Written By: Forrest Baumhover
In the military, we face this decision more than most civilians. We buy a house because we intend to stay in it for a while. We hope that we can hold it long enough to actually have the value rise over time, then either rent it or sell it for a profit.
Sometimes, life can get in the way of our best laid plans We get an unexpected set of orders, exciting and nerve-wracking at the same time. Career-enhancing, but life-altering. As we get used to the new reality, we start to think: “What do we do with that house?”
When real estate prices plummet, 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 I faced this decision, I ended up renting out our house. Hindsight being 20/20, this is the ONE decision that I wish I could take back. Although I didn’t know it at the time, we just weren’t cut out to be landlords (much less deployed overseas, managing a property during the Great Recession). 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 landlords 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 to maintain a rental property. First, you should factor in repairs, maintenance, property management, insurance, and capital expenditures (replacing big-ticket items like air conditioner units or appliances).
Also, you should account for vacancies. While this isn’t a cost, it’s really the lost revenue that occurs when you don’t have rental income. Even with multiple year leases, 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. Then you should factor the amount of time it spends on the market. Finally, there’s 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 the website Bigger Pockets to learn more about renting out a property, 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.
Why 50%? Well, the other 50% goes to the other expenses:
- 10% Property management
- 10% Repairs
- 10% Capital Expenditures
- 10% Taxes & Insurance
- 10% Vacancies
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 may want to reconsider your plan.
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 property manager is no guarantee of success and it might lull you into a false sense of security.
While this doesn’t represent the overall market, it does seem that 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 $1,500/month rental is $150 per month. Would you rather have that in your resume or a commission split from a $150,000 home sale?
Not to say that good, professional property management isn’t available. Do your due diligence to ensure your property manager 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 for property managers who come and go.
Alternatively, you could do it yourself. Many people do. In this case, the 10% really is going back to you (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 have a trusted family member, but 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 property managers, but with anyone with whom you expect to do work on your house. This includes contractors, electricians, plumbers, pest control, painters, cleaning folks, etc. Don’t just rely on your property manager to give you the names of people they recommend. I’ve seen examples where my the property manager received a kickback from the contractor for doing substandard work. Most property managers 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, you probably won’t have enough to handle any of the problems that go wrong.
Need to replace a roof? Even if you have insurance, you still need a deductible.
Tenants walk out on rent? Lost rent is only the beginning. Most tenants who walk out on their rent don’t leave behind 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 can be tricky 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 my 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 tenant for four 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 temperament and 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 Permanent Change of Station (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 could have sold the house, even though my wife would have been doing all of 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.
Forrest Baumhover, CFP®, EA is with Westchase Financial Planning. Visit his website at www.westchasefinancialplanning.com or reach him by email at firstname.lastname@example.org. To post your comments, join the Military in Transition Facebook Group!