Should I rent or should I sell my house?

You may be in a situation where you are wondering if you should rent or sell your house.  In this article we review 3 good reasons to rent your house rather than sell it.

In this article we also review the pros and cons of renting vs selling. And I’ll show you how to use an online rent vs sell calculator to determine what the numbers really say. The math may surprise you. It surprised me!

Contents

• The Average Home Owner is Inclined to Sell – Investors May Rent
• 3 Good Reasons to Rent Your House
  1. Cash Flow
  2. Principal Paydown
  3. Appreciation
• Wealthy People Own Income Real Estate – So Should You!
• Renting Vs Selling – Pros and Cons
• Checking the Numbers – The Math Surprised Me
• Conclusion
• Moving Forward

The Average Home Owner is Inclined to Sell – Investors May Rent

As an investor, I am surprised when I hear friends talking about moving and selling their home.  Most people sell their homes without seriously considering the benefits of keeping their home as a rental property. To be fair, many people don’t have much of a choice (i.e. it doesn’t make financial sense). 

Entrepreneurs and investors, on the other hand, would be looking for every opportunity to add a rental property to their investment portfolio. 

This reminds me of a realtor I met years ago.  He used to work for a company that moved him all over the country. By the time I met him he owned nearly a dozen properties across the US.

The company he used to work for gave him a moving allowance every time they asked him to relocate.  The first time this happened he used that money, as down payment, to buy a small home.  This meant he didn’t have much left to relocate, which forced him to live frugally.   

The next time the company moved him he rented out the first home and bought a second one.  His plan was to use rental income to pay for the mortgage of his first home.  He repeated this process several times. Each time he was forced to live frugally and to figure out how to relocate on a very limited budget.

I realize not many people have a lump sum of money they can use as down payment to mimic this strategy.  However, part of the story here is that this realtor was smart and frugal.  And you too can be smart and frugal. 

3 Good Reasons to Rent Your House

Cash Flow

Envision for a moment a situation where you moved somewhere else, you rented out your house, and you are clearing $1,000 of cash flow per year.  This means you received the rent payment, paid for all related expenses (mortgage, taxes, insurance, etc) and still had $1,000 left over.

Could the number be even higher? We’ll review the numbers below as there are many variables at play.  Perhaps the most important variable is the current market rents. Other variables include your original mortgage amount, the current interest rate, and other costs such as tax and insurance.

Depending on these variables, your numbers may not look so rosy.  However, don’t give up yet.  Let’s look at the other reasons to rent your house, rather than selling.

 Principal Paydown

Assume for a moment that instead of clearing $1,000 of cash flow per year you are just breaking even.  In other words, you really aren’t netting anything.  On the surface, it would seem there is no good reason to rent your house. 

However, as you pay down your mortgage the total amount owed is going down.  This is true provided your loan is NOT an interest payment only type of loan. 

The longer you’ve been making loan payments, the more you pay down to principal and the less you pay on interest.  So, if you’ve owned your home for a while, you are now making some nice contributions to principal paydown. 

Wouldn’t it be nice to have your tenants pay off your mortgage? In fact, every year that goes by you gain more equity on your house, simply from principal paydown.  And speaking of equity, let’s talk about appreciation.

 Appreciation

Investors and entrepreneurs get excited about appreciation. We all want to assume the real estate market will continue to go up at solid rates indefinitely.  Real estate market corrections do happen. So, a little caution is in order on appreciation. 

As I am sure you know appreciation is primarily about location, which drives supply and demand.  If your home is in a hot market, then you may see some good appreciation.  However, if that market has been unsustainably hot for an extended period, you may see a price correction.  In which case you may see home depreciation, instead of appreciation.

The net value of appreciation can be very significant.  For example, at a 4% annual appreciation, a $300,000 home would increase in value by $65,000 in just 5 years.  This is why it is easy to get excited about appreciation.

Other Considerations

There certainly are other good reasons to rent your house, rather than selling it.  One commonly mentioned reason is the many tax advantages that come from owning real estate.  This brings me to the next subject. 

Wealthy People Own Income Real Estate – So Can You!

The reason wealthy people own income real estate is because that’s what made them wealthy in the first place.  And it made them wealthy because of the same reasons we discussed above.  Income real estate provides cash flow, it pays for itself (principal paydown), it gains value (appreciation), it provides great tax advantages, etc.

So, why is it that most Americans don’t own income real estate? Most people would say that they don’t have the money to do so.  The reality is that this is really about priorities. 

I know plenty of people with a good paycheck that live in a nice home, own many vehicles, perhaps even a boat, and other toys, but don’t own any income real estate.

Entrepreneurs and investors think differently from the average American.  They would much rather live frugally in exchange for the opportunity to own more real estate.  These are the individuals that will be wealthy in the future. They are the ones that will truly be able to afford the boats and the toys when the time comes. 

The bottom line is that with a little sacrifice and some knowledge, you too can own income real estate.  And you too can become wealthy and gain financial freedom through real estate. 

Renting Vs Selling – Pros and Cons

Unfortunately, owning rental properties is not necessarily easy and it is not for everyone.  So, let’s review renting vs selling and review some of the pros and cons. 

Checking the Numbers – The Math Surprised Me

Despite the 3 good reasons to rent your house discussed above, it is important to dive into the numbers. In fact, I feel compelled to disclose that prior to looking at the numbers I was much more optimistic about the rental option.

The good news is that we can easily run various scenarios using online calculators.  Allpropertymanagement.com has about the best rent vs sell calculator I’ve found. Lets start by first defining the variables.

