Should I Sell My House or Rent it Out?

Should I Sell My House or Rent it Out?

You’re intrigued by the idea of passive rental income. And for good reason: Passive income forms the building blocks of financial independence. Early retirement. Freedom to ride off into the sunset and do whatever your heart desires. But does that mean you should keep your old home and convert it to a rental when it comes time to move? Maybe…

Things to Consider About Renting Your Home:

1. Am I cut out to be a landlord?

You’d be surprised how many people jump into rental investing only to find out that they simply don’t have that special balance of diligence and detachment. Are you swayed by sob stories? Would you postpone filing eviction because your tenant called you with one? You probably just shook your head and said, “No, of course not.” But let’s color in the details of what that could look like in reality.

A single mother calls you at 9:30 at night on the sixth of the month, crying. They’ve cut her hours at work — she tells you — at the worst possible moment. Her daughter broke her leg in a bike accident, and she doesn’t know how she’s going to pay all her bills.

She asks you, choking back the tears, if you can hold off on filing for eviction — just for another week?

How would you handle this? If you can’t do that, that’s completely fine. But you’re probably not cut out to be a landlord.

2. Will renting my house be profitable?

Instead of introspection, this question requires some research and calculation.

Expenses when renting a home:

• Mortgage – calculate both the principal and interest into the equation.
• Insurance – Almost every year insurances rises. Keep this in mind.
• Repairs – repairs are almost a certainty. Remember Murphy’s Law.
• Taxes – In most areas taxes don’t go down.
• HOA fees – this may or may not apply to your circumstances.
• Management fees –  (if you hire a property manager).
• Vacancies – don’t expect to maintain full occupancy the entire time.
• Commission – are you going to be paying a real estate agent to rent the property?
• Advertising – if you are renting your property without using an agent don’t forget about advertising expenses.
• Miscellaneous – don’t forget about other smaller expenses like credit checks on tenants.

As a rule of thumb, the 50-percent rule states that your expenses will run around 50 percent of the rent — not including any financing (principal and interest) that you pay. If the rent is $1,000, and your mortgage payment (P&I) is $400/month, you can expect roughly $500 in additional expenses, leaving you with a cash flow of $100/month.

The golden rule of cash flow with rentals is that it’s based on a long-term average of your expenses, not on what happens in a typical month. In a typical month, you’ll just pay your mortgage payment. Then suddenly you’ll be slapped with a $3,000 roof repair bill.

Get comfortable with the numbers in your neighborhood. How much can you expect to rent the property for? What’s the average vacancy rate? If your property has carpets, what will it cost to replace them between each tenancy?

And yes, include property management fees, even if you plan to manage the property yourself. It’s a labor expense, whether you’re doing the labor or someone else is.

3. What’s the opportunity cost of leaving money tied up in equity?

If you have $50,000 in equity in your property (beyond what it would cost you in closing costs to sell), then there’s an opportunity cost in leaving that money tied up in your old home.

We’ll keep running the same example from above. You can charge $1,000 for rent, with $100/month in average cash flow, for $1,200/year net income. You have $50,000 in equity in the property. Keeping that property as a rental means you’re effectively investing $50,000 to earn $1,200/year. That’s an annual return of 2.4 percent. What kind of return could you earn on that $50,000 elsewhere? In mutual funds perhaps?

4. Is the market going up in the future?

Some housing markets seem to be almost guaranteed to get stronger in the next few years. If you are in such a market, and you feel like there is a good chance your home will increase in value significantly, then renting will let you keep it, pay the mortgage and realize a bigger payday down the line.

Maybe there are home improvements that you know you’ll need to make but don’t have the money right now? If this sounds like the case, renting could be a good option. Renters are not like buyers in the sense they will be accepting of specific improvements that need to be made. Buyers, on the other hand, can often be pickier.

5. Should I sell my home and use the money to buy better-performing rentals?

Just because your old home may not be a prime candidate for a rental investment doesn’t mean you shouldn’t become a landlord. Imagine you sell your home and walk with your $50,000. You use $25,000 as a down payment on a fourplex, which cash flows $500/month. Then you turn around and do the same thing with the other $25,000.Now you have $1,000/month in cash flow, instead of $100/month from your old home. Your annual return on that $50,000 is 24 percent, instead of 2.4 percent.

Your situation might look completely different. Maybe your old home will cash flow beautifully. Maybe you don’t feel confident in your ability to buy rentals that will cash flow in your market. Run the numbers. If you like what you see, move forward. If not, sell the property and invest the proceeds elsewhere.

Things to consider about selling your home:

1. You get to walk away after the sale.

There is something to be said for the freedom that comes from unloading a significant investment in your home. Every one of the burdens that come from renting your home out is avoided by selling it instead. Selling is still stressful, and there will be work involved, but when it is all over you get a check for your home and get to move on.

2. You can escape a dropping market.

If you have a feeling that your real estate market is going to go down the drain in the coming years, it makes sense to get out now. Selling your home allows you to generate as much income as possible from it, and much more revenue than you would if the market does drop out in the next few years. Of course, you can’t adequately predict what will happen, so it is possible you are wrong about the future. But if you feel like you are right, selling makes sense. By having the equity from your home, you’ll be able to invest that money and hopefully make more.

3. You can take advantage of current tax laws.

Right now, selling your home lets, you take advantage of current tax laws that exclude your sale from capital gains tax up to $250,000 on your own, or $500,000 if you are married. Limitations are depending on your tax bracket, but for most homeowners, the current law means they get to avoid a reasonably sizable tax on a huge sale. Requirements change, which means this law could change.