Money in the PiN household isn’t holding my interest this week. We paid our bills, and saw our investments drop by 1x our annual spending. Nothing that I feel like dwelling on at length.
I thought instead I would write about someone else’s money instead. My brother is hoping to sell his first house, which has been a rental for a few years.
In this post, I review some reasons why becoming a landlord isn’t the family dream, and what to do when one comes into a large sum of money.
My Brother’s First House
My brother lives in a very high cost of living area, and has done so since he graduated college.
He spent 6 or 7 years making good money but living very cheaply: renting a house with several college friends, eating lentils and rice (voluntarily), driving an old Honda Civic he repaired himself. During these years, I think he had a lot of fun and saved plenty of money.
However, as he approached 30, he started to get very worried about rising real estate prices. He wanted, eventually, to own a home, but worried he would soon be priced out of the housing market.
Near the height of the market, he overpaid for a house in the suburbs, a 45 minute commute from his work.
He was very proud of his house, especially the yard (which he didn’t have in his city apartments), and took on paying house mates for a few years to help with the mortgage.
It was all good–though he missed being able to go out easily on the weekends–for a few years. I lived near him at the time, and enjoyed coming over to visit and enjoy his beautiful yard.
Then, 2008 hit. He was clearly underwater on his house. Stretching to buy an overpriced house in the suburbs no longer seemed so smart, but he didn’t want to sell the place at a loss. The thought of losing his considerable down payment was depressing.
It was harder to go out on the weekends, and he had a long commute, but he could manage the mortgage. He had a roof over his head, in a decent neighborhood. He would stay a while.
What Mama Wants, Mama Gets
On the real estate side, nothing much changed for a few years. He kept his job, and paid his mortgage. He hung out with his roommates, and worked on his social life.
After a few false starts, he brought home a nice girl to meet our parents, and they got married a year later.
My sister-in-law is a very modern woman. She can drive, but wanted to set up her life so she didn’t need to. As a single professional woman, she lived in a small apartment, close to work, and enjoyed what the city offered.
She gave up a lot to live with my brother out in the ‘burbs.
However, when she was pregnant and commuting for hours while feeling ill, she put her foot down. Within a few months, they were living in a small apartment in the city, and the suburban house was up for rent.
My brother wasn’t ready to sell, especially as he would have to sell at a loss (the market hadn’t yet recovered from the Great Recession). He was able to rent it out for more than the mortgage, so this wasn’t a total disaster.
A Time Sink
A year after moving into the city, the growing family moved out to the suburbs again.
They found a pretty house–a bit smaller–in a closer suburb. It is in a walkable neighborhood, with good schools, and an easier work commute. You can correctly infer it cost a lot more than his first house.
My brother was still underwater on the first house, and decided to keep renting it. He called it the college fund; he hoped it would appreciate enough in 17 years to pay for college.
Unfortunately, despite being suburbs of the same city, the two homes were in totally different directions. Going to visit the old place was a 2 to 3 hour round trip.
Over the years, he spent a lot of weekend time taking care of his first house: yard work, cleaning up between tenants, etc.
His rental agents didn’t always do their best work for him. He definitely faced several periods where the house sat empty between tenants, usually at an very inconvenient time for my brother’s finances.
He kept firm with his decision to keep the house though. As my niece joined my nephew, and then the baby arrived, my brother continued to insist that he would keep the house. He enjoyed having some cash flow, and was planning on the appreciation to fund college for his (now) 3 children.
Anchors Aweigh!
I can’t say exactly what changed my brother’s mind.
It could be his wife didn’t like the time and energy it took to deal with the first house as a rental. It could be that the tenants were a little more troublesome. It could be that house prices went bonkers in his metro area with the pandemic and he can finally sell it for a profit.
Whatever the reason, the house is going up for sale.
The lease has ended, the tenants are out, the realtor is helping him arrange repairs and staging to get the thing done. He is very excited to off-load the house.
I think he will get some more time to himself, and definitely will lose a large mental distraction.
Money, Money, Money
He should also clear a very large sum from the house sale. I expect that at closing he will receive a sum that is approximately 3 times his gross annual salary.
That’s a lot of dough, and I sure hope that he does something smart with it, because he probably won’t see a windfall like that for many years to come (if ever).
There may be those reading who feel that it’s no one else’s business what he and his wife do with any profits they see from selling that house.
They are obviously not members of our family.
Talking with my brother, it turns out that every single member of our family has told him he needs to save some of this money.
He still has plans for spending some of this money: he has an old house that needs repairs and 3 growing children. It hasn’t been super easy for him and my sister-in-law to work from home while the schools were closed, and I suspect they have some splurges in mind for themselves.
However.
My brother has also been through a few periods of unemployment, and at his age, age discrimination in the workplace is a real thing. Emergencies happen, and with 5 in the family, they have more opportunity for something expensive to happen. That isn’t even counting saving for college and retirement.
My brother hasn’t asked me for advice, and I haven’t given any (besides to save some of his money), but I sure do have opinions about what he should do with the money. IF he asked what to do with the profit, this is what I would suggest (adapted from The Waterfalls post at the White Coat Investor):
- Make sure he is clear on the tax obligations before making plans to do anything else. This house has not been his primary residence for any of the past 5 years, so he will pay taxes on any capital gains.
- Pay off any high interest debt (credit cards). I don’t know if he has any, but even with inflation making carrying debt a little more attractive, paying off debt at 18%+ is a great use of this extra money.
- Buff up the emergency fund. Given their history, I would recommend at least 6 months of routine spending. 12 months would not be entirely crazy.
- Max out retirement contributions, if not done already.
- Look at how much money is left. Spend no more than 50%–some of this is tentatively earmarked to home improvements, so one can argue that some of this is being invested anyway.
- Of the remaining money to be saved, split the money into a taxable investment account (for retirement), education for the kids (529 plans), and paying down the mortgage (personally, now that I know about recasting a mortgage, that would be my choice: it reduces the monthly required payment, giving more budget wiggle room; but if you choose to keep paying the old amount, you can shave years off the mortgage).
Lessons for the Reader
If you’ve made it this far, you may reasonably ask: what can I learn from this?
One. Overpaying for a house has long-reaching consequences. My brother told me this weekend how much he had bid over asking price to buy his first house in the first place. Had he just paid the asking price, he could have off-loaded the house at a break-even point several years ago. Or enjoyed better cash flow while renting it.
Two. Renting a house is not necessarily so easy, or profitable, as others make out. Especially if you are an accidental landlord, having purchased the house for your personal use, rather than going into the purchase with a plan to rent it.
Three. Sometimes you get lucky, and actually see some profit in real estate even if you overpaid to begin with. Though I don’t know that I would try to compare my brother’s return on this house to what he would have if he had simply thrown the money into a broad market index fund (hint: he would have made more money in stocks). I suspect he would also have less grey hair.
Four. If you are a member of my family, everyone will have an opinion on your financial life. Though if we are being good, you might not have to listen to our suggestions.
Five. It’s probably a good idea to have a plan (a smart plan) for your extra money. If you are not my brother, you may have different priorities: student loans, mortgage down payments, renovations, daycare, college. Nevertheless, you should decide how much money to put aside, and where to put it, before you look up and realize that the money all that effort made possible has now evaporated into thin air.
What would you do if you came into a windfall of this magnitude? What if it were your sibling who came into money–would you offer advice?