PSA for the Accidental Landlord: Profit is Not Guaranteed
The alternative of renting your home in a slow market has become increasingly viable in the past few years. I’ve worked with a number of buyers lately who have mandated that their new home be viable as a rental further down the road. Even though the market is improving, there are also still sellers out there who don’t want to short sell and turn to rental as an option. I call it “accidental landlording.” As one of the few Realtors in my office specializing in rentals I pick up several of these each year as referrals from my peers. With at least a quarter of the accidental landlords I meet, I have to have the following conversation:
Me: “Based on the current market, I’m thinking we could get $X per month for renting this property.”
Client: “But my monthly expenses are $X+500!!! We have to ask at least $X+600 so that I can turn a profit on this rental.”
Me: “I wish I could say it worked that way.”
So let’s say you’re 25 and you are living in Rogers Park without assigned parking. Poor you. You need a car, though, so you buy a little 5 year old Jetta second or third hand. You can parallel park anywhere and not pay too much. It serves your purposes. You have your brother paint it purple so you can pick it out in the mall parking lot. You cover it in bumper stickers. It’s unmistakeably your car, through and through.
10 years pass. You’re still driving that Jetta, but now you’re working for a catering business in Elk Grove Village, and you have two kids. You finally have to bite the bullet and give up your beloved compact. The folks in town don’t look kindly on your old John Kerry ’04 bumper stickers and there just isn’t room for your life in your car anymore. Back when you were 25 you never thought you’d be in this situation. You didn’t consider if the Jetta would suffice if you wound up in a situation where you had to haul a lot of stuff and small people around.
A single-purpose purchase will not necessarily serve well when faced with new tasks. The more something is customized, the harder it is to make it change gears (pun intended).
The same thing goes for your home.
Why did you buy your home?
If you’re currently a homeowner, chances are that you didn’t give much though to the rental value of your home when you bought it. You might have thought a bit about resale value, but not about whether or not it would make a good apartment. Likewise, if you took out secondary loans on the property you probably didn’t think about having some poor renter cover that cost on your behalf further down the road.
You probably considered how you could customize the house, the caliber of the kitchen appliances, the color of the wood floors and the size of the yard. You ensured it would suit your particular needs for light, space, and storage. You thought about whether it fit within your monthly budget. You probably didn’t consider whether or not it would generate positive cash flow 8 years later.
There’s a lot of investors out there who won’t purchase a property until they’ve analyzed whether or not it will generate positive net cash flow. They think about what will appeal to the largest number of renters. How long those renters will stay. The cost of gas to drive back and forth to the property. The breakdown rate of the appliances. The value of parking spaces. The depreciation. And when it comes to apartments, there are more owned by investors than by “accidental” landlords. Investors set the market rent rates.
Going back to the car analogy, let’s suppose you tried to lease your 10+ year old Jetta for $180 per month when you were done with it. Laughable, right? Who on earth is going to sign a fourth hand lease on a heavily customized car? And who on earth is going to pay the same for it as they would for a new 2013 Jetta at the dealer?
Why should you expect that your home, bought for and customized to suit your needs, will work well when repurposed as a means of generating ongoing income?
Agents Can’t Force the Market.
If I’m trying to list your home as a rental, I want to list it for as high a rent as I can possibly get. I’m working on straight commission here. Your profit is my profit. However, “possibly” is the real operative word in that first sentence. If it’s priced too high, your home will not rent. Nobody will even see the ads.
Most renters don’t care about your monthly expenses. The general opinion of a landlord is that they’ve got bottomless pockets full of money, especially if they own a fancy condo with granite counters and stainless steel appliances. After all, you have two homes and they have none.
If I deliver a number that’s lower than your cost of ownership, the question should not be “can I find some idiot renter who’s willing to pay $500 over market rates.” After all, that type of renter is not likely to remain financially solvent for long in any respect, and an insolvent renter is a renter headed for eviction court. Rather, the question should be, “which will cause less damage to me in the long run?”
Short selling your home has its problems. It affects your credit, your tax returns, your buying power, and your self esteem. You may face long market times. You’re at the mercy of the banks. Renting frees you from all of that. For some it may be easier to write off a $500 loss each month than a $300k loss all at once. The market times will probably be shorter. The banks don’t have to get involved.
However, renting doesn’t free you from the property itself, and you may find that dealing with tenants and the Chicago rental laws for a year is far worse than dealing with a bank for 60 days on a short sale.
The better approach is to expect both the sale price and the rental price quoted by your agent to be below what you paid for the property, especially if you bought in during the 2000’s. Rather than weighing just the money values, think first as to the benefits of the entire scenario before making your decision.