Author Topic: Converting to a rental - other considerations?  (Read 1833 times)

Mr. Green

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Converting to a rental - other considerations?
« on: June 15, 2017, 01:03:43 PM »
My wife and I have lived in our townhouse for the last 12 years. We're planning to move out of the area in the next 1-2 months but we're not 100% sure if the relocation will stick. We plan to keep our house until we know which way that will go. This would probably be 4-6 months but could be up to a year. We're trying to start a family, I'm FIRE'd and my wife works remotely, so we have great flexibility and are not inclined to rush the decision to sell. After we move, we'll be paying $1,450 a month (mortgage) for a house we're not living in. We're in a 15 year mortgage so at least a substantial part of that payment is equity. If we do come back, we like the idea of coming back to our townhouse because we really like the house/area and it's inexpensive to maintain, as opposed to trying to find a new area/house and not knowing if we will like either as much.

In the event that we don't come back we had planned to sell our house. Townhouses in the neighborhood are selling for about $250,000 and rents are $1,500-1,600, so it doesn't meet the 1% rule. Rent would basically cover the mortgage and that's it. We're not buying a house where we're moving (staying w/ friends, maybe semi-permanently) so I also like the fact that selling would free up almost $100,000 in equity that we can invest in after-tax accounts.

A neighbor a couple streets down needs to move because their landlord is selling the house. They've rented the place for over 2 years and appear to be good tenants. They don't have plans to leave the area and would like to rent a place for 2+ years if they can. The fact that I can walk into their house and see how it's been maintained over the last 2+ years and also the fact that I don't have to deal with a vacancy has me considering renting to them. A tenant would take care of the mortgage while we are still deciding on the relocation, though if we rent the house and decide we want to come back, we would still have to find a temporary place to stay until the tenant's lease was up.

I would only consider renting in this one specific instance because it's about as hassle free as it gets, assuming the tenant has taken good care of their current house and they're in good financial standing. If we don't come back, at the end of this tenant's stay we would sell. One potential downside to renting is an unknown future housing market. Townhouses in our neighborhood are hot right now so we would have no problem selling our house, assuming no dramatic market changes in the time it take us to determine if we're coming back. If we end up renting the house for 2-3 years, who knows if the market will be as hot then. Another potential downside to renting is the age of our home (19 years). It will need a new roof soon and the HVAC systems will need to be replaced at some point. Continuing to hold the property only increases the likelihood that we'll pay those costs, and I would not expect to receive anywhere near full value on those costs during a sale.

On the financial side of things, we gain just over 10k per year in equity, thanks to the 15 year mortgage. If we took our current equity (~100k) and invested it we would need about a 10% return to match that. This assumes the tenant causes no degradation of property beyond the items we would already intend to touch up during a sale. Am I viewing this correctly? I'm not worried about "average" income being lower than full rent in this particular scenario because we have one tenant in mind and no intention to rent beyond that so unplanned vacancy doesn't really come into play.

We have no capital gains (bought for 260k, worth about 250k now) so we wouldn't lose a tax advantage if we moved out and rented for a while as opposed to selling fairly immediately.

Are there any other considerations I'm not thinking of in this particular situation?

SeattleCPA

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Re: Converting to a rental - other considerations?
« Reply #1 on: June 15, 2017, 01:56:54 PM »
I didn't see if you guys moving out of area meant you're moving out of state...

But keep this in mind... if relocate to another state but keep a rental property in"old" state, you'll need to file state income tax returns in both states.

This isn't a deal breaker BTW... just a minor housekeeping issue to remember.


Mr. Green

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Re: Converting to a rental - other considerations?
« Reply #2 on: June 15, 2017, 02:08:11 PM »
I didn't see if you guys moving out of area meant you're moving out of state...

But keep this in mind... if relocate to another state but keep a rental property in"old" state, you'll need to file state income tax returns in both states.

This isn't a deal breaker BTW... just a minor housekeeping issue to remember.
I think that may be a weird situation at first. We are moving in with friends out of state, but we may keep an in state address (parents' house) until we know whether the relocation will be permanent. My wife's employer is based out of the state we live in now. We also plan on doing some traveling/visiting parents once we move so it's even conceivably possible that we wouldn't meet the residence requirements for paying tax on W-2 income if we end up with no real primary residence. I know we would still pay state tax on property income though.

I have a pretty detailed spreadsheet on income and expenses regarding renting the house from a couple years back before we decided it wouldn't be worth it to keep as a long term rental. The property may or may not produce a profit once we include depreciation, etc. Since it's a 15 year mortgage all that cash flow is going into equity on the house.

waltworks

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Re: Converting to a rental - other considerations?
« Reply #3 on: June 16, 2017, 06:33:11 PM »
I think the scenario sounds fine. We did something similar when we left Boulder 5 years ago (rented to folks who we knew would be great tenants that were acquaintances).

