You are a homeowner and for whatever reason, it’s time to move on. Maybe you’ve outgrown your house, perhaps there’s a new job waiting in another location or you’re just ready to move to a more appealing home in a different neighborhood. No matter what the reason, you are no doubt struggling with the question, should I rent or sell my house?
This decision often comes down to where you are in life and what your long terms goals are. If you don’t have a lot of cash reserves or investments, you might need the proceeds from the sale of your existing home to go towards the down payment on a new home. If on the other hand, you’re looking for investments, managing a rental property might be a great option for you.
Deciding Whether to Sell or Rent
There are a lot of different factors to consider before jumping into the world of rental property investing. Some of them are financial, while others have to do with the demands this type of investment can make upon your time and lifestyle.
Let’s take a look at the major considerations that will affect your decision.
Start with the money
Cash flow should be the primary focus when considering the financial side of the rental business. Just like it sounds this term describes how cash flows in and out of your accounts.
Cash can flow positive or negative, but for most people, positive cash flow from your rental property will be the goal.
There are rare exceptions to this principle, these exceptions usually involve taking losses for tax purposes, certainly not something most people are looking for.
The other reason you might consider taking the negative cash flow would be if you were pretty far into a 15-year loan. You would do this in order to pay off the house and own it free and clear.
Establishing Cash Flow
In order to establish cash flow, you’re going to have to do some estimating of both income and expenses. It’s important to be realistic about these numbers. When I work with a new property owner in our property management company, I tend to lean on the pessimistic side of these numbers.
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If the property leases for more money and the expenses end up being less, our clients are pleasantly surprised. If there is some kind of negative trend in the market, having forecasted from the worst case scenario means they’re less likely to get hurt. I suggest you do the same when making your estimations.
Your Property’s Income
Rental property income can come from a number of different sources. Some landlords offer various services and options to tenants for a fee. Services like landscape maintenance, cleaning and various insurance policies for late rent. It’s a good idea for the new landlord to keep it simple, this means using only the rent payment when calculating income.
Establishing Rental Rate
The first thing you need to establish is how much you can realistically lease your property for. You want to be realistic because you want the property to lease quickly, no matter what the condition of the rental market. Keeping it leased goes hand in hand with keeping the cash flow positive.
You have several options when it comes to pricing.
- There are free valuation websites like Zillow where you can get a ballpark idea of what your home could lease for. This gives you a starting point, but ultimately you’re going to want to do detailed research to get a more accurate estimation.
- You could ask a REALTOR® to do a rental analysis. They will most likely use data from the MLS (Multiple Listing System), this is a good option because the data is generally accurate and verified.
- Another option would be to do your own research by combing through sites that feature rental properties in your neighborhood. You can talk to neighbors in order to see what they know about rental prices as well as calling any “For Rent” signs to see what people are asking.
- Finally, you might use a property management company to manage the property. One of the primary services they provide will be pricing. Since they manage multiple properties and will usually have MLS access, their price is usually the most realistic.
I can’t stress enough how important it is to get the pricing right. Tenants tend to move in waves, this means they usually start looking 30 to 45 days prior to when they want to occupy. Additionally, they probably need to give notice to their current landlord. If you take the first couple of weeks testing your price, you may find your rental sitting vacant for a couple of months. This mistake will kill your cash flow.
It is important to be methodical about your pricing and please don’t use the ”This is how much I need to get method”. This method consists of the homeowner looking at their payment and adding a little profit in order to determine the rental rate. This doesn’t work because the market doesn’t care how much your payment is or how much profit you want.
Renters will be looking at everything available on the market. If your rental is overpriced they will more than likely politely pass leaving you clueless as to why they didn’t lease it. So, before you do anything else establish a fair market rental value for your property.
Your Property’s Expenses
Once you establish the fair market rental value for your property you can start to apply debits to that number in order to see if the cash flow will be positive. here is a list of expenses you’re going to want to use in order to figure out if this is going to work.
- Mortgage: Add up your principal, interest, property taxes and insurance (landlord policy).
- Taxes: You will need to pay federal income taxes on the net income (rent plus other money minus expenses) you receive from your rental property each year.
- Each year when you file your tax return, you will add your net rental income to your income for the year, such as salary income from a job, interest on savings, and investment income.
- Property Taxes were covered above in the Mortgage section. If you, not your lender make your own tax payments, you can add them here.
- Owning a rental property allows you to make several tax deductions for things like interest and depreciation.
- Operating expenses: This is a broad category
- Advertising – Websites, Print, Social Media
- Travel – Driving back and forth to the property
- Cleaning and maintenance
- Legal fees – Documents (leases, disclosures, etc.)
- Credit and background checks
- HOA Fees: If you live in a neighborhood that has an association you’re going to want to pay those fees yourself. Since late payments of HOA fees can bring serious consequences and fines, you don’t want to leave this one to the tenants. Having said this, you may want to roll the HOA cost into the rental rate.
- Management fees: if you choose to use a property manager you will need to calculate their monthly fee along with any other additional fees into your expenses total. Using a property manager can eliminate other expenses along with a significant amount of time and hassle. if you are the least bit squeamish about dealing with tenants you owe it to yourself to talk to a property manager.
- Commissions: if you or your property manager are putting the property into the MLS system for REALTORS® to show and help you lease, you’ll need to offer a commission which varies from area to area.
Once you’ve tallied all of your expenses and compared against the potential income you’ll receive from the property, you’ll have a better sense of whether or not renting versus selling is a good idea.
Your Time and Effort
In addition to the financial aspects, you should consider the effect managing rental properties will have on your personal life.
If you’re going to self-manage your rental property, you will need to handle the following:
- Advertising – The internet makes this a lot simpler than it used to be. You’ll still need to prepare ads, take photos, compile house details and post all of this information.
