Part 6 of 6 of Wela’s series on buying a house.
The year was 2007.
Peyton Manning and the Indianapolis Colts had just won the Super Bowl. The Boston Red Sox swept the Colorado Rockies to win the World Series. Tiger Woods actually won a major that year, and the San Antonio Spurs swept the Cavaliers to win the NBA Championship.
Sports cities were on cloud nine. In honor of the Kentucky Derby this past weekend, let’s remember that a horse named Street Sense won the Derby back in 2007.
Considering the name of the winning horse, there is some irony to the winner of the Kentucky Derby from 2007.
For homeowners, 2007 was also the last great year for real estate. Rumblings were happening beneath the surface for Main Street. Housing was on the brink of calamity and only a select few seemed to know it.
Just look at our own backyard in Atlanta. In 2007 the median sales price for homes in Atlanta were about $250,000. Then we get blindsided… a knockout punch.
The housing crisis had struck. From the peak of 2007 to the bottom of 2010, sales prices for homes dropped 60%... to about $100,000!
It felt like a Mayweather right hook and a Pacquiao jab combined into one jaw breaking blow.
How is anyone supposed to get back up from a 60% decline in value from one of the largest purchases you make in a lifetime? Why is anyone ever going to trust housing again?
Homeowners are still asking themselves, “How am I ever going to be able to move without taking a bath on this current house?”
Given this whole backdrop, why in the heck would I then write a blog about whether or not to sell your house or rent it out? Given the recent environment, who the heck even wants to continue to own property?
This should make the answer to the question easy… sell it and get rid of the house when it comes time to move to another home. Right?!
It’s not the market, it’s us
Some people took the knockout blow to the real estate market as an opportunity to ramp up their investment portfolios.
They went around and scooped up all these depressed properties while the prices were cheap, and they could borrow the money for the mortgage for even less.
Now in 2015, these people are sitting nice and happy.
Others of us were impacted negatively by the Recency Effect.
Basically the idea of the Recency Effect is that if someone were to be asked to spit out a list of their last twenty meals, they would start by mentioning the most recent meal and go backward from there.
The theory suggests that people are able to best remember the first thing in the list and the last thing in the list. Everything in the middle tends to be foggy.
The reason we’re able to remember the most recent stuff best (other than it was most recent!) is because it stays in our working memory. Makes sense.
Now take a quick second and look at the Wikipedia page for working memory.
What will you find? Well the first line will read, “Working memory is the system that is responsible for the transient holding and processing of new and already stored information, an important process for reasoning, comprehension, learning and memory updating.”
What sticks out most to me are the words “processing” and “reasoning.” Because the working memory helps us process new information into our memories with our past experiences and then reason what to do.
How does this relate to the housing market?!
Well the most recent thing that most of us remember about housing is from 2007-2008 when we watched our house prices fall nearly to the floor. While trying to reason how we would ever recover and earn back what we put into that house.
The American Dream was dead. Our dream was a distant memory and was actually causing us harm.
Despite the calamity and the ruin of our dream, it’s time to get back to understanding opportunities for our current home. Maybe it’s time to move, but you aren’t yet back above water. What can we do? Should we sell? Should we stay? Or maybe we can rent it and help lengthen the recovery?
It’s time to overcome working memory ,and become strategic on what to do with your house when it comes time to move… should I sell or should I rent?
A decision must be made
It’s that time. We have outgrown our house, and it’s time for us to move on to another home.
What should we do? Sell the house or get into the real estate investment business and rent the house?
Multiple factors come into play when thinking about this decision.
They range from whether or not you are moving out of state or staying close to your current house. The state of your financial situation, and whether or not you think the area of town you are in is a good one for renting.
Nobody can write a one-size-meets-all blog for the topic of whether to sell or rent your current home. What they can do is provide a blueprint for thinking through the situation. This will hopefully help lead a reader to the right decision.
Many homebuyers are obsessed with the price of their home. They constantly look at how much above or under water they are. This can lead to enthusiasm or deflation.
Given this mentality many people just assume that selling the house for that value they had recently seen is the only option. That the normal thing to do is to sell your current house, go buy a new house and watch the price of that new house go up or down.
But is this the only option? Not at all.
Think about this. What happens if you could have a house where someone else pays the mortgage for you and you reap the benefit of the equity (or the value of the home)?