The only potential drawback here sounds like the length of lease they want (might be longer than you prefer) and the usual friends+money=disaster problem. If these folks aren't close friends (or you wouldn't mind losing them as friends) then have  at it. If they're your besties, I'd rent to someone else so the potential for ruining a friendship goes away.

-W

sokoloff

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Re: Converting to a rental - other considerations?
« Reply #4 on: June 18, 2017, 05:31:09 AM »
On the financial side of things, we gain just over 10k per year in equity, thanks to the 15 year mortgage. If we took our current equity (~100k) and invested it we would need about a 10% return to match that.
If that $10pa equity is coming out of your monthly payments, you're thinking about that totally wrong. Invest the $100K in an account and keep adding $800 per month to it (like you are now via the mortgage) and BAM, that new account is also making $10K in gains, thanks to your equivalent of the principal payments.

It is only external equity gains (from the property value increasing) where you would need to be concerned with matching the rate. If the money is coming from your right pocket into your left pocket, you don't consider that.

Mr. Green

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Re: Converting to a rental - other considerations?
« Reply #5 on: June 19, 2017, 12:35:33 PM »
On the financial side of things, we gain just over 10k per year in equity, thanks to the 15 year mortgage. If we took our current equity (~100k) and invested it we would need about a 10% return to match that.
If that $10pa equity is coming out of your monthly payments, you're thinking about that totally wrong. Invest the $100K in an account and keep adding $800 per month to it (like you are now via the mortgage) and BAM, that new account is also making $10K in gains, thanks to your equivalent of the principal payments.

It is only external equity gains (from the property value increasing) where you would need to be concerned with matching the rate. If the money is coming from your right pocket into your left pocket, you don't consider that.
Under normal circumstances you have a great point here. Thank you for reminding me of that. In this case though, my wife plans to stop working once we sell the house (or if it were rented so it's cash flow neutral) so the income stream generating the extra money will go away.

Mr. Green

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Re: Converting to a rental - other considerations?
« Reply #6 on: June 19, 2017, 12:39:13 PM »
We're having second thoughts. We haven't officially started an application process with the interested party but I see from court records (public info) that she's had two cases brought against her in the last couple years for debt collection. Both of those cases were dismissed, but I'm not sure of the circumstances regarding the dismissal. One of the collections appears to be from a vehicle repossession. That's usually one of the last things people allow to become delinquent they need their cars to go to work. Of course she could have gotten her life together and things are better but it gives me pause.

tralfamadorian

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Re: Converting to a rental - other considerations?
« Reply #7 on: June 19, 2017, 01:36:30 PM »
...two cases brought against her in the last couple years for debt collection...

It's good that you are looking into it.  When I read your original post, the first thing that came to mind is to make sure you run a full application with credit and background check.  I've talked with several first time landlords who were burned by being casual about this and ended up with an eviction.  Professional tenants are really good at sniffing out non-professional landlords.  I would not even consider a tenant with debt issues in the last couple of years. 

Personally, I would math it out as much as possible-
Income:
Rent: $1,550/mo
Keeping your home peace of mind: $?

Costs (/mo):
PITI: $1,450
HOA: $75
Vacancy: $120
Repairs: $145
CapEx: ((% chance of roof replacement over period of time)($ roof cost) + (% chance of HVAC replacement over period of time)($ HVAC cost))/(estimated rental period in months)
(normally 10% but since you have specific numbers)
Management: $145
Total: $1,935 + CapEx

I would also run a few best and worst case scenarios and see if any of them sway you one way or another. 
Maybe Best: AirBnB your furnished house.  Pros: Cover total holding costs plus probably some income; ability to stop whenever you are ready to move back. 
Possibly Worst: You decide to make your relocation permanent.  The roof and HVAC go.  The market slips and the house is more difficult to sell with a renter in situ.  Renters in general are tough on houses and you have additional costs to get the townhouse ready for sale.  You sell for X% less than you would now in addition to the monthly negative cash flow of keeping the property while rented. 
« Last Edit: June 19, 2017, 01:40:57 PM by kellyincville »

sokoloff

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Re: Converting to a rental - other considerations?
« Reply #8 on: June 19, 2017, 02:47:59 PM »
We're having second thoughts. We haven't officially started an application process with the interested party but I see from court records (public info) that she's had two cases brought against her in the last couple years for debt collection. Both of those cases were dismissed, but I'm not sure of the circumstances regarding the dismissal. One of the collections appears to be from a vehicle repossession. That's usually one of the last things people allow to become delinquent they need their cars to go to work. Of course she could have gotten her life together and things are better but it gives me pause.
Normal people that you want to rent to don't get to the point of two collections cases filed against them.

If she's gotten her life together and will be on the debt repayment straight and narrow for the next 50 years and you don't rent to her, you're still fine. If she's not gotten it together and you rent to her, you're going to be in for a painful experience.

The risk/reward is way, way out of whack here.

Try to play the landlord game on easy mode; it's hard enough as it is. Playing on hard mode (renting to tenants with recent, serious collection actions filed against them) makes for a lot less fun experience.