With declining market values the last few years more homeowners are considering renting their home instead of selling, becoming unintentional landlords. If you are thinking about this option, do your homework and analyze the financial, functional and legal aspects of becoming a landlord to determine if it makes sense for you.
Most economists predict that market conditions will remain sluggish for awhile. If you decide to rent until market conditions improve, you should likely expect to be a landlord for several years. If your property cash flows while renting it could be a good solution. If it doesn't, it could be a question of selling and losing money now or renting and paying over a long, slow process.
FINANCIAL
Cash Flow
- Determine the likely rent you will receive – check local comparable listings, talk to some landlords, property managers; be realistic
- Factor in vacancy time – the US Census Bureau Quarterly Rental Vacancy Rates for the 75 Largest Metropolitan Areas posted a rate of 7.6% for the Minneapolis-St. Paul area for 1st quarter 2010, better than the 10.3% average for all 75 areas
- Estimate property expenses – include taxes, mortgage payments, insurance, association dues, utilities, repair and maintenance costs (~1-2% of home's value, depending on age and condition) and property management fees (~10% of gross rent) if you don't want to deal with tenants yourself
- Calculate your projected profit – estimate annual gross rent, deduct vacancy percentage and estimated annual expenses
Tax Impact
- Deductions – may include interest (both mortgage and credit cards for items related to the rental proptery), depreciation, repairs, travel
- Tax issues when you sell – if you lived in your home for 2 of the last 5 years when you sell you can earn up to $250K for a single or $500K for a couple in capital gains tax free, but you may be taxed on the amount you depreciated while renting it; once you start renting, the clock starts ticking on the 2 out of 5 years
- Consult a tax accountant – this can be pretty complicated, talk to a tax professional to determine how renting will affect your taxes and discuss if this makes sense for you
FUNCTIONAL/LEGAL
- Screening tenants – some standards to consider: income (common criteria is gross income 3.5 times rent), employment/income stability, length of time at last residence, past evictions, complaints from previous landlords, number of occupants/vehicles, pets, smokers vs non-smokers, credit, background check; verify applicant information
- Who is responsible for what? - the water bill stays with the property so is often paid by the owner; heat may also be paid by the owner to ensure heat isn't turned off and pipes don't freeze; other utilities, sanitation? who takes care of lawn care/snow removal?… etc…; be sure to have responsibilities clearly defined in the lease
- Lease – lease term and penalties for breaking the lease, security deposits (often 1st and last month's rent), rent due dates and what happens if it is late, who is responsible for what, when can you examine the property, restrictions on the number of occupants or vehicles, pet restrictions, what happens if you sell during the lease term, what if the tenant wants to purchase, what happens if buyer or landlord do not perform
- HOA – if you are part of a homeowner's association (HOA), are there rental restrictions? does the association have to approve tenants?
- Know the law – US Fair Housing Act prohibits discrimination according to race or color, national origin, creed or religion, sex, familial status, and handicap or disability; in addition, the Minnesota Human Rights Act prohibits discrimination on the basis of marital status, public assistance or sexual orientation
- Rental License – check with your city to see if a rental license is required
- Insurance – when you become a landlord, your home goes from being a residence to a place of business; talk to your insurance agent about landlord insurance, which covers both the property and your exposure should anyone get hurt in it
- Are you cut out to be a landlord? – becoming a landlord isn't for the faint of heart; are you prepared to find and screen tenants, deal with late payments and possible evictions, maintain the property and deal with emergencies, deal with annoyances you never dreamed of?
- Professional property management – if you decide you are not cut out to be a landlord, it could be well worth the approximate 10% of gross rent charged for professional management services
CONSULT with PROFESSIONALS
While deemed accurate, the above information is neither comprehensive nor guaranteed. It is intended to stimulate further investigation before making the decision to become a landlord. Consult with professionals for expert advice.
- Talk to an accountant to learn how renting will affect your taxes
- Contact your insurance agent to ask how renting will affect your insurance
- Check with a lawyer to become acquainted with landlord and tenant rights, leases, etc
- Consult with a property management company for more information on professional management options
Sharlene Hensrud, RE/MAX Results - Email – HomesMSP.com
