If you find yourself in a situation where you’ll have an extra home you won’t be living in, and assuming it’s safe to inhabit and can be spruced up without too much investment, what should you do? I’ve been there a couple of times due to job changes. Here’s how I dealt with it.
Two main factors, of course, are usually financial: How long and secure is the financing (if any), and what’s the expected cash flow?
When Would You Need the Money?
Do you have a lot of equity tied up in the home, and how soon will you need the money? My time line has so far been indefinite so there has not been a need to sell.
Most residential mortgages are backed by Freddie Mac or Fannie Mae with decent interest rates fixed for 15 or 30 years (who else could or would give such a sweet deal?) so that’s as straightforward as it gets.
If you have a floating or adjustable rate mortgage you might want to consider getting out of that loan whether by selling or refinancing, especially if it’s due for an adjustment soon.
What’s It Costing You?
Aside from utilities that you or a tenant would pay for living there like gas and electricity, what else do you pay for the home’s upkeep that a landlord would typically pay? Boil it down to an average monthly amount.
Be sure to include property taxes and insurance (unless already accounted for in the escrow portion of your mortgage payment), and applicable expenses like homeowners association dues or condo fees, pest control, yard care, home warranty, maintenance of heating and air conditioning systems, plumbing and the roof.
What’s the Going Rent?
Determine the comparable rents and sales prices (“comps”) for the neighborhood and surrounding area. Keep the comparisons relevant by narrowing down on those with the same number of bedrooms, similar square footage and dwelling age. What’s the range of asking prices?
How’s the location and neighborhood compare with others in the area? Not surprisingly though, homes that are in safe or improving neighborhoods close to good jobs, schools and amenities tend to command higher rents and have the best long term investment prospects.
Reviewing stats on sites like Neighborhood Scout and Spot Crime can yield interesting, if some times troubling insights about your area.
Show Me the Money
At this point you can surmise what the likely cash flow situation will be if you rent the home, as well as what you could potentially sell it for.
Would the rent in your neighborhood cover your cost of upkeep and mortgage payment, and leave you with something extra at the end of each month? Would you still breakeven if you assumed 10% less rent per year for vacancies?
If not then how much negative cash flow are you facing, and how long do you think you’d have to carry that? If you can refinance to get a lower rate and gradually increase the rent you may be able to get it into positive territory.
I went from negative $100 per month to positive $130 per month doing so over the course of two years on my first move. It was worth it since the home was underwater at the time. But since then its value has edged back closer to where it was when I bought it.
Assuming you’re not in a hurry to sell and you’re in a positive (or manageable) cash flow scenario, then it’s a trade off and depends on your situation, needs and the property itself. The main question is if there is a cash flow issue. Would you have to pay for it out of pocket each month?
Know Your Tax Breaks
But wait there’s more. Your after tax cash flow situation is likely to be better if you hold on to the home.
Not only is mortgage interest deductible in most cases, but when you turn a home into a rental investment property you may also benefit from a slew of additional expense deductions related to maintenance and upkeep, and depreciation. Be sure to check with your tax adviser.
How much would you net if you were to sell the home? A ballpark estimate is that transaction costs would run you about 8% of the selling price. You’d then pay off the balance of your mortgage. Your income tax may well be impacted as well. Again, consult a tax adviser for your particular situation.
Is Landlording For You (Or Your Property Manager)?
If everything checks out on a financial basis, the next question to consider is do you have the time, expertise and inclination to hold on to the home and rent it out yourself?
If not can you outsource that to a good property manager? Fees typically range from 5% to 10% of the gross monthly rent, plus a leasing fee each time a tenant signs or renews a lease.
With property management your main responsibility becomes managing the manager rather than managing the property. Professional management made it possible for me to move to a different state. It takes a lot of the load off, though by no means does it eliminate all the work.
To Sell or Not to Sell?
I’ve made this decision twice now and ended up holding on each time. The homes are worth more now than if I had sold previously, and there have been very few problems with the properties themselves. In other words, it’s been pretty good.
Overall if you are not in a negative cash flow situation you have the luxury of time. It’s a sustainable proposition.
The analysis you did for maintenance costs and rental comps is the same as if you were considering buying an investment property. Many landlords start out by renting their first home and moving to another, perhaps after doing an exercise like this.
As long as the home can be maintained and you can find a good property manager, you can collect the long term benefits of ownership of appreciation, tax breaks and have someone else pay down your mortgage without much effort on your part.
And if you need to tap the value of the property? You may be able to have your cake and eat it too by keeping it and borrowing a (responsible) amount of cash against your equity. Real estate makes some of the best collateral for borrowing as long as it’s done right.