Should You Become a Landlord Instead of Selling Your Home?

by Carrie Kirby on 12 July 2012 17 comments

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.

Build Equity

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.

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Guest's picture

Great article. Way to many homeowners think that renting their old home is a quick/easy fix, when in reality there are a ton of things to consider.

Guest's picture
Guest

ZOMG! NEVER AGAIN!!!!!!!!!!!!!!!

We did this, and were we ever sorry. Stress? That's what you call it? Long-distance mental torture is more like it. Trashed? Every time you change tenants, it will cost you at least thrice whatever security deposit you're holding to get the place back into habitable shape. No pay? Your security deposit usually becomes the last month's rent...if you're lucky. And then you have to worry about the neighborhood, which goes downhill quick the more houses are rented instead of owner-occupied. The last time I Google Earthed our old neighborhood, it looked like one of those places where Sally Struthers would make commercials.

We bought this house for $45,000 in 1987. Nineteen-fricken-87. Ronald Reagan and Michael Gorbachev were still heads of state, Michael Jackson still made hit records, gas was 69 cents a gallon, and the New York Mets were the defending world champions of baseball - A quarter of a century ago. We sold it two months ago for $25K, and were glad to get that.

Being a landlord just plain sucks unless you have deep pockets, a thick skin, and no soul.

Generation X Finance's picture

We are currently in this situation. Thanks to poor planning on our part, a few years ago when we found out that we had a child on the way we knew we'd need to find a better house, and with the market drastically cutting prices here in Michigan we knew we could find a lot of house for not a lot of money. We also knew that we couldn't sell the existing house without likely doing a short sale.

So, we bought a new house and held onto the old house and after about six months finally found a tenant. It's not in a prime location for a rental property, but just getting somebody in there to help recover some of the costs was helpful. The tenant wasn't a model tenant by any stretch of the imagination and they were regularly late on payments, so that was kind of stressful at the time, but still better to get some money rather than no money.

But due to the late payments we didn't renew their lease at the end of the first year and kicked them out. I guess it was a bit of a blessing in disguise because it just happened that we had some family members in need of affordable housing so we offered to help them out and rent to them. So far it seems to be working out quite well.

Of course, I'd rather not have the house at all and remain hassle-free, but being able to avoid a short sale or foreclosure has been nice, and after a couple of years of maintaining a not so profitable rental instead, there should be enough equity in the house to come out in positive territory.

Andrea Karim's picture

Hey, Carrie,

Do you have any tips for screening tenants? Services you used or processes that you found particularly helpful?

Guest's picture

I've read a few of the comments on here, and I have to present a different side of the coin. My wife and I actually love being landlords. Luckily, we live in the same town as our rental houses so we can keep a fairly close eye on them if need be. However, when we moved out of our first house, we kept it as a rental. It has worked out brilliantly for us. We bought a second rental house as well.

The biggest benefit that we see (mentioned in the original post) is that other people are building our wealth for us. They are paying the payments. They are paying the taxes. They are paying the utilities. It is a great way to slowly build your net worth.

Sure, we have to put a little bit of work in every once in a while. When something breaks, you have to fix it. Also, you definitely need to do a good job of screening your renters. If you do that, you should have very minor fixes between tenants. Another thing that we did was to buy houses fairly nice houses. That way, we could set the rents high enough so that we could weed out many of the potentially troublesome tenants simply because they couldn't afford to live there.

We are not wealthy. We don't have deep pockets. Granted, we live in a smaller community (20,000 population) as opposed to a city where everyone rents. Still, our experience being landlords has been great. In a few years, we will own the houses outright...and we will only have paid a few thousand dollars out of our own pockets. The rest was paid by our tenants. You can't beat that if you are looking for ways to easily increase your wealth!

Guest's picture
Guest

"That way, we could set the rents high enough so that we could weed out many of the potentially troublesome tenants simply because they couldn't afford to live there." Equating income to character quality is offensive, and says that great tenants who make less money do not deserve a nice home.

Guest's picture
Bryan

This is how we see it as well. We are renting a place, but we have our own place that we are renting out to some other family. One would ask, why are you still renting if you already have your own home? That is because we earn profits with that kind of arrangement. The place we are renting is nearer to our kids' school and nearer to almost every establishment one needs. We save on gas because we can walk to anywhere we need to go. Our own house is in the same city but farther than the kids' school and the city center, so you need to use a car to go some place. We rent out our house for twice the amount we pay for the house we are renting, so we both save and earn from this arrangement.

Still, we are not planning to stay in this rented house forever. We are just waiting for an opportunity to buy a house in this area.

Carrie Kirby's picture

It's such a relief to hear that some people have good experiences being landlords!

