Should we keep our house as a rental?

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jerome99
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Should we keep our house as a rental?

Post by jerome99 »

My wife and I are wrestling with the above decision. We currently live in a 2200 sq ft house in the best suburban area around Indianapolis. We are purchasing a new our home in the next 6-8 months. Our budget for this home is all in at $350,000.

Current house
Estimated value- $150,000
15 yr mortgage- $112,000- mort, taxes, ins is $1100/m
Estimated rent- $1,400/m

Our annual gross income is $325,000 and currently save ~$130,000/ yr including all available per and post tax opportunities.

We currently have $145,000 in savings for downpayment and emergency fund.

What additional information is needed for recommendations in our situation?
Honobob
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Re: Should we keep our house as a rental?

Post by Honobob »

What has the appreciation been over each of the last decades? What is the rent growth? Do you anticipate better worse or the same?
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jerome99
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Re: Should we keep our house as a rental?

Post by jerome99 »

Not sure where I would find that information. The homes zip code is 46062.
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momar
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Re: Should we keep our house as a rental?

Post by momar »

Yes, absolutely. I read somewhere that being a landlord is equivalent to being retired.



Seriously, without more information I would say no. Just from the standpoint that the amount you are clearing is so small compared to your income and annual savings. Not worth the headache.
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jerome99
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Re: Should we keep our house as a rental?

Post by jerome99 »

So if we made less money and had less in savings it would make more sense to do?
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momar
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Re: Should we keep our house as a rental?

Post by momar »

jerome99 wrote:So if we made less money and had less in savings it would make more sense to do?
If you had much lower income, it is possible. If you had much lower savings, it is doubtful since your net worth would be too concentrated.

You are talking about 3.6k per year if it is rented 100% of the time with good tenants and there are no maintenance costs. You can either pay your full marginal rate on that and clear less than 2k or you can depreciate and lower your basis. But it won't be rented 100% of the time and there will be maintenance costs. Plus you will be spending some amount of time renting it out, arranging maintenance, and dealing with the tenant. So it's still work.

All this to increase your income 1% at best?
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YttriumNitrate
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Re: Should we keep our house as a rental?

Post by YttriumNitrate »

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connya
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Re: Should we keep our house as a rental?

Post by connya »

momar wrote:You can either pay your full marginal rate on that and clear less than 2k or you can depreciate and lower your basis.
Can you elaborate on that? I thought basis is lowered by allowable depreciation whether you take it or not.
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noyopacific
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Re: Should we keep our house as a rental?

Post by noyopacific »

Having been a landlord for most of 3 decades, I would not recommend it as a job to be undertaken lightly. Assuming that your $325K annual income is from a job or from owning and operating a business, I'd say that the potential gains you might expect from being a landlord are not anywhere close to being worth the effort. I would encourage you to seriously consider the time and economic realities of maintenance and repairs, property damage, lawsuits, collecting rent and doing the occasional eviction before becoming a landlord.
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momar
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Re: Should we keep our house as a rental?

Post by momar »

connya wrote:
momar wrote:You can either pay your full marginal rate on that and clear less than 2k or you can depreciate and lower your basis.
Can you elaborate on that? I thought basis is lowered by allowable depreciation whether you take it or not.
Sorry if I wasn't clear. Yes, you have to depreciate the basis even if you don't claim it.
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Twins Fan
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Re: Should we keep our house as a rental?

Post by Twins Fan »

Let's start with this.... Why do you want to keep it as a rental? Simply because it may be a future income stream, or hoping the value of the home will increase a bunch? Or, it is some nostalgia deal... first home? Along those lines, the only way I see it making sense for the OP is if the "rental" home were to be paid off, or paid off quickly (going by savings rate here). So, that way there would actually be income from it. The possible $300/month you think you see now, OP, is not going to be $300 when all the other things involved in a rental come into play.

Next, if you were living in the next home, which I'm guessing is more the "dream home", would you WANT to take on the current home as an investment property... do you want to be a landlord? Along those lines, woud you be using a property management company to run the show, or trying to landlord all by yourself? How far will you be moving from the current home when you move to the new home?