Main Variables

Home Value: 

This is the current market value of the property.  I like to use Zillow.com, but any other similar website will do.

Price Paid: 

This is the price you paid for the home when you bought it.  Zillow also shows this value.

Original Mortgage: 

This is the original mortgage amount.

Mortgage Balance: 

This is how much is left to pay on your mortgage. Keep in mind that the longer you’ve owned your home, the better the numbers will look in favor of renting.

Interest Rate: 

This is the interest rate for your mortgage.  If you have a variable interest rate, you may plug in a conservative (higher) than current rate. In this example I am assuming a fairly low interest rate. This assumption is based on the fact that home owners have been refinancing to take advantage of low interest rates.

Taxes and Insurance: 

This is self-explanatory.  If you don’t care to dig out your actual info, you can use the information provided in Zillow.

Monthly Rent: 

You must really understand the rental market conditions in your area.  Again, I like using Zillow to figure out what the rental rate should be.  But other websites I use are craigslist.org and rentometer.com.

Appreciation Rate: 

This is the expected annual appreciation rate.  Avoid being overly optimistic.  I like to use a bestplaces.net to get an idea of what home appreciation has been in the last few years, in a given city.  However, keep in mind that past home appreciation is not indicative of future home appreciation.

Years to Hold: 

This represents the number of years you intend to hold the rental property.  At the end of this period it is assumed you’ll sell the home, at which time you’ll have to pay selling fees. Most investors would be looking to keep income properties indefinitely.

Occupancy Rate: 

It is a good idea to assume your rental property won’t be rented 100% of the time.  The value to enter here depends on the market.  If demand is high, you may be able to get away with 95% occupancy.

Property Management Fee: 

This also depends on the market.  I would suggest plugging 10% for now.  I’ve been able to negotiate lower fees than that in the past.  But, as anything you get what you pay for.

Annual Maintenance Costs: 

An older home will require more maintenance than a newer home.  For now, I would use 2% of the value of the home.

Reinvestment rate: 

This is the return you’ll get on the cash you get if you sell your home.  The default rate in this calculator is fine at 6%.

There are other variables not defined above, but the values entered are indicated below.

Assumptions – Scenario 1

• Home Value:  $386,000
• Price Paid:  $340,000
• Original Mortgage:  $255,000
• Mortgage Balance:  $220,000
• Interest Rate:  3%
• Mortgage Payment: This is calculated for you.
• Taxes and Insurance:  $6,320
• Monthly Rent:  $3,280 <<== Caution! This feels optimistic, relative to home value.
• Appreciation Rate:  2%
• Years to Hold:  10 Years
• Primary Residency: Checked
• Make Ready Costs: $0
• Mortgage Term: 360 Months
• Transfer Costs Now: 1%
• Transfer Costs Later: 1%
• Prepayment Penalty 0%
• Property Management Fee: 10%
• Occupancy Rate:  95%
• Tax Rate on Rental “Profit” (if any): 25%
• Effective Capital Gains Tax: 15%
• Selling Costs: 6%
• After Tax Re-Investment Rate: 6%
• Annual Maintenance Costs:  2%
• Annual Change in Rents: 1%

In this example, I adjusted the rent to show a net cash flow of close to $0 (see the fifth column in the table above). 

Although there is no cashflow, the math shows you’ll be better of renting out your property, as you’ll have $34,820 more wealth in 10 years. But note the drop in wealth on the blue line, at year 9. This drop is due to the cost of selling the home. At year 9, the difference in wealth between renting and selling is closer to $80,000.

Assumptions – Scenario 2

Now, let’s change the rent from $3,280 to $2,860 per month.

This shows you’ll be cash flow negative, the entire time.  In other words, you’ll have to pay additional money out of pocket to keep this house as a rental. So, renting your home out becomes more difficult to justify.

And finally, from a wealth perspective it also looks like you’ll be better off selling than renting. The numbers show that after paying selling costs at year 10, you’ll have $9,537 more wealth by selling now than keeping the home as a rental.

Again, it is worth pointing out that at year 9, you’ll have $37,570 more in wealth by renting than by selling. That’s because year 9 does not include selling costs. Those costs are included in year 10.

Conclusion

In this article we reviewed 3 good reasons to rent your house rather than selling it, the pros and cons of renting vs selling and the numbers behind it all. The main reasons to rent your house relate to cash flow, principal paydown, and appreciation. Certainly there are other advantages such as the tax benefits related to owning real estate.

The pros and cons of renting vs selling must be carefully evaluated. Each situation requires its specific analysis. And in the end most of this comes down to understanding the numbers.

In addition, even when there is no cash flow, it is possible to increase wealth more under the rental scenario.

And finally, I must say again that before looking at various scenarios, I was feeling a lot more optimistic about the renting out option. A home owner must really understand the numbers before making a decision. If you want another opinion, the video below may come in handy.

Moving Forward

In this article I touched on how rich people utilize income real estate to increase their wealth, which leads to financial freedom. The real key to financial freedom is cash flow. I realize not everyone has enough money saved to purchase real estate. Keep in mind cash flow can be from other types of investments.

I’d like to encourage you to check out the article titled The Bridge to Financial Freedom. In this article I explain a simple and proven strategy to get cash flow and gain financial freedom.

Disclosure

Please keep in mind I am not a real estate professional or a financial advisor. As such, please do not take any of this as advice. If you need to make an informed decision on this subject it is best to seek the advice of a professional.