As a former successful landlord, it was my first choice, but the wrong one! Am I giving away my entire thesis in the first line? If you think so, you may be wrong. I addressed this question about seventeen (17) years ago and remained a landlord for another year. Although this is a personal decision, you should consider certain factors before you chose one or the other.
Just a few months ago, I addressed the other side of this question of renting vs. buying. I went so far to consider the possibility of renting out my house and rent another home. In this low interest rate environment, many people bought homes to rent out. Is it the right decision in all cases? In less than three (3) years, I will have my home paid off and I can sell my home for five hundred thousand ($500k+) plus dollars. What should you consider?
Factors to consider
- Return on investment – On average, I can achieve a eight (8) to ten (10) percent return on investment (ROI) in the stock market. Can I net eight (8) to ten (10) percent renting out my home? Initially, definitely not. How many years will it take to achieve a reasonable ROI? Does it make sense?
- Tax free or capital gains – If I rent out my home for more than three out of the last five years, I will lose my tax break. I can qualify for the $250,000/$500,000 (single/married) home sale exclusion, if I own and occupy my principal residence for at least two years. I am not obligated to reinvest the profits and I do not pay any tax on my profits up to the stated limits.
- Market conditions – Can I get eight (8) to ten (10) percent in net rent? Although my home will be paid off, there are other expenses. I pay a home owners association (HOA) dues, property taxes and insurance. Without getting into the specifics, I lose about a thousand ($1,000) dollars monthly. The rental market does not support an eight (8) percent return. The ROI is more like 3.4%!
- Longer term – Could I increase my rents (ultimately better ROI), property value by renting and waiting? Waiting also means delaying investment too. Will the property value increase more than the eight or ten percent? There is a limitation (2 years) in this thinking because I do not want to lose the $500,000 profit exclusion. Any additional profit would be subject to capital gains.
- Risk – There are risks in every decision! One of the risks is future value of the property. There are several other risks related to the rental market. The tenant may damage or destroy the home, not pay rent or just cause problems. I can do a number of things to reduce these risks, but they are still possible. Last, repairs and maintenance may exceed my estimate. All these things may reduce my ROI for my home.
- Costs to ready the home for rent – Just like getting your home ready for sale, you have to take care of deferred maintenance or be prepared for a lower rental or price. Just cleaning the home can add up to five ($500) hundred dollars. There are costs to maintaining the home during the rental period and to return it to salable condition two (2) years later.
- Personal factors – It may be the wrong time to sell and you need/want to wait one or two years to see if it will change. Another may be you decided to convert your personal residence to a rental and will trade your equity in order to defer taxes. Converting to rental property is probably only a choice if you have little or no equity. If you meet the exclusion, it would make better sense to sell and use the proceeds to purchase rental property.
Final thoughts
Your decision should be a financial one! The numbers will tell you a great deal after you calculate your return on investment. I know I can achieve a much better return in the stock market with little or no risk. Is this true for everyone? This is why it is a personal decision and it depends o your residence and the numbers you calculate. If you bought a foreclosed property at a price low enough compared to market, you probably could generate a reasonable (8-10%) ROI. Landlord or seller is a choice to consider!
Photo by: Flickr
I think I would prefer to invest in the stock market. Renting out your property means you have to have tenants, and you never know how they will turn out be, even if you have implemented steps to weed out the bad ones. On the other hand, investing in stock market also has its own risks, but I prefer this because it doesn’t always involve big initial investment unlike if you invest in real estate.
I made my decision based on the numbers. Unless, I cannot sell my property, I would sell and reinvest in another principle residence. The ROI for renting out my property is under 5%! I can get a better return in either real estate or the stock market.
Thanks so much for this post! I’m not familiar with the finances of being a landlord so I’m glad to have some idea of what factors to evaluate.
Curious- how much of your investments is tied to real estate?
I sold all my real estate except for my home years ago.
We have been considering purchasing a rental to rent out. But we hear so many horror stories of tenants and going to court, etc.
I owned income property(44 units & rental home) for 16 years. I had about a half dozen bad tenants over those years compared to probably 100+. First and foremost, the numbers have to make sense. Second, you can screen the tenant enough to reduce the risk. It is not all that bad or difficult. The alternative is to invest in either real estate mutual funds or REITS. Good luck.