Author Topic: Transition Principal Residence to Rental Property  (Read 1633 times)

dhague

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Transition Principal Residence to Rental Property
« on: August 28, 2015, 03:13:21 PM »
This is my first post ever to any sort of forum, so excuse me for any noob mistakes :)

I'm also new to the mustachian world and am loving every moment of it (granted I still have a long ways to go).  Lately I've been wondering about the pros/cons of owning a rental property, specifically transitioning my current principal residence to a rental property once I purchase a new home.

Here are a few details:

3 bed 2.1 bath, 1850 sq ft home.  3000 sq ft property.
The current mortgage amount on my home is $239000.  Zillow estimates the home value at $290000.
We've got a 3.25% FHA loan and the monthly payment is about $1600 right now (includes MIP, property tax. Currently only about $450 goes to principal :( )
HOA is about $60 a month (I absolutely hate this...)
I live in the Portland Oregon metro area.

Based on what I've researched, it looks like I would be able to rent the home for more than what my monthly mortgage + HOA fees are, but that doesn't leave a whole lot left over, though I have read up a little on tax deductions etc for rental properties.

So a few specific questions:
Would it be better to sell the home outright or switch it to a rental?
What tax deductions could I use to get more out of the rental fees?
What about writing up a lease agreement?  Is there a reliable, cheap resource to do this?
What are some "gotchas" I should be careful for it I do make the transition to a rental?

Any resources you can share with me would be appreciated!  I'm not planning on selling the home immediately, so I have plenty of time to do more research.  Let me know if any more info is needed.

Thanks!

clarkfan1979

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Re: Transition Principal Residence to Rental Property
« Reply #1 on: August 28, 2015, 11:16:03 PM »
If you think that you would like to get experience as a landlord and have some reserve funds (at least $10,000), then go for it. Many others on this forum want you to rent it out for at least double of your total mortgage. If you can't get that, they will recommend selling. I think you could get some valuable experience.

There are many other things to consider. Assuming the new place is a little closer to work and a little cheaper, it seems more doable. If the newer place is farther from work and more expensive, then I would say no.

sol

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Re: Transition Principal Residence to Rental Property
« Reply #2 on: August 28, 2015, 11:32:45 PM »
So many questions, this will take people many posts to address them all.

Renting for barely more than your mortgage payments makes it tough to do as well as you could on another property.  Most people recommend you rent for twice your costs, usually calculated as payment minus principal amount.  That said, your situation is pretty common in your area.

You will be able to deduct some of your expenses, like insurance and taxes and maintenance, but the rental income is taxable so that's not usually a money saver on its own.  Also, depending on your tax bracket, those deductions can vary quite a bit in value.

You can also deduct depreciation, typically 1/27 of the value of the building without the land.  This is what usually pushes houses into profitable territory, but you have to pay it all back when you sell so it's really more of a tax deferral than a tax savings.

Standardized lease forms are easy to find online for each state, and then you can modify as necessary.  Likewise for online credit checks, which your tenants usually pay for.

You'll probably need to pay for an inspection before you rent, to find liabilities like missing handrails.  That cost should be deductible though.

sol

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Re: Transition Principal Residence to Rental Property
« Reply #3 on: August 28, 2015, 11:48:53 PM »
Maintenance and vacancy are usually the killers that people fail to plan for adequately.  Some years it can be zero, especially if you've lived there a while and have the place in good shape.  Some years you will need a new roof and carpets and it will sit empty for three months while you do it..  These costs always seem to end up higher than you think they will.

In our case, we add up the positive cashflow (after maintenance allocation), tax benefits, and equity pay down by renters to find total return, and then divide by our expected extractable equity to find our effective rate of return.   We figure 10% transaction costs in a sale, so extractable equity is 0.9 times the difference between expected sale price and remaining loan balance.

This makes new mortgages look more profitable, since you have less equity.  That's backwards from what you might expect, where older mortgages are getting a bigger equity contribution, but it helps me mentally compare the ROI to alternatives like selling and buying index funds.

Generally speaking, my equity is so low that even clearing $5k/year (excluding depreciation) in cash flow, taxes, and equity pay down makes them look pretty good compared to selling to buy stocks.

Then there is potential appreciation.  You're about 1:6 leveraged (50k equity on 300k value) so if the property appreciates in value at 3% per year, that's like getting 18% return on your equity.  That part is pure speculation though.