Generally, people don’t take on investments they don’t understand. The most successful investors are cautious people, and you’ll rarely see a seasoned veteran put down significant money on a fund they know very little about.
Unfortunately, that same caution often doesn’t apply to rental properties.
While converting an unused home to a rental property can be a great investment, it’s not bulletproof. There’s a lot that can go wrong, and a lot that prospective landlords fail to take into account. Sometimes, it’s just better to sell.
Wondering which side of the coin you fall on? Read on to find out.
When should you keep your house and convert it to a rental unit?
Real estate agent Tiffany Alexy said she uses a simple formula to determine when it’s best to sell a house.
“If your house won’t rent for at least 1% of the purchase price or more per month (12% annually), then I would sell. After property management, repair and maintenance expenses, you’re barely going to break even,” she said.
To get an idea of what you could charge for a rental, look at current listings in your neighborhood via Craigslist or Zillow. Don’t forget to account for variables such as the washer/dryer situation, whether or not pets are allowed and who pays for utilities and parking. All these factors can affect how much you’ll be able to charge.
People who have experience in construction, real estate or property management tend to have the most success in converting properties. This is especially true if the house has the potential to be a multiple-family home – such as a duplex or triplex.
Don’t underestimate the effort and knowledge it takes to be a landlord. Those with little experience can learn the ropes, but don’t expect to go in blind without disastrous results.
When is it better to sell a house?
One of the easiest ways to find out if you should sell your home is by asking if you can afford a new house without selling your old one.
“Most people don’t have enough in savings for the down payment on the new house, and depend on the proceeds from the sale of their old house to come up with it,” said real estate investing expert Mindy Jensen of BiggerPockets.com.
If you don’t have the time, knowledge or desire to be a landlord, it may be a good idea to sell your property – even if it seems like rent prices are increasing in your community. Being a landlord can easily turn into a part-time job – or worse if you have needy or destructive tenants.
Use the 12% formula to determine your margin. If the house will fail to show a significant profit, it’s better to sell. The time-consuming aspects of property management aren’t just tedious; they’re completely pointless unless you’re recouping the investment.
Being a landlord also comes with fewer tax advantages than being a homeowner. For example, Alexy said you can avoid paying capital gains tax if you end up earning a profit on the house (as long as you’ve lived in the home for at least two out of the past five years).
If you start renting, you may lose that tax advantage if you decide to sell later. That could lead to a large tax bill, depending on how much housing prices increase in your area.
Surprisingly, many of the qualities that make great rental properties make for poor primary residences, according to Alexy. Even if you want to be a landlord and own a rental property, you may find that your current home doesn’t attract tenants as well as you thought it would.
Keep an open mind while you explore your options. People tend to underestimate the equity in their homes, leading to rash decisions with severe consequences. It can take years to save for a down payment – don’t throw that away by misusing the value of your home.