing to hold it shouldn’t hurt you further (at least not much), but it’s still not a very good investment. If you can get the rent back up to $1500/mo (while still maintaining good tenant quality and low vacancy) then it might be worth holding on to, with a price-to-rent of 133X, but it’s still not a stellar investment, especially if you find being a landlord to be a time-sucking chore (and the time commitment will only get worse as your unit approaches 10 years of age and starts to need more maintenance and appliance replacements).

So ask yourself whether you have a good non-investment reason for holding on to the condo, and if you don’t, then speak to a real estate broker about selling it. If you do still want to hold on to it even if it isn’t a good investment, and if you have the cash available to pay down the mortgage and refinance, then speak to a mortgage broker or your bank about your refinancing options.

For my Canadian readers (which I thought was all of you — no idea where Rhea came from!) this is an example of “speculative holding.” Rhea didn’t buy her condo with the intention of being a real estate speculator, nor the house that followed… but instead of selling the condo to buy the house, she held on to rent it out. Thankfully no one I know in person has become a speculative holder, but I’ve seen them around the various personal finance fora, choosing to borrow against the starter home to buy the second and then rent it out, rather than sell to move up… becoming real estate speculators in the process. This is a kind of phantom speculative demand: you don’t see them lining up in the cold, clamouring to buy pre-construction, and they’re not at any point applying for an investment mortgage, but the speculative holding has the same effect on the market… and on the speculators themselves.

Not to pick on Rhea, but in this particular case it was egregious speculation: with an interest-only mortgage if it’s cash flow negative you should know immediately something is going wrong. With an amortized mortgage if you’re not very good at math, it’s easy to fool yourself that you’re at least “building equity” while being “a little” cash-flow negative.

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