In today’s market Sellers are often tempted to rent out their property vice selling it. This is especially common among military homeowners due to the facts that 1) VA loans make it very easy to purchase a home with 100% financing and 2) they often move every 3-4 years. In many military communities home values have continued to dropped significantly over the last 3-4 years now leaving these once proud owners having to pay to get out of their home to fund a move that they are required by the DOD to make. Often times, through stories from neighbors or peers, young, desperate sellers often think that renting their home out at a price equal to their mortgage payment is a much easier, guaranteed option. What they fail to realize is that is simply not the case at all. I think that some people are often embarrassed about their seemingly poor investment through home ownership and are pressured to give a much duller version of the truth when describing what I term their “accidental landlord” experience. Here are some facts that sellers, who are considering renting as a viable alternative to selling for small loss, must understand before they compound a bad investment decision with a worse one. For the sake of this model lets assume, for easy math, that this mortgage is an even $1200 per month and that the seller is looking to “break even” each month by charging that in rent.
Occupancy Rates. With occupancy rates of these “distressed” neighborhoods or areas as low or, in some cases lower, than 80% then the seller must be aware that statistically speaking, his property’s performance will mirror occupancy rate. So in this scenario that $1200 automatically becomes $960. The only way to counter that is to consistently lower the subject property’s rent below market value. Right out of the gate, the “accidental landlord” falls way short of “breaking even”.
Most novice landlords don’t realize that you have to incentivize showing and renting of your property through two vehicles: 1. agent bonus and 2. tenant incentive. Real estate agents get nearly nothing to show a rental property and so landlords are highly encouraged to pay hundreds of dollars in agent bonuses so that the office’s newest agent will have incentive to show their property instead of the same or better one down the street. In this case, let’s say $600. Due to ever-expanding inventory of rental properties in these areas and the law of supply and demand, tenants have also come to expect a move-in incentive such as ½ off the first month’s rent. Again, in this case, that is $600. Based on a 12-month lease, these two fees add up to $100 per month driving the monthly income down to $860.
Property Management Fees: Standard property management fees are 10% of the received income. In our scenario, after occupancy rate, the monthly income was $960 meaning that property management will take $96/month off of the post-marketing income of $860, taking the income down to $764. Also, some of the less-than-reputable property management companies will charge you for an “optional” annual inspection (that they should be doing as part of their 10% fee) costing $60-$120. So let’s split the difference, call it $90, bringing down the monthly income to $756.50.
Routine Maintenance. Tenants pay rent and in return expect to be able to be super picky about things that owners may or may not notice or, even worse, may turn a blind eye to a major problem such as a small leak below the upstairs guest bathroom sink. They also refuse in most cases — as they should — to do any work themselves. Anytime a vendor is required to come inspect a potential leak, they charge a service call fee. Even if a drain simply required hand-tightening or Liquid Plumber, then the homeowner is paying a $90 (for instance) for a five-minute visit. Annual requirements at a minimum include one (perhaps two) pressure wash per year ($240), a termite inspection ($120), basic fertilizer, mulch, and pruning ($240 minimum). That, plus one basic service call each quarter for an issue that may require either a plumber, HVAC, carpenter, landscaper, roofer, appliance repairman, electrician, handyman, or general contractor, then you are looking at $80 per month — and that’s without the inevitable major repair. Now monthly income has fallen to $676.50.
Rental Curb Appeal. Often times, renting the first time around is somewhat simpler because the home is good condition due to the fact that it was just in the hands of the actual owners. Statistically speaking, tenants won’t — and shouldn’t be expected to — keep up any sort of curb appeal meaning that before you re-rent it, you as the homeowner, are going to have to pay for touchup paint or stain along with some landscaping on the outside ($240). On the inside you are going to have to touchup paint, minor repairs, and get the carpets cleaned ($360). These issues are curb appeal issues and don’t often come out of the security deposit. Now we are down to $626.50.
Things that haven’t been addressed are HOA dues, increase in property taxes, increase in fire, flood, and/or wind & hail insurance which all widen the gap between mortgage payment and “rental income”. Through very simple math using conservative, round numbers one can easily see how through “breaking even” an uneducated “accidental landlord” doesn’t even come close. If you are still skeptical at this point then realize that the math doesn’t lie and it doesn’t care about back-stories or how bad someone wants it to be different. It is what it is and in this case the homeowner would be paying $573.50 per month for someone else to live in their home: before any major repairs and without access to their VA loan for their next purchase. That’s $6,882 per year.
It is also worth mentioning and common sense would tell you that a tenant is obviously not going to take care of the home as the homeowner would and so the home will statistically depreciate more rapidly in a depreciating market and appreciate more slowly in an appreciating market. Therefore when you get your home back and try to sell it will be worth less (compared to the competition) than it was before. Also, homes don’t typically show well with unmotivated tenants in it (with regards to keeping a home in constant showing condition) so you’ll most likely have to wait until they move out. That means you’ll be forced to be priced very competitively or risk having the home sit on the market completely vacant for several months during the sell while pay 100% of the mortgage and bills. Conversely, when you sell from the start, you, the homeowner, are in it (so it’s not vacant) and are motivated to keep the home in showing condition.
So you are probably saying well that’s well and good but “I don’t have the money to sell”. Sellers need to realize that when it comes to selling, the money can come from anywhere; family, friends, pawn shop, and even credit cards. Remembering the scenario above, you would be paying $573.50 per month for some stranger to live in your home. If you signed them to a 12-month lease then that’s $6.882 lost ($13,764 over two years) — even before the accelerated depreciation and impending vacancy when selling at a later date. I would submit the unpopular yet mathematically superior idea that if that same seller would instead be willing to borrow or put, on a credit card, a similar amount and pay it off over that same period they would be in a better situation, financially, by the end because they wouldn’t then have to sell at yet another loss. So before you decide to rent out your single-family home, promise yourself and your family that you will have an educated real estate professional with an investment background run through those numbers with you. If you live in Southeast North Carolina then call Dalton Elite at 910-777-9928.
*If possibly coming out of pocket to sell your home, then please read our article, “Is a Short Sale right for You?”