My situation... I'm pretty much the other end of the situation momar and the OP are talking about. I ended up owning a rental property through personal circumstances a few years ago (divorce, moved to be by the kids, yada yada). I couldn't sell at the time because the house was underwater compared to the mortgage. It still is, but is recovering nicely now. I was finally able to the refinance the mortgage, and the renters now pay the mortgage even after the prop. managment co. takes their piece. I have much lower income than the OP, which means I don't have near the ability to save like they can. At this point, I am probably going to ride it out in hopes that it becomes an income stream for me someday, or the value goes up a good bit so I can at least get something out of the deal. But basically, I WISH I could have just sold the place when I moved and been done with it.
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frugaltype
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Re: Should we keep our house as a rental?

Post by frugaltype »

noyopacific wrote:Having been a landlord for most of 3 decades, I would not recommend it as a job to be undertaken lightly. Assuming that your $325K annual income is from a job or from owning and operating a business, I'd say that the potential gains you might expect from being a landlord are not anywhere close to being worth the effort. I would encourage you to seriously consider the time and economic realities of maintenance and repairs, property damage, lawsuits, collecting rent and doing the occasional eviction before becoming a landlord.
I was a landlady once. Never again. In my state, you can have the most abominable tenants and still have a very expensive, very stressful, long drawn out mess getting them evicted. And that's assuming they don't trash the house in the meantime.
Honobob
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Re: Should we keep our house as a rental?

Post by Honobob »

jerome99 wrote:Not sure where I would find that information. The homes zip code is 46062.
http://www.neighborhoodscout.com/search ... ter/#rates
a local realtor/investor would give a better figure.
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deanbrew
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Re: Should we keep our house as a rental?

Post by deanbrew »

I would say it isn't worth the hassle unless you can answer yes to two questions:

1. Do you think the house will increase in value significantly over the next three to five years?
2. Are there lots of qualified, honest, respectful potential tenants moving into and out of the area on a regular basis.

Question 1 relates to the current economy and housing market in many areas. I don't know your market, but prices are recovering in many areas, and it's not unrealistic to think they will continue to improve for a few years. Do your homework on housing prices from 2000 to the present and local job and wage growth.

Question 2 relates to tenant demand and quality. I owned a couple of rental properties years back. The only thing that made it worthwhile was the location near two military bases. I rented to upper-rank military families who were moving into the area for three-year commitments. They got generous housing allowances they were looking to spend, were very honest and upstanding, and took wonderful care of my properties. I had great tenants in these properties and never had a single late payment. I was told, but never needed to verify, that if a military tenant was late with rent, all you had to do was call his superior officer and the renter would catch hell and pay the rent.

I owned a different house in a different location, and had a (not surprising) different experience. Not terrible, but enough problems to make me rethink my desire to be a landlord.
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Valuethinker
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Re: Should we keep our house as a rental?

Post by Valuethinker »

If you did not own this house.

Would you consider buying it at the price you are suggesting it is worth, as an investment?

In other words, are you engaging in the 'sunk cost fallacy' that says since you already own it, you should consider it as an investment?

Already owning it is irrelevant *except* for diminished costs of acquisition. Ie the correct comparison is if you sold it and what you could do with the money.

FWIW I think US housing prices are going up-- supply is now below demand, a lot of supply has been taken off market by Private Equity type investors who are buying and holding (probably for 3-5 years). Housing starts have been way below natural demand since the financial crash leaving pent up demand and too little supply (but that would only be true in some localities, not others). However if the US economy slows, that won't matter-- prices won't rise if people are not confident about buying.

FWIW I don't think the hassles of being a landlord are worth it for most people. You really need to have a business plan to reach scale-- say 5-10 properties where you can hire/ go into business with a property manager. Owning rental property is a business decision as much as an investment one. Requiring time, careful research, and a commitment to a 5-10 year view at least.
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indexfundfan
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Re: Should we keep our house as a rental?

Post by indexfundfan »

I rented out my house when I moved out about 4 years ago. This is because I believed at that time the price will recover and more importantly, I didn't want to come up with money just to sell it (it was underwater).

