Should I sell my house or rent it out?
This may come as a surprise to you (sarcasm intended here), but most people do not stay in their original home for their whole lives. In fact, if you are like most people you will move at least several times over the course of your life. Your lifestyle and family picture will most likely look much different over the different seasons of your life. Some people buy a house when they are barely out of high school and the house may fit their needs at the time, but then they get married and start having children and then the perfect bachelor pad is not so perfect anymore. Instead of looking for the hip spots in town you now may be looking for safer areas to raise young children. Then when your kids begin entering school you may need to move again to get your children into the best school districts. Your income will probably be rising as your children get older and then it may be time to buy a bigger and nicer house and start building equity into this house. But then a few years later your kids will likely be moving out (at least you hope so) and you may want a smaller house again that is easier to keep up as you get older. Or you may want to move to a warmer climate, closer to the beach, or closer to children or other family. Simply put, most people do not stay put over their entire lifetime.
So, what do you do when it is time to move? The traditional way to do it is to sell your current home and use the equity you get from it to make a down payment on your second home. This seems like the most straightforward way to do it, but you have heard your friends talking about the benefits of having rental properties. You may be thinking it seems harder to rent a property out… What if the tenants don’t pay or trash your place? On the other hand, what if you sell your house and then the market goes way up and you lose out on appreciation that you would have gained? How do you make the right choice?
I am not here to try to convince you to either sell or rent. Certainly, your individual situation will likely make the decision very clear for you. I only intend to lay out some of the pros and cons of both approaches (selling versus renting), and if you are still awake at the end you will have maybe a little bit more information to consider when making a decision.
What’s so good about renting?
It is widely known that owning real estate is a great way for building wealth. The research proves that 90% of millionaires over the last 2 centuries have either become wealthy through real estate, or once they have become wealthy have invested in real estate. Real Estate is a time-tested strategy for building wealth all over the world. Many very successful real estate investors would likely tell you to never sell a property because you are giving up the future appreciation and cash flow that the property could produce. Most of us have heard something along the lines of “buy real estate, because they are not coming back and making more of it”. So, with all of these benefits of owning real estate, and with all the evidence pointing to the fact that it builds wealth, the case is closed and you should rent your property, right?
While it is absolutely true that real estate can be a terrific investment vehicle, there are many times and instances when someone should not rent out their property. One of the first things you should consider is whether or not you have enough cash in the bank, or will have enough cash in the bank after buying another property, to pay the mortgage, property taxes, and expenses related to the rental property. If the rental does not have a mortgage this helps, but there could still be vacancies and unexpected repairs and you should have enough liquid funds to get the home rent ready should you get a bad tenant who does not take care of the place. You could have to evict the tenant which means that you would not collect rent for possibly several months (or longer) depending on your local laws. All the while you will still have to pay taxes, insurance, and other expenses related to the house. Then when you finally do get the bad tenant out you will likely have a large capital expenditure getting the house ready to re-rent. Then it may sit on the market for several more months before it is rented. This does not sound like the “mailbox money” that you would hear at some real estate seminar, but is definitely something that happens every day all across the country (and world).
If you have decided that you believe real estate is a good investment, you have some cash (or equity- I’ll explain this later) available for worst case, and you can stomach the occasional frustration that can come with rentals properties, next you should look at the numbers. Since house prices and rental rates vary so much depending on where you live, you will need to look at the numbers for your own markets, but I will provide an example below:
Let’s pretend you have a house that would sell on the open market for $250,000 and you owe $100,000 on the property with 7 years left on the mortgage. Your payments are $1600 (principal and interest) and your property taxes and insurance add up to $250 per month. Your total monthly payment is $1850. If you have HOA fees you will also need to add these fees on top of this number.
If you sell your house today for the $250,000 and pay a 6% realtor commission and part of the closing costs (which is standard)- you will likely get about $225,000. We take 10% off the sales price to account for the 6% commission plus we estimate 4% in closing costs. So, you have $225,000 and you have to pay off your $100,000 mortgage, leaving you with $125,000. In many cases this $125,000 is tax free, but you would need to check with your accountant to make sure.
Now let’s look at the rental numbers. Let’s assume that your house would rent for $2500 per month. For this example, we will pretend you manage the property yourself. If you decide to hire a property manager to deal with getting the property rented and managing the tenants, you could expect to pay 10% of gross rents to the property manager (so you would get $2250 rather than $2500). For this example, we will pretend that there is no property manager. Typically, we would take the $2500 per month and reduce it by 15% to account for vacancy and maintenance (7.5% respectively). So, after vacancy and maintenance assumptions and your mortgage payment, property taxes and insurance, you would cash flow $275 per month. There are also tax advantages of owning rental properties such as depreciation and interest deductions, but those topics are beyond this discussion.
It looks like a no brainer to sell the property and get the $125,000 right now rather than going through the headaches of renting out the property, right?
Let’s assume that you live in an area where homes typically appreciate by 4% each year (the national average is 3 to 5 %). In 10 years your $250,000 property would be worth around $370,000. For this discussion we will assume that rents stayed the same for the next 10 years. If you collected rent for 10 years, you would have cash flowed $275 per month for the first 7 years while you had the mortgage, then after the 7th year you would have cash flowed an additional 1600 per month (your principal and interest amount- you would still be paying property taxes and insurance, vacancy and maintenance). So, in the first 7 years you would have made $23,100 in net rental income, and in the last 3 years you would have made $63,900 in net rental income, for a total of $87,000.
If you had put all of that cash flow into your bank account and saved it (no interest assumed) and sold the house at the end of the 10th year for $370,000, here are the numbers:
$370,000 minus 10% (costs of selling) = $330,000 plus $87,000 in net rental income = $420,000.
If you sold your house today and left closing with $125,000, you would need to get a return of 13% year over year to have $420,000 in 10 years.
So, what is the verdict?
In the example above, you should not compare $125,000 today versus $275 per month today (unless you want to, who am I to tell you what to do?). I would suggest looking at $125,000 today versus $420,000 in 10 years (or $846,702 in 20 years) when making your comparisons.
The other benefit of real estate is that you can borrow against your equity. I know, I know… Some people follow the Dave Ramsey method and never borrow money, ever! But you could take the equity in your property and use it to purchase another property that you rent and the numbers would compound very quickly and make you very wealthy over the course of time.
As you can see there are so many variables that can change the numbers. If you live in an area where rents appreciated and property values typically appreciated more that 4% these numbers would lean more towards renting the property. If you live in an area where real estate is more stagnant then the numbers would lean more towards selling the property. Property tax amounts can severely affect the numbers as can demand for rentals (you would reduce vacancy and increase cash flow if you rent properties faster). You may be someone who never wants to rent a property at all, but if you have read this far you are probably at least considering it. Make sure you look over all the numbers and do not be swayed by rental margins that look low. Run the numbers over a longer term and you may see why owning real estate is one of the best ways to build wealth. On the other hand, if you believe that it is the top of the market and think that real estate values may be coming down (this is a legitimate concern), it may make more sense for you to sell.
All of the information on this page is based on the writer’s opinion, which is based on his own personal experience and self-education. This is not legal or financial advice.