Guest's picture
Rick

One point to add about capital gains tax on a future sale of a rental. Your cost basis on the home decreases every year you file a return because you are "depreciating" the home (not the land). The IRS is going to recapture the value of the depreciation when you sell. The final tax bill is going to include a whole more than just capital gains...cost basis decreases, capital gains increases!

Carrie Kirby's picture

Hmm... I am not an accountant but I believe that as long as we have inhabited our house as the primary home for 2 out of the last 5 years, we won't have to pay capital gains tax. So that would be something we'll need to consider if we still own the house 3 years from now.

I'm not really expecting to sell it for more than we paid for it -- breaking even would be nice. Are you saying that if we bought the home for $329k and we sell it for $329k, the IRS could still consider that we made a profit due to depreciation? Confusing. I'll have to ask our accountant about that.

http://taxes.about.com/od/taxplanning/qt/home_sale_tax.htm

Guest's picture
Guest

Landlords have a tendency to be short-sighted when screening tenants. First, some of them rely on a credit report which fails to tell them the most important things they want to know about a prospective tenant, that is, if they are quiet and clean. Secondly, they reject great tenants who are savvy about landlord/tenant laws. A great tenant should have corresponding expectations of the landlord, and landlords should show appreciation for great tenants. Too many landlords are more interested in moving as much money as possible from the tenant's pocket to the landlord's pocket.

Landlords tell stories of terrible tenants and some are true. By the same token, there are plenty of terrible landlords, especially now. Many of them buy a fixer for too much money, fix it up only minimally, and rent out a crummy rental they themselves would not want to live in (the Golden Rule applies) for way too much money. They console themselves that tenants must be happy with the rent because they signed the agreement, conveniently forgetting that housing is not like a book. I can live without the book, but I have to put a roof over my head.

Some landlords try to illegally make part of the security deposit nonrefundable by putting illegal provisions into the agreement, such as the tenant must pay for carpet shampooing and cleaning or have it taken out of the deposit. Sometimes they make it pretty clear they have their eyes on the deposit when they want to charge a longtime clean, quiet tenant an extra deposit to have a pet. No wonder such otherwise great tenants want to avoid the hassle of a deposit dispute after they have moved (possibly out of the city or state) by simply not paying last month's rent.

If you are getting tenants who routinely trash your house, you might want to self-examine not only your screening techniques, but your attitude toward the tenant.

Guest's picture
Guest

A big problem is that too many sellers (for whatever reason) paid too much for their houses in 2006, and understandably chafe at the prospect of losing thousands of dollars because buyers are unwilling to make the same mistake. On the other hand, it is unreasonable to expect buyers to make the same mistake as they did.

Guest's picture

I think most of the possible negatives are outweighed by the positives, especially for anyone whose underwater in their current situation. Just ride out the current market, and trust that better days lie ahead.

Guest's picture

I own couple of houses and was thinking about renting one but decided against it because of the negatives that you mentioned in an article. If I was to purchase a rental property I would rather buy a 4-5 unit house. There's not much difference between having one tenant and 4 (it's super stressful either way) but at lest you get better compensated for the time you spend on it

Guest's picture

Great article with nice tips and advice for before, during and after the process. One of my favorite tips is being conscious that the income is taxable and preparing to pay on it.

Guest's picture
JudyL

I rent a home in the Tampa/Clearwater area. I've had four different tenants in nine years but luckily the only bad one was the first. They not only trashed it (all carpeting ruined by a small dog, urine, feces), but didn't pay electric bill, the refrigerator became infested with maggots, holes in the walls etc. Amazingly they did not ruin the kitchen cabinets or appliances (except the refrigerator), which was replaced. Apparently they had no interest in cooking or dishwashing.

We ripped out all the carpeting and tiled all the floors instead. My husband is a good handyman so he fixed the holes in the walls and repainted where necessary. All this with a broker (realtor). The broker did work with us (cleaning services and other repairs) and we were able to sue the tenants for damages after they left. It was shear luck that the "girlfriend" of this couple worked for a lawyer so she knew enough to just pay up. The amount didn't cover everything but combined with the deposit and last month's rent, it was sufficient. Again we were lucky but we also had a broker (legal documents, lease, etc.) which makes the deal a bit more binding.

If you're going to do this, at least get a good realtor/broker to help you. Worth the 10% (of monthly rent) commission they get.

Guest's picture
Kimber24

What a great article and thanks for sharing! I recently became a landlord for the first time. I am single and my elderly parents live in the same town where my rental home is located. I was struggling financially, and they are having health issues, so I moved in with them for a while. In my situation, I know the tenants very well, which is a huge plus! They are wonderful renters and have been fixing up the place for me while they are there. Also, financially this has been a huge weight off my shoulders, and the rent covers my mortgage, insurance and taxes with a few hundred left over.