Should You Turn Your Residence Into a Rental?
Before going this route, here’s a checklist of top questions to ask yourself.
Do I need the equity? For many Americans, their home equity is a huge part of their net worth. If you’re planning to buy another home or you have another need for that equity, then renting the house may not be an option, says Larry Rosenthal, a certified financial planner and president of Rosenthal Wealth Management Group in northern Virginia. “In order to use the equity, you’ve got to sell the property, rent it or mortgage it,” he says.
What’s my long-term plan? “Investing in real estate is a great option. Just understand what your goal is with it,” Rosenthal says. “What do you want the property to do for you?” he asks. Often, a property where the mortgage is already paid off can bring in the most free cash flow since rent only has to cover smaller expenses such as property taxes and maintenance, rather than a mortgage. This typically creates the most ideal circumstance for the landlord.
However, if you’re a retiree who wants to turn a paid-off property into a pension-type income, Rosenthal says many retirees tire of dealing with the complexities of rental properties as they age and want more simplicity. And if your goal is to generate cash flow beyond your carry costs, including the mortgage, property taxes and maintenance, don’t forget that vacancies or non-paying tenants can cut into that free cash flow.
Or, if you’re planning to rent out the property for a few years and build up more equity, remember those gains in equity could be wiped out by future fluctuations in the market. Planning to cash in on the popularity of short-term rental sites like Airbnb or VRBO? Frequent short-term rentals can be more lucrative than long-term leases, but be prepared for more work and check your local ordinances. “The city of Santa Monica is cracking down on Airbnb and the short-term rental industry,” says Jose Tijam, a realtor with Grand Avenue Realty & Lending Inc. in the Greater Los Angeles area. Even if your municipality currently allows short-term rentals, that may change in the future.
Can I afford the carry costs? As a homeowner, you already know that you’re on the hook for more than just the mortgage. But don’t base your calculations on current carry costs, because some of these costs may actually increase once you turn the property into a rental. Do you have the cash to cover the mortgage and other costs such as utility charges and property taxes during vacancies? Have you priced out a landlord’s insurance policy rather than a homeowner’s policy?
If you’re moving across town or across the country, you may need to hire someone to do the maintenance work you previously handled yourself, such as cleaning the gutters and mowing the lawn. “Those are just some hidden costs, and things like that that will creep up from time to time,” Rosenthal says. You’ll also owe income taxes on rental income, but you can use expenses such as local property taxes and mortgage interest to reduce your tax liability on rental income.
Do I want to be a landlord? If you’re managing the property yourself and find someone who’s self-sufficient, it might be smooth sailing. Or you might have to deal with late-night plumbing emergencies and tenants who bounce checks or damage your home. Since damages can sometimes exceed the size of the security deposit and it’s stressful to evict someone, “it’s better to have your property vacant than have a nightmare tenant,” Tijam says.
Josh Rosenthal has turned several Washington, District of Columbia-area residences into rentals and says screening tenants is tricky. “Good credit scores are often a good indicator but don’t tell the entire story,” he says. “Verifying income is good, but unexpected unemployment happens,” he adds. He takes cues from how prospective tenants interact with him and whether they’re on time, and assesses how tidy their car is at a glance.
Josh Rosenthal’s experiences as a landlord inspired him to create MoveIn.Space, an online tool expected to launch later this year that is designed to help landlords and tenants document each property’s condition. While renting units to young professionals, he’s found that “you definitely get people who are very delicate with the property, but sometimes they can be a little more boisterous,” he says. “‘It was like that when I moved in’ seems to be the biggest line,” he adds.
Being a landlord isn’t for everyone, so some residence owners choose to hire a property manager, especially if they’re moving far away. That means you won’t have to deal with day-to-day maintenance or other issues, “but in some cases, [the cost of hiring a] property manager throws off the math,” Larry Rosenthal says. “You may be getting rent that’s very close to what the liability payments are,” he adds.