So far, the prices have indeed recovered some, but not high enough that I want to sell.

I used a property management company to take care of renting out the place. It charges 6% of the rent collected. If it sits empty, the management company gets nothing.

Maybe I was lucky, but for the past four years or so, it has sat empty only for about a month -- and during this time, I took the opportunity to paint the place.

Good luck.
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WhyNotUs
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Re: Should we keep our house as a rental?

Post by WhyNotUs »

In my relatively short time watching these boards I have not found a lot of love for real estate investment. There are lots of broken dreams in real estate and the tenant issues are real but not universal.

When I look at your situation, it seems doable to me. Your house is in an exurb of Indianapolis, has median income of $80k per household and you property at $150 is below median. All of that seems favorable.

The numbers are ok, not great but not terrible. If I deduct 8% for vacancy/maintenance and assume that your other numbers are correct, I see a property that is paid for in 15 yrs. in what should still be a good neighborhood. With $1400 rent, you have have $1288 after 8% deduct for vacancy/maint. Since I did not know your breakdown for mortgage, taxes, insur. I had to make up some numbers for my spreadsheet but you end up with $224 cash flow. I am assuming a standard 15 year fixed rate mortgage, if that is not the case then this is worthless. Also assumes that there are no deferred maintenance issues.

Those assumptions produce Annual gross rent multiplier of 8.9, cap rate of 8%, and cash on cash return of 7.2 %. If I assume 3% appreciation (key assumption), then after 10 years you have a market value of $201,587 and a loan balance of less than $50,000. A sale at that point would result in a IRR of 20.8%

On the other hand you could sell for $150k -6% transaction cost= $141 - $112 mortgage= $29k. $29,000 invested and earning 8% (another key assumption) after ten years becomes $62,600.

You have to put in some work with being a landlord and faithfully build reserves. Over the course of ten years something will go wrong, but there is a potential reward.
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patriciamgr2
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Re: Should we keep our house as a rental?

Post by patriciamgr2 »

1. Rental real estate should be approached as a business. You want to protect your life from this investment. Absolutely, consider placing this into an LLC (with e.g. the street name, not yours) & buy liability insurance. Because this is a property you have owned, your name will be in the chain of title, so you have less protection. Make sure your financing & tax ownership records are consistent with it being a rental. [you should check on whether the transfer to an LLC will accelerate your mortgage (ie make it due immediately); if that's true you need to balance asset protection issues against the cost of new financing]

Calculate, in advance, whether you'll have enough other investment income in taxable accounts to "use" the depreciation, etc. or if you're just creating carry-forwards which need to be time-value discounted. I'm sure you realize that tax bene's even if not used in current years do reduce your basis, so that you'll have a larger cap gain when you sell.

2. You should read boards like Mr. Landlord to get an idea of the nefarious/insane behavior of tenants. I don't care how nice the area is (& Carmel, Ind. is wonderful!) & how carefully you screen, problems can arise (in the case of my own rental from hell, it was tenants who moved in across the street who adversely impacted my rental). If you are holding this property for resale, consider whether the finishes are appropriate for a high-turnover rental; for example, many landlords use laminate or vinyl, not carpeting. If you need to redecorate the home to sell it in a few years, you can destroy your profits. In general, I don't like to try to sell a home which is renter-occupied unless you provide a financial incentive to the renter to help you sell it. So, if resale is your primary objective, plan on higher vacancy levels.

3. If you value your free time at a high level (as I do), calculate how much time it will take realistically to manage this investment. If you use a management firm, they will choose vendors they work with regularly, rather than being price sensitive.

