Don't Give It Away!

I can't tell you how many times a client has said to me, “I want to sell, but I'm not going to give the house away. If it doesn't sell for the money I'm asking, I'll just cancel the listing and rent it.” When your current home no longer suits you, the most popular option is to sell and move on, but in some cases, turning the old home into a rental unit might make pretty good sense.

Among the factors to consider:

Your financial situation
Local market conditions for rental homes
Your future housing plans
Your tolerance for being a landlord
State and federal income taxes
Current and projected home prices

Renting a home is a job and it can become a full time job when you factor in collecting rents, repairing damage, attending to general wear and tear, pool and lawn maintenance, and stuff that breaks....most people have no idea what's involved. There are management firms who will do much of the heavy lifting, but their efforts are not free. When all is said and done, very few owners-turned-landlords manage a rental home over the long term.

Unless your plan is to amass a number of rentals, and leave them all to your kids—or sell them one at a time during retirement, you still have the old family home and will want to sell sooner or later...remember, the reason we're in this situation is the house didn't sell for the money you wanted--so you have to hope the market improves so you can actually sell at a later date.

Before you decide to rent the old home, determine if your financial situation can support hanging onto to the house. Sure, you own it now, so keeping it comes with known expenses, but you should talk to a financial professional who will go over your savings, your credit, and your equity in your existing home. This way you'll know if you have the money for a down payment on the new home you want without using the equity in your present home.

If you don't need all the equity in your home for your down payment, you might be able to take out a home equity loan or refinance into an investor loan and use the loan proceeds as your down payment, and still make your home a rental.

Of course, if you go this route, make sure the new house payment on the old house is still low enough that it can be covered by your renter, and then some. Here's a rule of thumb: take the actual value of the home in today's dollars, and multiply by .01. One percent of the value of the house should give you a monthly rental target. So a $200,000 house rental target should be $2,000/month. If the neighborhood you live in won't support that amount, then renting may not be a good plan. This formula may also demonstrate why homes that rent for $500 a month are such dumps.

If you have a mortgage payment to contend with and the home is in a marketplace that offers tough competition, you may be only be able to generate a profit of $200 to $400 per month on a property. The name of this game is cash flow, and obviously the more cash flow the better. Awesome cash flow properties don't grow on trees. It really is a personal decision on how high of returns are needed to justify spending a lot of cash on a rental property. Some people would be happy with 15 percent, 10 percent or even five percent returns on their investment.

If your goal is to buy a different home, one drawback with renting is obtaining a loan on the next house. Once you claim the property as an investment, lenders want to see two (2) years rental history for that property, including a Lease and separate Escrow account for the security. The income will not be credited as income to you so you will have to evidence ability to carry both mortgages.

But if your main goal is to hold onto the home as a family legacy or wait until it's value has grown to help pay for retirement, lower monthly cash flow might be OK - as long as you can cover your mortgage and monthly expenses. This might also be true if you are in an area where projected growth over the next several years is expected to positively impact home prices.

There are pluses in renting instead of selling. You can depreciate the building, and you might be able to get out of doing expensive renovations. If you were considering updates like a new kitchen to get your house ready to sell, you may be able to put them off and do only what is necessary to make the place clean and livable.

Depending on the rent you charge, tenants are willing to overlook outdated home fixtures because they're just short-term residents, not owning it. For years I owned rental homes near a state university, I rented to grad students generally, and they both paid the rent on time and didn't mind the worn kitchen floors and single bathroom off the kitchen.

Renters who offer up to three apartments in their home for rent fall into a protected category, but if you don't live there, you must obey equal housing opportunity laws.

Don't forget insurance. As a landlord you will pay more for insurance on a home you're renting out, despite the fact that you're not insuring the contents, only the structure. And remember to get credit checks on the potential tenants, these are people you'll be entrusting your home (and your own credit score) to.

If you use a rental management company ask them to help determine a rental price for you, and to find tenants (to comply with fair housing laws) and to manage the building once the renter is in place. Management companies will usually take a portion of each month's rent in exchange for handling the screening, rent collection, repairs and other day-to-day landlord management aspects. So be sure you can afford to have their services.

Dane Hahn is a real estate professional with Sarasota Realty Associates. He can be reached at dane.hahn@gmail.com or by phone at 941-681-0312.