Should You Become a Landlord Instead of Selling Your Home?
When a job change forced our family to move across the country at short notice, we decided to join the ranks of "accidental landlords" instead of selling our Chicago-area home at a loss. We are so new at being landlords that I don't presume to offer advice on how to be one, but here are the pros and cons my husband and I considered when deciding to rent rather than sell. I also threw in some tips we have picked up along the way. (See also: Top 10 Real Estate Tax Write-Offs)
Pros to Becoming a Landlord
These are the advantages that drove us to hold onto our house.
Avoid Selling at a Loss
By holding onto a property during a down market, you give yourself the chance to sell for a better price in the future. Of course, there are no guarantees — we could end up selling for even less in a year or five years.
Collect Extra Cash
The housing collapse has pushed rents higher in many markets, since more families who are unable to buy houses are competing for rental units. In our case, we were able to charge enough rent to cover our mortgage, taxes, insurance and management fee, with a few hundred dollars left over to build a maintenance reserve fund.
Besides the extra cash each month, every rent payment we receive pays our mortgage, which means that when we do sell, we will have more equity in the house than we do now.
Save Time and Money Upfront
The time and money we spent fixing up our home to rent it out was less than what we would have spent to market it for sale. Since my husband moved to our new location to start working three months before the kids and I joined him, I had to handle most of our move single-handedly. Maintaining the home in "selling" condition would have been tough.
Avoid Risk of a Long Marketing Period
We avoided the risk of having our house sit empty for months or a year while waiting for it to sell. Paying two mortgages during that time with no rental income would have been a real strain on our budget.
Avoid Paying Commission
We avoided having to pay a 5% real estate agent commission at this time. If a current or future tenant likes the home, there may be the opportunity to sell without involving a real estate agent.
Postpone Saying Good-Bye
We did not have to say goodbye to our beloved home permanently when we moved out — if a job brings us back to our old town, we could return.
Store for Free
We were able to store some items in the crawl space of our rental home instead of moving or disposing of everything we own.
Cons to Becoming a Landlord
There are serious potential downsides that you would want to thoroughly investigating before making the leap into landlordhood.
Your Capital Is Tied Up
Until we sell the home, we can't get back the equity we sank into it. This forced us to borrow more than we would have for our new home, resulting in higher monthly payments and less cash on hand to repair and update the new home.
Getting a New Mortgage May Be Difficult
Because we still owed money on our old home, it was harder to get a mortgage for a new home. Different lenders have different criteria, but we were required to hold 30% equity in the old home — and had to pay for an updated appraisal to prove it. We also needed to secure a lease and security deposit early in the escrow process when we bought our new home, even though this was more than a month before the lease on our new home was to begin. If we had failed to get a renter in place in time, we may not have been able to close on our new home and may have even lost the chance to buy it.
There Are Transition Costs
Although it may not have been as much as we would have spent to prep for a sale, we still had to pay to fix up our house somewhat: we painted, had one area of flooring refinished, did repairs, and paid for cleaning before our tenants moved in. We spent more than the first month's rent on all this. Keep in mind that tenants may want you to fix problems that never bothered you when you lived in the house — and local laws may require you to comply.
You Will Feel Stress
We opted to find our own tenant instead of outsourcing this job to an agent or our property manager. This added a lot of stress to the months before our move. Advertising, showing the house and screening tenants took a lot of time. The stress didn't end there — there is always the worry about whether something will break in our old house, or whether there will be any problem with the tenants.
You Will Feel Emotional Weirdness
My 2-year-old keeps asking why someone else is living in our old house, and he's not the only one having trouble with the concept. When you sell a home you make a clean break, but it's another thing entirely to have to field a tenant's request to change a paint job that you just paid for, or to remove the window treatments you sewed by hand.
Some of the Costs May Be a Surprise
Bankrate.com lists four hidden costs of being a landlord, including potentially higher insurance and tax costs, and of course maintenance. If your rental property is an older home, like ours is, you must take potential maintenance costs even more seriously.
Rent Money Is Taxable Income
I didn't really think of the rent money we collected as income, since most of it goes to pay the mortgage and escrow payments on our old house. But of course, it is income, and we will have to pay taxes on it at the end of the year.
The Tenants Could Trash Your House
Most leases call for only one month's rent as a deposit, and a few hundred dollars extra for a pet. If you have owned a home, you know that it is all too easy to do more than a few hundred dollar's worth of damage. As soon as we decided to become landlords, it seemed everyone we knew had a tenant horror story: flooded bathrooms, cracked tiles, stained carpeting and holes in walls. With this in mind, we screen our tenants carefully — but you never know.
The Tenants Could Leave or Fail to Pay
This is the one that really keeps me up nights. Tenant law varies wildly by location, but our manager warned us that if our tenants failed to pay or left before their lease was up, it would be very tough for us to recover that money in court.
You Could Have to Pay Capital Gains Tax When You Sell
If you have not lived in the property for two of the past five years when you sell it, you could face capital gains tax on any profit. Of course, at this point, we'd feel lucky to have any profit or even break even selling our property.
Real Estate Prices Could Decline Farther
There's no guarantee that we'll get a better price for our home by holding it a few years. We may end up getting even less.
Tips for Renting Your House
Here are the lessons we've learned — some the hard way.
Hire a Property Manager, Especially If You Are Moving Far Away
Once we secured excellent tenants, I wondered if we really needed a property manager since I didn't anticipate problems. I'm so glad we went ahead and hired our manager. Many little things came up between our departure for our cross-country move and the tenants' move-in, mostly due to our own rushed moving job, and it was a relief to have the manager on-site to help tie up the loose ends.
Screen Potential Tenants Thoroughly, but Talk With Them as Well
One thing I learned when showing our house is that many people in the market to rent a home right now have been through financial difficulties, and have short sales, bankruptcies or foreclosures on their records. You should know the applicant's financial history, but according to the experience of our property manager, you don't have to automatically reject people because of past trouble. Find out the circumstances, and ask for a co-signer or other precautions if necessary. From our manager's experience and everything else we have read, good references from previous landlords and employers go a long way toward making up for past credit problems.
Remember: Until You Have a Signed Lease, You Don't Have a Tenant
We had a couple of false starts where people said they were interested in renting our place, but then changed their minds or delayed signing the lease. I learned that if you want to get a place rented, you should keep advertising it and scheduling showings until the lease is signed and the security deposit is in your bank account.
Talk With Your Neighbors About the Impending Change at Your Home
I have great neighbors at our old place, and I know that they will let me know if anything is amiss at our property. I also went out of my way to keep them informed that we were going to be renting, and even introduced them to the renters on the day that we signed the lease. After all, living next to a rental house could be a cause for concern for them, both for their lifestyle and their property value. In addition, great neighbors can be a selling point for potential tenants and future purchasers, so you want them smiling and waving when you show the house.