Would you ever sell a million dollar house?

A reader (thanks Zac) posed a question in the context of a separate post, but I’ll repeat it here, out of context, and then go on to discuss it:

Why sell a million dollar house so you can rent? Especially if you are going to be renting something that is not going to be competitively priced or in good physical condition

So, the question is, would you ever sell a million dollar house? (Let’s ignore the second part of the question).

Answer: It depends.

Let us assume that the current property market prevails, so rental returns are about 2% to 4% (which is crazy but that is what a speculative bubble creates).

Let us assume that we can invest the proceeds of selling the house and get a return of about 10%. This is not unreasonable – there are a number of shares you can buy on the stock exchange which will give a dividend yield of about 5.5% to 6% fully franked. This is an effective equivalent interest rate of 7.7% to 8.4%. By paying attention and buying carefully, a long term capital gain of a further 1.5 to 3% is quite achievable.

So, if I sold my million dollar house, rented it back, and invested the sale proceeds, I would probably pay out (based on the rental yield – lets assume 4%) about $40,000 per year in rent (well… it was a million dollar house!).

My million dollars invested is returning about $77,000 to $84,000 in cash and cash equivalents, and a few more dollars in capital gains.

So, my house when sold generates an income that covers the rent with money left over. And there is another benefit… I don’t get to pay the council rates any more – the landlord does!

Now, assume I don’t want to live in a million dollar house any more, I’m happy with ordinary suburbia, paying (say) $400 a week. That gets me a pretty flashy house in Adelaide… That means I’m paying $20,800 per year in rent and I am even better off.

Now, before you question if this really happens, the answer is a resounding yes.

I know somebody who figured all this out, and sold their house in order to rent for the rest of his life. He was able to get a far higher rate of return by taking the capital value of the house and investing it.

I also know a landlord who bought a house from somebody who was happy to rent, because the capital could be used to generate income.

Next: what if the figures change – what if rents are higher and other investment returns are lower? In that case, the results will be different and it may not be worthwhile. That is why the answer is “it depends”.

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