Maybe I Should Rent My Home Rather than Sell It

We're in the process of looking for a new house -- an adventure that may take us a couple years or more (do we buy now, do we wait for prices to go lower, do we build, how do we sell our house -- so much to decide, especially in today's down market.) But here's an idea on the selling side I hadn't considered before (at least not seriously) -- not selling our house but renting it out instead, waiting for prices to go up (could be a few years) and then selling at that point.

What are the pros and cons of renting a house? Kiplinger has some thoughts on this, starting with the benefits:

On the plus side, you'll be entitled to tax breaks, including depreciation (you can write off a portion of your home's cost basis, or the price you paid, each year over 27 and a half years), plus deductions for maintenance and repairs (see IRS Publication 527, Residential Rental Property). And it's important to time the rental to preserve your exclusion from capital-gains tax on any appreciation in the home at the time you sell. If you lived in the home for two years out of the previous five, you can exclude $250,000 of profit if you file a single return and $500,000 if you file jointly.

The negatives seem to be two-fold: 1) can we afford this financially and 2) do we want to spend the time and effort to make it work?

The answer to the first is that we're in pretty good shape since we own the home outright and have enough for at least a 20% downpayment on the new home already saved. So for awhile, we could afford to keep both houses.

The second issue is the bigger problem in my book, but there's a decent solution for this:

Unless you want to become a landlord, hire a property manager. For a fee of 6% to 12% of the rent, a property manager will find and screen a tenant, negotiate the lease, collect the security deposit, take the tenant's 2 a.m. distress calls and ensure that you adhere to a raft of landlord-tenant laws. You may be able to find a property manager through your real estate agent, or search for a local member of the National Association of Residential Property Managers.

Hmmmm. If I could turn over much of the hassle associated with renting to someone else, would it be worth it then? Of course I'd still need to pay for replacement items such as the furnace, water heater, etc. and having someone live in the home who doesn't own it may rough it up a bit in case we want to sell. But to me it at least seems worth considering.

What do you think? Anyone out there have experience with being a landlord? Any advice you'd give me?

Comments

[Ciji]

FMF, I say if your income/expense ratio is in the positive, go for it!

Even if you have the perfect tenant, your home is going to have some wear and tear. You must remove any emotional attachment to your home and look at it as an investment and source of income.

And may I suggest that if it is financially feasible --and since you own your home outright-- you save your cash for the downpayment on your new home a leverage some of the value of your existing home instead?

[G. Duda]

My parents own an apartment building in West LA and for a few years while I was in grad school I acted as their manager. Consequently, I have no desire to ever, and I mean ever, become a landlord. Hey, you think, I can make some easy money -- there's not much to do, right? Believe, it's not that easy. It's a huge hassle - things break and you have to fix them. People are late with their rent or break their lease. It's not so bad if you have really good tenants, but the ones who aren't ...

If you're really set on this I think it's important to temper your expectations. It's not going to be easy money. It's going to become your second job. You will have months where your expenditures exceed your income. Major appliances will fail, and yes, you will have to repair or replace them. You can save on money by performing minor repairs yourself (hence the second job part).

Approach this with caution. If you do decide to do it, here's the most important thing to remember: always, and I mean always, run a credit report on prospective tenants. Sure it costs you some money, but it's worth it in the long run!

[Jon]

I became a landlord May 2006 when I moved from my townhome to a new home. I rented to a high school friend so I know who lives there and even am invited to dinner occasionally, which gives me peace of mind since I get to keep my eye on the place. Since it was a friend I am charging slightly less than I would otherwise.

I have a mortgage on the townhome and the monthly payment is $510, but will settle around $500 once my escrow shortage is covered (keep in mind when you move out, you lose homestead exemption and your property taxes increase...hence my escrow shortage). In about 18 months my PMI will fall off, and the monthly mortgage will drop to $475 or so.

I charge $510/month now and that will increase to $525 in October.

I've been thinking a lot lately about how much I need to charge to say I am making a profit. It seems logical that I would want to charge enough to cover all out of pocket expenses (mortgage, maintenance, etc.). But then, part of the mortgage is PRINCIPAL payment, so should I really worry about covering that part, or should I focus on covering expenses only, in which case interest would be included but not principal.

I've been thinking about this a lot lately because I am purchasing a foreclosed HUD home and will be renovating it before renting it out. Trying to decide what the fair rent should be here.

[limeade]

You could also try and do a lease option, also called rent to own. With this type of lease, you shift the maintenance and other issues to the lessee with the option. They will treat the home better because they plan on purchasing it.

Also, if you decide to just rent it, you can get creative with the tenants. Tell them up front what the rent is, but give them a discount if they don't ever call for minor repairs and handle it themselves. You can also give them a discount for paying the rent by the first. This way you'll always get paid on time and won't have to hassle with minor things. Tell them also that at the end of the year, if they haven't called you for anything (except for something major like the furnace or fridge going out) you'll buy them a digital camera or a TV or give them a gift certificate to their favorite store.

There are lots of creative ways to have things work in your favor. A little goodwill with your tenants will go a long way.

[Tyler]

FMF,
Go for it!
Having been a landlord, I can say that having one proeprty to rent/manage is something that you can handle and make great strides with financially.
It's all about getting great tenants! If you can secure great tenants with a solid lease and damage deposit, then you are in business. The tax breaks are awesome!

[Patrick]

You have a wonderful advantage in that you own your house outright. You will not have to worry about getting a rent check to cover your mortgage (unless you were counting on the value of your current home to lessen your expenses on your new home).

I think if you are willing to put in the work, the benefits will be well worth it. (This is coming from a first time homeowner who has zero experience as a landlord). But if I had a similar situation, I would seriously consider renting it out.