- Answering calls – No matter how automated you try to make the leasing process, tenants still want to talk to a human. They have questions and frankly, want to get a feel for what kind of person you are.
- Scheduling showings – Plan on showing the property at all times, even on evenings and weekends. People with 9 to 5 jobs are going to request this. In our experience, if someone is really looking for a house to rent they will carve out time during the day.
- Showing the property – This can actually be a lot of fun and it’s good to get to know your prospective tenants. One important word of warning don’t be wooed by their personality, you need to be objective and make your decision on the application and the data you get from that exercise. In other words, put a lot of weight on the tenant’s credit score, background check and references.
- Processing the application
- Pulling credit
- Checking background
- Calling References (previous landlords, employment & personal references)
- Preparing a lease – You can find a boilerplate lease online, but an even better idea is to contact a local real estate attorney and pay for a copy of their lease. Remember, every market is different and a local real estate attorney will most likely have a lease that takes into account aspects of your local market.
- Documenting the property condition – This is important because when your tenant moves out you need to be able to prove any damage claims you make against them prior to deducting any monies from their deposit. You want to avoid any opportunities for subjective opinions about property conditions and damages.
- Emergency Phone Calls – You should offer your tenants a way to reach you at anytime day or night in case of emergencies. To minimize these calls, it is a good idea to explain to the tenant who to call in case of certain types of emergencies. For example, in most cases, a gas leak should elicit a call directly to the gas company instead of the property manager.
- Ongoing maintenance- You’re going to want to make sure the property is regularly maintained. This means winterizing and de-winterizing sprinklers, cleaning and servicing the furnace and making sure smoke detectors and CO2 detectors are in proper working order. These items are important because carbon monoxide is so dangerous and landlords own much of a liability around it.
- Performing regular property inspections – Even the best tenants lose sight sometimes of the fact that this is your house. Regular inspections are necessary for a number of reasons:
- Making sure all occupants are on the lease
- Checking for unapproved pets
- Verifying there are no illegal activities taking place
- Checking for things like smokers in a non-smoking property
- Collecting Rent – This includes dealing with late and or unpaid rents.
- Evictions – The possibility of having to serve and process an eviction
- Preparing a property to release – At the end of the lease term, the property needs to be returned to a condition where it is ready to move into by another tenant. This can include:
- Carpet cleaning
- General cleaning throughout
- Patch and paint of walls
- Other maintenance items in the property
- Rekeying of all locks
- General landscape maintenance
Some homeowners have no problem with performing any of these items. But oftentimes, it is very time-consuming to find the right vendors and schedule all of the work to be completed in a timely and cost-effective manner. A property manager will handle all of this for the homeowner and this is one of the big benefits of using a property manager.
Other important reasons you might lease
You might consider renting your property if you have a desire to return to the area. Here in Colorado Springs, we often see military families that plan on returning to the area at retirement or when they’re through with their military service. For this reason, they will decide to put their home into a property management program or in some cases, manage themselves from a distance. The upside is that when they return they know exactly where they’re going to live. Additionally, pricing fluctuations don’t affect them as they don’t have to buy back into the market at a higher rate.
Another good reason to rent your home is the possibility of catching a rising equity tide. During the latest recession, we used a term referring to some of our homeowners as “accidental landlords”. These were people that were unable to sell their homes without writing a check and were not willing to walk away or go through the short sale process. These people put their homes up for rent and decided to weather the storm. Fast forward to the latest real estate boom, and many of these people have sold their homes at a tidy profit.
Some people have a genuine desire to own property and be a landlord. Every now and again you meet someone who just loves owning a lot of property and getting to know their tenants. They really don’t mind the hassles involved and always seem to be on the run and energized by what they do. Yes, these people exist but are rare.
The Upsides of Selling
Selling your home and walking away with a profit is a great feeling, especially in a seller’s market. Doing so can give you the flexibility to take advantage of other opportunities.
This money can potentially be a substantial amount of money which you might use this as a down payment on your next property. Many people love the prospect and the excitement of starting over in a new home.
Be aware that in an extremely hot seller’s market you will need to be able to find someplace to move to. Talk to anyone trying to buy in a hot market and you will soon learn about the stress and disappointment of navigating this type of market. This is a problem you don’t want to discover after your house is under contract.
If you’ve lived in your home for at least 2 out of the last 5 years prior to the sale, you may be eligible for an exclusion on any capital gains tax up to $250,000. If you are married and file jointly this amount doubles to $500,000 (2017). You’re not going to find a lot of other Investments that give you this kind of break.
Handling a rental property as a homeowner takes a fair amount of time and effort. Re-read the section on Time and Effort and ask yourself if you are really ready to handle all of those responsibilities. Using a property management company alleviates most of these responsibilities, but selling your property alleviates all of the responsibilities once and for all.
Escaping Maintenance and Repairs
If your home is a maintenance nightmare, or in need of repairs, renting it out is probably a bad idea. The tenant will certainly expect the condition to be up to a livable standard. Repair requests will create a constant hassle and eat into your bottom line.
With a home in need of numerous repairs or remodeling, selling is most likely the best option. This allows you to deal with any repairs and deferred maintenance in one fell swoop, after the inspection and prior to closing. Once you negotiate those items, the maintenance and repair headaches are over.
This list will certainly get you thinking about the core issues that surround selling versus renting. Timing, lifestyle, income and a long list of other factors go into the decision to be a home seller or a landlord. This information should go a long way to get you pointed in the right direction.
As always, if you have any questions or help to get started selling or renting out your home, feel free to give me a call.
Here are some helpful resources I used while putting this article together:
Should I Rent or Sell my House-Bill Gassett
Pros and Cons to Selling a Tenant Occupied Property-Michelle Gibson