Not long ago, my significant other and I visited a bank to talk about getting pre-qualified for a home loan. Everything went swimmingly until we mentioned having to sell his current home before we could comfortably purchase a new one.
The loan officer asked, “Have you considered renting it out?”
Though we were not interested in becoming landlords, there is good reason to believe that more and more homeowners burdened with properties they cannot sell are turning to “reluctant landlording” as a way to avoid foreclosure or selling at a steep loss.
The Wall Street Journal reported last year that the insurance company Allstate had noted a 27-percent spike in homeowner-to-landlord policy conversions between the first quarter of 2008 and the first quarter of 2009. While 2009’s first-time home buyer tax credit may have moved some hard-to-sell properties, and housing forecasts for 2010 are better than they’ve been over the past few years, forecasts also say that foreclosures will peak this year. The Washington Post recently reported that 5 to 7 million homeowners are currently on the brink of foreclosure.
If you are considering renting out your home rather than facing foreclosure or letting it sell for a fraction of its value, ask yourself the following questions before you yourself join the ranks of “reluctant landlords.”
1. Is Your Home Really Rent-Worthy?
You may have lived with a drippy bathroom faucet, an occasionally damp basement or a front door that sticks when the weather turns humid. If you didn’t fix these things before trying to sell your home, you’ll have to do it before trying to rent out your home.
If you were to sell your home, the purchaser would negotiate repairs, negotiate price or simply buy your home as-is. In contrast, a tenant will have a wide-open, constant window in which to request repairs that only closes on the day he or she moves out, perhaps to be replaced by another tenant — in which case the window opens again. And anything that breaks or fails to operate correctly while you have tenants will be your responsibility, too.
Property owners living in their own dwellings will often forego or put off minor repairs and maintenance when the cost outweighs the benefits. But if you try this with a tenant when you’re renting out your home, you could be dealing with lots of phone calls and complaints.
2. Do You Have Plenty of Free Time and Lots of Patience?
You may get lucky and rent your house to a tenant who never bothers you and pays his or her rent on time, every month. This, however, is not extremely likely especially if, as described above, you give your tenant any sort of reason to bother you. It is also not extremely likely if you do not have the time and resources necessary to properly screen your rental applicants.
Tenants will sometimes call at inconvenient times, including dinner or during your favorite TV show or when you’re at work finishing up an important project. This is not always a tenant’s fault. Air conditioners seem to break down, pipes seem to burst and basements seem to flood at the most inopportune times — and all require immediate attention. Can your lifestyle accommodate these types of interruptions?
Do you have time to meet with a tax specialist and your insurance provider, not to mention a lawyer, in order to set yourself up as a landlord and protect your rights? Do you have time to research market rent rates and fair housing laws? Last, do you have the time to show your house to prospective tenants over and over again, for a month or possibly more, before you find the right tenant?
You can hire a property management company to do most of these things for you, but it’ll cost you. The website Manage My Property.com reports that property management professionals will charge anywhere from 4 to 12 percent of your tenant’s monthly rent for day-to-day management, but look to pay in the 10-percent ballpark in most markets. In addition, you may pay extra fees for leasing work and maintenance.
3. Can You Afford Monthly Negative Cash Flow?
One of the reasons you may be considering renting out your home is because either you can’t stomach the idea of selling at a loss, or you can’t afford to do so. Unfortunately, many first-time landlords underestimate the costs and overestimate the revenue associated with renting their homes out.
If you are still paying a mortgage on your home, you’ll instinctively want to charge a rent rate that reflects not only your monthly payment but also your property tax, insurance, and any utilities you plan to keep in your name. However, the figure you come up with may not be one that your local rental market can bear, warn the how-to experts at Bob Vila.com, especially if you purchased your home at an inflated price during a housing boom or if you have a high interest rate.
Once you arrive at the monthly rent rate that would meet your mortgage payment plus the costs of your property tax, insurance and utilities, compare that figure to the rent prices on similar homes in your area advertised as For Rent in your local paper and on websites like Craigslist.org. If thee-bedroom homes in your zip code are renting for between $800 and $1000 a month, you’ll never be able to attract a tenant who will pay $1400 to rent your own three-bedroom home. There is no amenity in the world worth $400 a month to a typical tenant.
In this case, you’d be looking at a $400 cash flow shortfall per month — $500 if you pay 10 percent of the rent toward property management. And don’t forget the costs you may incur when you go to advertise the house for rent. The worse news is that the rental income you make will be taxable.
There can be tax advantages to renting out your home, though, such as new business expenses to claim and depreciation on the property. You’ll have to decide if these annual advantages make up for your monthly deficit.
It may turn out, after all, that a decision to sell your home at a loss is financially more sound than becoming a reluctant landlord.