A Generation of Landlords
I have seen a unique scenario happen to my generation, we have become landlords. One of the first things I did when I graduated college all those years ago was purchase a house. Against my better judgement, the allure of home-ownership and the dreaded thought of moving back in with my parents, I persuaded myself to purchase a house even though the market was starting to look shaky. Over the next couple of years many of my friends also purchased houses, condos, and townhouses. Step One of the American Dream is purchase a home, right?
Well, for most people, this was the exact worst time to be purchasing a house as we now know. The housing market was on the verge of the largest collapse we have ever seen and probably (hopefully) will ever see in our lifetime. Then the inevitable happens, life changes. We get married, have kids, switch jobs and have to move. But now the houses that were purchased only a year or two ago are worth 10, 20, or even 30% less then what we paid for them. Most of these houses were purchased with 0% down or FHA 3.5% down financing, which means there is no equity left. Because of this, we have become accidental landlords. I have seen many financial plans and many tax returns listing a rental property as evidence of this. After a year or two of this the stress and financial burden become too much. This past couple years have seen a recovery from the ultra-lows of 2009-2011. Now the question that many are asking is, "Should I continue to rent out my house or sell?"
Things to Consider:
- Cash Flow - I don't just mean covering the mortgage, interest, and insurance. There is a popular rule of thumb in the real estate world called the 50% rule that states that over time 50% of the rent will go towards expenses. It might seem like your rental property is making you money until it needs a new roof, furnace, siding, etc. These large repairs could easily eat up years of "cash flow". If your property isn't cash flowing properly then this is one strike against keeping it.
- Time - How much time do you spend managing the property? Showings, repairs, handling tenant calls, and managing contractors all takes time. If your property is making money, is it worth your time? If it isn't making money, it is most definitely not worth your time.
- Rate of Return - Are you getting a good rate of return on your time and money? I always compare any potential investment against the rate or return on the general stock market, which is approximately 10%. I do this because I could purchase some low-cost funds and get close to 10% return on my money with minimal effort. So, why would I purchase (or hold) a rental property if it is only providing me with a 11% rate of return? The risk and time is not worth an extra 1%. If the property is providing anything less then a 10% rate of return, this needs to either change or the property should be sold.
Should I sell my Rental Property at a Loss?
So what if the property isn't making any money, takes a lot of time and adds stress, but you can't sell because you are underwater or would lose too much money if you do?
Well, this depends. If you are able to sell without bringing additional (or minimal) money to closing then the above rules still apply. If you have to bring a large amount of money to closing then you have to think about the opportunity cost. Could you invest the money that would need to be brought to closing in the stock market instead? If so, you have to think about whether the time and headaches are worth putting up with for now. Or worse, what if you don't have enough money to bring to closing to sell the property? Then you have to consider how much of a financial and emotional hardship the property is causing you. If it is too much to bear, then you can consider a short sale. But be very careful as this can ruin your credit for quite some time.
Analyze it as an Investment
In any of these scenarios, you need to know the numbers. I'll bet you have a good idea of how much time and stress the rental property causes but do you really know how much money your property costs or makes for you? What are you assuming for appreciation? What about taxes?
Either way, if you own a rental property it will probably be a large part of your financial plan. You need to know when to hold it and when to sell. This can be done by analyzing your financials or if you don't track that info, then your tax return (schedule E) will work well too. See how your situation looks with and without the property. Ask yourself if you would purchase it today as an investment knowing what you know now. If not, this is a strong indication that you should sell. Let the numbers be your guide.
Are you stuck with a Rental Property that you aren't sure you want to hold onto? Share your story below in the comments section and I'll try to help. If you need a Realtor I can put you in touch with the right one.