4. IMO, people always seem to ignore the role of debt in real estate investment. Return calculations assume you're using Other People's Money (debt that's recourse to property only). If your own credit is on the line, your investment is the entire amount of the house value. (or, conversely, you can compare your projected returns on the real estate to buying e.g. a REIT using a margin loan--you'll see higher returns, but it's due to leverage.) [REITS, of course, tend to be commercial not residential].

i'm not hostile to real estate investment. for some folks, it's an excellent business. my ex's family did very well over time: they held properties for rental stream & heirs got a stepped-up basis at death of original investors. they did work themselves ( tips: buy locks that need a key to lock to avoid "lockout" calls & learn how to fix a toilet) or, for really complicated repairs, used a small group of trusted subcontractors who were responsive because there were enough rentals to generate a stream of work. the family managed the properties themselves without identifying themselves as the owners. i personally have had wonderful renters (although my issue was that when you get a great tenant, you hate to raise rents much, so some of the inflation protection is diminished).

as with any investment, it's useful to understand it fully before buying it. I concur strongly with an earlier poster who suggested you analyze this as a new investment. good luck
WhyNotUs
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Re: Should we keep our house as a rental?

Post by WhyNotUs »

Leverage is the main attraction of real estate investment, if one is not comfortable with leveraging off of an asset such as that after doing their homework then they should not invest in real estate.
I personally do not see this as similar to buying equities on margin but I understand that some folks who do not like real estate investments consider it similar.
Without getting too philosophical, the core value of well researched real estate gives me at least as much comfort as the $0.001 Par value of a stock.
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DiscoBunny1979
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Re: Should we keep our house as a rental?

Post by DiscoBunny1979 »

deanbrew wrote:
Question 2 relates to tenant demand and quality. I owned a couple of rental properties years back. The only thing that made it worthwhile was the location near two military bases. I rented to upper-rank military families who were moving into the area for three-year commitments. They got generous housing allowances they were looking to spend, were very honest and upstanding, and took wonderful care of my properties. I had great tenants in these properties and never had a single late payment. I was told, but never needed to verify, that if a military tenant was late with rent, all you had to do was call his superior officer and the renter would catch hell and pay the rent.
This is a matter of Location. It certainly does not apply to places like 29 Palms Marine Base In California where any calls to the Base or Marine numbers I've called have said that any issue involving Marines living off Base is a Civil Matter.
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Re: Should we keep our house as a rental?

Post by White Coat Investor »

$1400*12*0.55 = net operating income of $9240, divided by a value of $150K gives you a cap rate of 6.2%. Seems like a reasonable investment, especially assuming you have it financed at an owner occupied rate. It'll probably be cash flow negative though given your 15 year mortgage. You could refinance to a 30 year and make it cash flow positive if that is important to you. If you want to do that, be sure to refinance before you move out (at least several months before.)

Be sure you wish to be a real estate investor before doing so.
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White Coat Investor
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Re: Should we keep our house as a rental?

Post by White Coat Investor »

Valuethinker wrote:If you did not own this house.

Would you consider buying it at the price you are suggesting it is worth, as an investment?

In other words, are you engaging in the 'sunk cost fallacy' that says since you already own it, you should consider it as an investment?

Already owning it is irrelevant *except* for diminished costs of acquisition. Ie the correct comparison is if you sold it and what you could do with the money.
Those diminished costs are not insignificant, nor is the ability to have an investment property financed at owner occupied rates.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
PacNorWest
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Re: Should we keep our house as a rental?

Post by PacNorWest »

No. Tenants will trash your home.
Even the best tenants will live like it's their place, not yours - and "living" expectations can vary widely.

If you have a nice home and want to keep it that way AND rent it out, it will require that you visit it almost monthly to make inspections.
A home and a rental house are two very different critters.

A home has emotional attachment. A rental house is more like a business.
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Re: Should we keep our house as a rental?

Post by Swampy »

Check out Zillow.com for information. If you decide to rent - check their credit!!! Anyone with a less than stellar credit rating should not be your tenant.

With your financial reserves, consider renting and adding an extra $3-500 a month additional principal curtailment to the mortgage payment. The rental will provide you with a depreciation write-off. If you can sell it within the next couple of years, any profit should be tax-free.

I was subsidizing a home for my tenants (it was costing me more than I was getting in rent) because of the poor real estate market. I finally sold outside the window of tax free opportunity at a marginal loss.

Now I sleep restfully at night.

Ultimately, it's all about cash flow for you, especially since you want to 'move up.'

Don't be house rich and cash poor, like I was for a long time. You will not like it.
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