You’re moving, and you’re trying to decide what to do with your house. Should you sell it, or should you rent it out? In the military, we face this decision more than most folks. Any military family who buys a house needs to be thinking about the all-important question, “Am I ready to be a landlord?”
This is a guest post from my friend Forrest Baumhover, a Navy retiree and Certified Financial Planner®.
If you have bought a house, you have two basic decisions when you move: rent or sell. When real estate prices go down, sometimes we’re locked into the decision of renting it out because we can’t afford to sell it. However, when real estate prices go up, we face a more challenging decision. One that can have lasting effects: Do we rent it out, or sell it?
When we faced this decision, we ended up renting our house out. Hindsight being 20/20, this is the ONE decision that I wish we could have taken back. Although we didn’t know it at the time, we just weren’t cut out to be landlords (much less overseas, managing a property during the Great Recession during a deployment). You can read more about my accidental landlord story here.
To help you decide for yourself, here are 5 questions you should honestly answer:
Landlord Question 1: Do the numbers work?
Many people figure that if you can get enough rental income to pay the mortgage, then that’s good enough. That’s one way to look at it. However, people who follow this rule usually end up putting more money into their property than they expected.
Why? The reason is simple. A mortgage is only one factor in maintaining a rental property. Other things you need to include are:
- Property management (even self-management costs money)
- Repairs & maintenance
- Capital Expenditures
- Taxes & Insurance
You also need to account for vacancies. While this isn’t a cost, it is lost revenue that occurs when you don’t have rental income. Even in a crazy-busy market, there usually is some turn-around time between leases. This turn-around includes the time you might need to repaint, refurbish, and get the property ready to go back on the market, plus the amount of time that it is ON the market, plus the time it takes for a successful applicant to actually move in. Most pros factor in a 10% vacancy rate, as a conservative estimate.
While you can go to Bigger Pockets to learn more about renting properties, a conservative rule of thumb is the 50% rule. The 50% rule states that if your mortgage (principal & interest only, not taxes or insurance) is no more than 50% of your estimated rental income, then you’re in good shape.
Assuming you’re able to make those numbers work, you should probably be able to weather most landlord challenges that come your way. If not, then you might want to reconsider.
Landlord Question 2: How will you manage the property?
Note that the 50% rule cites a 10% budget for property management. Generally, that’s the going rate (might be higher or lower in your area). However, hiring a professional PM doesn’t guarantee success…and it might lull you into a false sense of security.
While this doesn’t represent the overall market, in many areas, property management is viewed as a career stepping stone. Many real estate professionals start off as property managers, just to get their foot in the door. As they gain experience, demonstrate competency, and build relationships, many folks go to more lucrative opportunities.
And frankly, who’s to blame them? Not only do they hear it from noisy tenants, but they also have to deal with landlords who:
- Obsess over rent payments
- Micromanage the smallest repairs
- Have ridiculously high expectations of customer service
Oh, and 10% on a $2,500/month rental is $250 per month. Would you rather have that in your paycheck, or a commission split from a $350,000 home sale?
Not to say that good, professional property management isn’t available. Just do your due diligence so that you can ensure your PM plan is around for as long as you plan to rent out the property. This could be more than just 2-3 years, so make sure your property management company has a process in place in case PMs come and go.
Or, you could do it yourself. Many other people do. In this case, the 10% really is going back to yourself (or it’s something you’re doing to make the numbers work). In that case, you might want to join a community of like-minded people who have been there, done that, and can help you through the tough times. And there will be tough times.
Perhaps you’ve got a trusted family member…eh, don’t bet on it. Things work well with family, until they don’t. Then all bets are off.
Whatever your plan is, you need to really dive into the details and make sure you’ve got solid relationships. Not just with PMs, but with anyone whom you expect to do work on your house. This would include contractors, electricians, plumbers, pest control, painters, cleaning folks, etc. Don’t just rely on your PM to give you the names of people they recommend. I’ve seen examples where my PMs were getting kickbacks from contractors for doing substandard work. Most PMs will accept your contractor recommendations, or honor your service contracts. Hold them to it.
Landlord Question 3: Do you have enough money saved?
If you have enough money set aside, you can weather any issue that comes up. However, each dollar that you have saved for an emergency is a dollar that you can’t put towards retirement planning, college planning, or any other savings goal.
If you think about it, there are actually two aspects to this:
1. If you aren’t already saving enough for your retirement, emergency fund, or other needs, are you sure that you’re going to have enough money set aside for this?
This is a BIG DEAL! If you don’t have an emergency fund (for personal emergencies), you probably won’t have enough to handle any of the things that go wrong.
Need to replace a roof? Even if you have insurance, you still need a deductible.
Tenants walk out on rent? Trust me…lost rent is only the beginning. No tenant, in the history of mankind, has ever walked out on their rent and left an immaculate house. You’ll have to pay for cleaning, painting, and repairs. Hopefully, your old tenants didn’t maliciously damage anything on the way out.
Then, you’ll have to hope that you’re not a victim of market timing. You know, trying to rent a house out in the middle of February kind of sucks if you live up north. Or, if you’re in a college town, and your house is on the market in May…just in time for all the students to leave for the summer.
2. Even if you have money set aside, will this interfere with your retirement goals?
In our case, we were able to keep our rental property afloat during an otherwise challenging time. But that came at the expense of a lot of retirement savings. While we ended up all right, we definitely could have done better had we sold our house, then saved my deployment pay.
Landlord Question 4: Can you handle a triple-whammy?
What’s a triple-whammy? It’s a play on the superstition that ‘Bad things come in threes.”
You know, like a tenant skipping out on rent, doing $2,000 of damage to your house, and you can’t get a new tenant for 4 months.
Or a tenant that becomes a squatter, stops paying rent, and forces you to hire a lawyer to begin the eviction process.
It doesn’t just have to be all about your rental property. It could be one rental-related issue (like having a tenant that is consistently behind on rent). But then, you find out that you have to pay for airfare to attend a funeral, and your car broke down on the way to the airport.
Everyone should have enough money in their emergency savings for life’s triple-whammies. However, having a rental property increases the likelihood that a triple whammy will happen to you. And you need to be prepared for that.
Landlord Question 5: Are you better off selling?
If you’ve made it this far without saying, “That’s it, I’m done!” then congratulations! You might have the temperance & resources to weather the toughest landlord issues.
With that said, it might be worth taking a look at what you could get in the rental AND sales markets. For example, we were faced with making a significant profit, or having what seemed like great rental income. At the time, I was deployed, my wife was pregnant with our twins while having to handle our PCS by herself. We had decided that it was easier to stage the house to rent out than it was to get it ready to sell.
After all, it seemed that either way was a sure bet. I won’t go into numbers, but we were at the statistical height of the real estate market in Norfolk. Of course, knowing what we know now, we’d have sold the house…even though she’d have been doing all the hard work!
It takes a lot of work to get a house ready to sell. But when are you in the best position to do that? Probably when you’re living in it, or at least living in the same town. Moving away, having tenants, dealing with property management companies—those are all things that complicate the eventual sale of that property.
At the end of the day, you have to make the decision that best suits your particular situation. Hopefully, these five questions help you put some context into doing so. By knowing your finances, temperament, and possible outcomes, you’ll be able to make that decision with confidence.
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