Considering Renting Out Your Home? Read This First.

A post from Heather C., our CMF Finance Coach:


Here’s a common predicament:  you need to move.  Now.  The catch is, you would have to sell your current home for less than what you paid.  And no one wants to do that.

There is a solution.  Whether a job is requiring you to move or you’re outgrowing the home you’re in now, you don’t necessarily have to take a loss to sell your house, nor do you need to stay put.  Instead, more homeowners who are not in the real-estate business are becoming landlords, hoping to ride out the housing slump.

If you want or need to rent out your house, there are some perks to be enjoyed, but there are also some pitfalls, and you must be willing to take a few risks.

Let’s start with the positives:

1. You’re not stuck in your current home.  If your house is “under water,” you can move without losing money, and you don’t need to wait for the housing market to bounce back.  Just be sure you qualify to purchase or rent a new home.

2. With today’s favorable rental market, you have a decent chance of being able to charge enough rent to realize a positive cash flow and actually make money through your lease agreement.

3. While you might not be able to sell your home for a profit now, you can hope to realize some appreciation on your home in the next few years.  In fact, if you’ve lived in your rental property for any 2 of the last 5 years, you’ll pay no tax on any gain under $500K if married filing jointly ($250K if single).  Or, you can keep your rental property for the next 30 years and almost guarantee a sizable, albeit taxable, gain that you can enjoy when you retire.  And there’s more good news – you can further delay paying tax on this gain if you exchange it for a “like-kind” property.

4. If you’re actively involved in managing your rental property, you can write off a substantial amount of your losses on your tax return (your Adjusted Gross Income must be below $150K).  Best case scenario, you can have a cash gain, but a paper loss from the required depreciation and maintenance you would do anyway on your property.

5. Good tenants do exist.  I know they do, because I’ve been one.  😉 If you price your property fairly, you should be able to attract enough potential tenants that you can find someone who will take great care of your place.
 
But, there are some things to consider before taking the plunge into the not-always-glorious life of a landlord.
Picture this:  You just signed a 12-month lease on your current home, and you’re about to move into your dream home.  Your tenants drop off their rent early and call to ask if they can extend their lease and plant petunias around your mailbox.

Now picture this:  It’s 2am and your tenants call to tell you that your roof is leaking into the master bedroom.  Their rent is late, and last month’s check bounced.  You drive over there and find out they do, in fact, have a dog who seems to have relieved himself all over your hall carpet.

Here are some pointers that can help mitigate these and other risks:

1. Be prepared for vacancy and repairs.  In an ideal world, your home would be rented year-round with tenants who pay on time, take great care of your place, and honor the terms of the lease agreement.  This could be the case, but you need to be prepared for at least some vacancy and repairs.  To be safe, plan to have at least 6 – 12 months’ rent in your savings account.  You don’t want to be panicking about paying 2 mortgages or not having enough funds when you need to replace the washer and dryer on your rental property.

2. Know how much rent you need to charge to cover your expenses.  First and foremost, you’ll need to cover your mortgage payments.  But don’t forget additional expenses such as property tax, insurance, yard maintenance, utilities, etc.  Now that you have your ideal monthly lease payment, do some research to find out whether the rent is a fair value for the market, and be willing to negotiate with prospective tenants.

3. Work out the details ahead-of-time.  Who will be responsible for the yard maintenance?  The utilities?  The alarm system?  What will you do if the rent is late?  What’s your pet policy, sub-letting policy, etc?  Make sure your lease is air-tight so you’re covered should something unexpected happen.

4. Upon signing a lease, be sure to get at least one month’s rent as a refundable security deposit.  These funds should be used to cover any property damage caused by the tenant, and should not be applied toward any lease payments.

5. Screen your prospective tenants.  With their permission, you can and should run a credit check on potential lessees.  Be sure to get a signed rental application that includes a list of references.  Always verify employment, and call past landlords and personal references.  Trust your gut, and know the discrimination laws.

6. Know all the legalities.  Be sure to research topics such as escrow requirements, zoning and mortgage restrictions, lead-based paint disclosures, eviction procedures, insurance requirements, safety requirements, and utility liens.  Keep in mind that every state has its own set of laws pertaining to rental properties.
Becoming a landlord can be overwhelming, so consulting a professional could be a wise investment.  Tax professionals, lawyers, and real-estate professionals are all great resources for first-time landlords.  You might even decide to hire a property management company to take care of the logistics such as finding tenants, collecting rent and managing repairs.  Rates vary, but expect to pay a property manager at least 10% of your monthly lease payments.

Only you can decide whether renting your property is right for you.  Whatever you do, educate yourself; there are a lot more specific tax rules and laws that this article doesn’t delve into.  If you decide to go for it, be prepared and be realistic.  Sure, becoming a landlord can be lucrative and exciting.  But, it can also be time-consuming, stressful and costly.

Personally, I’m a four-time landlord and I’ve experienced quite a few scenarios – the good, the bad and the ugly.  Is it easy?  No.  Would I do it again?  Absolutely.

If you’re serious about becoming a landlord, I would gladly entertain any questions.  I surely don’t have all the answers, but I would be happy to share some of my lessons learned with you.

**Heather wants to know: Are you a landlord? Can you share any tips or stories?**