Before you put a sign in your side, you need to understand not just the steps in the process but also your motivation and the consequences.
Your motivation may be that your monthly expenses are too high on your current income or that your current job is so far from your current home that commuting is a real hassle. Or, maybe your child wants to be in a particular attendance zone for a particular school, and so on.
You have to know prices for houses where you’re headed and prices for houses where you’re coming from. That includes rentals. Then there are transaction costs, such as the closing, the moving, deposits for utilities, inspections, new furniture or household items, like refrigerator, curtains, etc.
An early step is get a rough idea of what your house is worth. The answer is not a single number – it’s a range. Not only is every house different, but every pair of buyers and sellers also come up with a different answer as to the price.
Remember your walking down the aisle at your favorite retail store. You may see several products that are all reasonable choices but one is lower priced than the others. One is the best looking. One seems to give you more for your money. The buyer is faced with the same array of choices when it comes to buying, and your house is only one of those products.
So, you do some research on what current houses like yours sell for, what they rent for, and how yours is different from those. A 4-bedroom house might rent for 20% more than your 3-bedroom, or a house with a corner lot might sell for 10% more than your interior lot, or an east-facing house might bring in 15% more than a north-facing house like yours. There are multiple factors involved.
Also, very little happens in the sales and rental markets from Thanksgiving until after New Year’s Day – are you buying or selling during that interval? Then, you should adjust your thinking accordingly. Light demand yields lower prices.
You may love your upstairs laundry room, but 85% of the population are turned off by it. You may hate your large backyard because you have to mow it, and others may love the space it gives them. After all is said and done, you can take the average prices and come up with an average price for homes with 3 bedrooms in your subdivision, and be mispricing by 20%. Your home could be worth more or less than that average. [Remember the average family may have 2.3 children, but there is no family with that exact number of kids.]
Lastly, in winter not many people care about swimming pools, but when the weather first turns warm, they favor properties with pools or with pool privileges. Trying to keep all these factors in mind is difficult and can easily lead to heartache, because you thought you could get more and didn’t or found out later you could have gotten more than your low estimation.
Rent versus Buy
The complementary question for sellers is important. Should they sell or should they find a renter? Renting to others brings its own issues. You’re responsible for some items of maintenance in the rent property, e.g. water heater, air conditioning, etc. You can make the renter responsible for some things but the more burden you try to put on him, the less attractive to rent it is for him. These costs fall on somebody and have to come out the rent.
Renters don’t want to be responsible for your yardcare. Yes, they want it to look nice – that’s what attracted them from the curb in the first place. But, making the renter cut the lawn, trim the bushes and so on, may discourage him from renting. Alternatively, the renter may have a green thumb and a strong desire to spend hours planting flowers in your rental property (as long as you don’t preclude that). So, part of the deal has to be negotiating who does what in keeping up the house. These costs may fall on the renter or on you, the landlord.
Qualifying for a loan with an existing rental property can be challenging. Nowadays lenders want to know that you’ve done it before. The experience will make you more careful in handling renters. The lender may ask for 2 years of rental income experience before counting rent income. Then, the lender may discount it more heavily than you think is warranted. If you get $1,000 a month in rent and the lender counts only $750 of that due to potential maintenance costs and possible vacancies, the $250 reduction will lower your buying power on the new house you’re looking for.
Collecting rent is no fun, either. Every month some renters have a litany of excuses to draw from to explain why they’re late and why you should penalize them. Your mortgage lender won’t be so understanding. If your payment is due on the 15th and the rent comes in by check on the 15th, you’ll be charged a late fee for the mortgage payment. So, you can’t allow the renter to pay less than several days before you incur a penalty on the mortgage. (Most owners have a owner to deal with.)
Getting workmen to fix the leak in the shower, or the dripping faucet, or the missing shingles and so on, is a job by itself. Besides reducing your income, it takes your time. So, you think you can just have somebody else deal with that. A property management firm will lighten your load, but will also lighten your wallet. Property management can easily run 5-15% of the monthly rent. Don’t be surprised if you lose $100 out of your $1,000 rent just for the peace of mind of having someone else collect the rent and take care of maintenance.
Don’t rent, you say? If all we considered were the downsides, no one would ever rent a property out (unless forced to). But, Federal taxes you pay can benefit from a side business. All your expenses are typically deductible [ask your CPA or tax advisor]. The real estate taxes reduce your gross taxable income, insurance premiums, HOA fees, maintenance costs, and maybe even travel expenses to manage the property all come under the same category.
Moreover, your property depreciates over time. Accounting for the depreciation actually can reduce your current income. If the useful life of your house according to IRS rules is 27 years, then you can deduct the full price of the house (except the land and so on) over that 27-year period. Every year taking a depreciation deduction of several hundred or several thousands can help reduce your income significantly. It’s possible that the income you receive for rent is all accounted for before it becomes a taxable item for you. If you don’t pay any taxes on current income because of the deductions, the idea of renting out becomes more attractive.
Of course, your basis in the house is dropping every year you deduct for depreciation. If you bought the house for $100,000 and deduct $80,000 over 25 years, your basis might be on $20,000 at the end of that time. You shielded $80,000 in income over the period, but when you sell, they do count gain on the depreciated basis. Hopefully, the long term gain will be at a lower tax rate in the future (unless Congress “closes this capital gain loophole for ‘rich’ people”), and you might be in a lower tax bracket by the time you sell it, too.
Wait! Won’t the value of the house appreciate over the years, too? Quite possibly the sales price in the future will be higher than today’s prices. Long term prices in real estate have risen almost continuously at a compound rate higher than the stock market. In recent years the rate of rise was higher, but the collapse in prices made the overall equity positions negative for many people, especially for purchases in the last few years. So, there are no guarantees, but “buy low, sell high” applies not only to stocks, but every asset we hold. As long as the Fed keeps pumping money into the economy, prices will be going up – we’re just not sure of the timing.
Get to the bottom line and compare.