Sounds pretty awesome, right?
Well that’s what could happen if you were to rent out your current house after buying your next one.
Of course, it’s not as easy as that and you will definitely encounter some expenses along the way. You may even experience periods of vacancy, but that’s part of the decision process of whether or not to rent or sell your house.
Let’s walk through this
First things first… do you need the equity (difference between your current mortgage balance and what you can sell the house for) in your current home to help buy your next home?
This tends to be the main reason that nobody gets to the next steps of this decision. Which is fine. We definitely don’t want to be in a position where we are financially at risk just because we wanted to expand our portfolio of investments.
There is another way to think about this, though. If we were to have this conversation with our significant other or ourselves early on, we could possibly plan to save for a new house (well before needing to buy it), which will let us turn our current house into an investment property.
The point being is that the conversation of whether you want the current house to be sold when you move or rented should happen early in the ownership phase as opposed to later.
Now, if we are planning on making our current house our life long house then this isn’t a question, but for many of us whose first house is likely to be a starter home, this question should be breached.
Next we have to look at the expenses for the current house on a monthly basis. We know what the mortgage and taxes are for the house. We have to look into what the insurance will be for a rental house as opposed to what it is for us living in the house as a primary residence. The insurance will likely change.
Don’t let this keep you from moving on. The costs could be slightly higher and that is ok… for this part of the process. We also have to account for upkeep of the house. Are we going to continue to provide lawn service? What about yearly maintenance on the A/C units? And then the usual wear and tear expenses; maybe just account for a couple hundred dollars a month for wear and tear.
Calculate this all up either on an annual or monthly basis and determine what you would need to get in rent to cover the costs.
Now it is time to see what type of rents are normal right now in the area. You can either use Zillow’s rent-Zestimate to see what they estimate you could get in rent for your current house.
Or you could use www.rentometer.com and put in your address and what you are thinking of charging for rent and see where that falls for similar homes in your neighborhood. When using Rentometer you may want to assume a slightly higher rent than what it will be to just cover the costs. This way you can see if you could cash flow right away on this rental.
See where your rent falls. If it falls in the middle, then you may be on to something that could be valuable to you longer term. But if you find that your rent falls into the higher end of the ranges than you may need to look at things again.
Either the expenses you are assuming are too high or you won’t be able to get the necessary rent to cover your monthly expenses. And this means we would likely want to go back to the drawing board.
These steps can lead you to determining whether or not it is even feasible or a good reality for you to rent your house.
But you also have to consider some other things:
- Would you be able to kick someone out of the house if they didn’t pay rent? If you can’t you may not want to be a landlord.
- Who is going to be in charge of handyman work?
- Are you going to have a property manager? Have you accounted for this in your costs?
- How far away from the house are you going to be? Further away makes it harder to manage.
- Have you talked to your accountant (or an accountant in general about the tax situation with rentals)
- Rental income is taxed
- You may be forced to pay capital gains on the sale of your current house down the road; depending on how long it’s a rental and how long since you lived in the house. Basically after 5 years, if you haven’t lived in the house for two years, you now are forced to pay capital gains on the gains you reap from the sale.
It’s decision time
In reality this decision comes down to just a couple of questions:
- Will you be able to rent the house?
- Do you think houses will appreciate in that area over time?
- Will you be able to cover the costs of the house?
- And do you want to be a landlord?
If you answer ‘yes’ to all of these, then looking at renting a house instead of selling it when you move could be a good option.
We must take into account all of these other considerations, but mainly we have to be comfortable with the four questions above.
There are definitely risks in renting. There are risks in any type of investment. Over time the goals of investing is that you are able to get a better return in the long run and that you are able to have more in the future than you do today.
With renting the house as opposed to selling the house you are hoping that renters can help you build more equity in your house.
And in the future this can provide one of two things: a new stream of income for you to use once the mortgage is paid off (or earlier). Or it could provide a larger lump sum on the sale of the house down the road.
Both of which are logical outcomes of potential investments.
Now eight years after that Derby and the crash that rattled us all, we need to look into the name of that winning horse from 2007, Street Sense.
We need to get past that working memory and overcome the Recency Effect that we are experiencing.
We have to overcome those barriers to provide us the ability to look at different opportunities with our own properties.
Use your street sense to make sure you have a winning financial move when it’s time for you to change addresses.