[Bronco]

FMF, I think you should probably sell it. Everyday on the news all I hear about is declining prices. Even the realators(tm) are suggesting there are more price drops coming. This makes me believe that it will even be worse than anticipated by the masses.

[Lord]

I know people who have never sold but just collect more rental properties until time to retire when they move back into each one for two years to recapture the capital gains. This may not be the best option for you if you can invest the proceeds better though. Can one write off a capital loss on an investment property if it was down when you sold later? The lease to own option is a possibility but is usually for those that can't borrow so you should prepare for some turnover. I suggest you contact a property manager. The cost is usually much more for a SFR.

[A Tentative Personal Finance Blog]

My parents decided to rent out their house when they retired and wanted to travel for a year or so. They returned and their place was wrecked. They had all the headaches of a lawsuit to recoop rent and other fees. Then they had to clean the place up. That's just our personal horror story.

On the other hand, I've also heard many successful stories. If you're prepared to spend the time, it might be a worthy option.

[Duane Gran]

I've done what you describe. You should do it if:

1) The cash flow is positive, in the neighborhood of 25%
2) You are willing to invest some time learning about being a landlord (or take 10% less profit with a manager)

People love to tell horror stories about bad tenants, but proper screening generally works well. You will probably want to put the mortgage on the rental rather than your personal home, as the interest is deductible as a business expense. Plan to use the first three years to decide if being a landlord works for you and then get another property. You will likely have some anxieties with one property since you are either at 100% or 0% occupancy. This business makes a lot more sense when you have multiple properties.

[plonkee]

I have only other peoples anecdotal experience to go on - several people at work are also landlords and they all use property management companies. Everyone is happy with it.

Over here, our property market takes about 13 years to completely recover from a crash - partly caused by the crazy amount of time it takes to buy somewhere. Are you willing to hold onto the house now for the long term?

Also, if relevant how will you (+wife/kids) feel about owning but not living in a house that you've previously loved?

[Wealth Building Lessons]

there are 2 ways to look at it.

depending on where you live, prices might be heading down and staying depressed for several years. if you bought in Los Angeles during the last peak, you were underwater for 9 years!

can you withstand the pain of being negative for so long?

having owned several rentals, i'll tell you its a real bitch. do not try to manange the properties yourself. hire a good manager. do not think you will make a ton of money from it.

the tax breaks are really good though. and at the end of 30 years, i think you'll have a lot to show for it. houses that were bought 30 years ago cost about 10 times less! (although that works out to only 8% rate of return, the tenants are paying a majority of the mortgage payments, so your rate of return is a lot higher).

[cory]

Another point to consider for landlording:

If you want good tenants, you will have to be a good landlord. That means keeping the property well-maintained, answering those 2 AM emergency calls AND answering the 2 PM emergency calls while you're in a meeting at work.

If you have a day job, you probably have no business managing a rental property. Hire a property manager or be prepared to deal with either resentful tenants or a hell of a lot more time and effort than the investment will be worth.

The type of tenant you have will make all the difference in your renting experience. I rigorously screen my tenants--to the point of holding vacancies if nobody meets my standards. It's cheaper to hold an empty property (especially in your case, since you own the property outright) than it is to get sacked with a deadbeat tenant.

In addition to getting a good property manager, familiarize yourself with local landlord/tenant law. Michigan's website has an overview
http://www.legislature.mi.gov/documents/Publications/tenantlandlord.pdf

[Rich Schmidt]

It depends. The first experience my wife and I had with being landlords was when we moved into our current house and rented out our old one. (It was actually a lease with option to buy, but they didn't end up buying it.) We only rented it for two years, but in that time, the house deteriorated enough that it was very painful for my wife to see it in that condition. As someone mentioned earlier, you're going to have to emotionally detach yourself from the house and see it as an investment. Otherwise, your heart will break a little when you see that the landscaping you spent so many Saturdays working on is now nothing but weeds and dirt.

So my wife has declared that never again will we rent out a house we previously lived in. But we just bought the house next door to ours and have a great tenant renting it. I'm hoping that will be the first of many houses that tenants will purchase for us with their rent money...

[Dre]

I've done this. You've already mentioned a couple of the biggest things to keep in mind.

- In about three years, you will begin to lose your capital gains tax deduction. That can be potentially a huge cost, and should be factored in. If you've appreciated $100k, that's a stealthy $20k cost that you'll have to make up.
- Owning a rental property isn't an investment so much as a job. It's a job that's unpredictable, where the work comes in fits and spurts. You can go a year without having anything blow up, then all of a sudden, at the worst possible time, it can all go horribly awry.
- What's the ROI on keeping it? In most of parts of the country, I'd say it's unlikely that your total returns (appreciation + earnings after expenses) will beat, say, the stock market in the next 5-10 years.

It did work out great for me - really great. But in my local real estate market (Los Angeles), there is not a chance I'd do this today. Renting is actually a much better deal than owning in most of Los Angeles right now.

If you don't do this, and you plan to sell your place and buy a new one, then you don't really need to worry about timing the market. If real estate goes up or down, it should mostly wash between the purchase and the sale. I'd probably lean towards doing it sooner while interest rates are still low. Good luck.

[Jaya]

Hi,

I own a townhome in Florida and have rented it out. I still have to pay 30-40% of the mortgage. This has become a huge burden on me. If I sell this townhome for a loss can I claim this as a loss on my investment?

Thanks,
Jaya

[Jaya]

Hi,

I own a townhome in Florida and have rented it out. I still have to pay 30-40% of the mortgage. This has become a huge burden on me. If I sell this townhome for a loss can I claim this as a loss on my investment?

Thanks,
Jaya