The recovering housing market has many people looking to move, but current homeowners might be confused on whether it’s better to rent or sell their current home.
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The shortage of inventory in some markets have created bidding wars that are favorable to sellers, however those with an underwater mortgage may have to pay to sell the home and waiting out home price appreciation by becoming a landlord may be a better option.
For those who bought their homes at the height of the market, the value will not reach that level for many years, according to Cara Ameer, broker associate and Realtor at Coldwell Banker Vanguard Realty based in Ponte Vedra Beach, Fla. “Markets go in cycles and there will be another real estate downturn again.”
Whether you should rent or sell your home addresses the question: how much can you sell your home compared to what you still owe. Regardless of what you decide, experts suggest knowing your competition to know how to price your home for sale or rent.
Becoming a landlord can mean a lot of work, says Ameer. It’s a very subjective decision—there’s no formula.
On the other hand, owning a home costs money. “Real estate is capital intensive and you always have to put capital into it to keep it up,” says chartered financial analyst Robert Stammers, director of Investor Education for the CFA Institute. “There’s always money you have to put in because the asset’s depreciating.”
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Since your current home could hamper your purchasing power of another property, experts suggest answering a few questions to make the decision process easier.
Question No.1: How much can you charge for rent?
“If you owe more than what you can sell it for and you have to leave the house anyway, look at how much you can rent the house for,” says Ameer. Consider whether the rent that you can charge will pay for the monthly mortgage payment, taxes and insurance or if you have to cover the difference every month.
The type of mortgage you have also makes a difference in the decision process, says Ameer. If you’ve an interest only loan, renting may not be the best option since your monthly payments will increase significantly at the end of the term.
Renting could work well for you if property values are rising, says Michael Corbett, Trulia's real estate expert. “Treat that rental property like its own company—any profit goes back into the property for repairs, maintenance and to pay down that mortgage.” He suggests holding all profits in an emergency fund or reserve for the property to cover any unexpected expenses or to help pay down the mortgage.
If you do have a positive cash flow, it may be better to hold onto the property and become a landlord, says Daren Blomquist, vice president at RealtyTrac, but consider whether you want this responsibility. “If you’re counting on home price appreciation to get your investment back on that property and in the meantime, you’re losing money every month [from renting], it may be a good time to cut your losses and not wait out home price appreciation.”
Question No.2: Do you have to upgrade your property?
A tenant won’t put up with the problems that you did, so Blomquist recommends walking through the house and assessing what needs to be repaired or upgraded.
If you decide to make substantial upgrades, analyzing every individual element isn’t an accurate portrayal of what you’ll get back. “When you do a few changes together, the kitchen, bath, painting and carpeting, all the sudden you’ve raised the level of the house to something nice,” says Corbett. “The whole is better than the sum of the parts.” Upgrades in strategic areas of your home create a lifestyle upgrade that could make the investment worthwhile.
While getting rid of clutter and painting can help sell your home, take a common sense approach to home improvements, says Walter Molony, spokesperson for the National Association of Realtors. Over improving your home won’t get you a return on your investment while improving your home to the neighborhood norm will get you more of a return. “If you’re in a buyer’s market with plenty of inventory, you’re going to have to make that home competitive.”
Question No.3: How much does it cost to maintain your property?
Rental properties have continuous maintenance expenses, especially when a tenant moves out. “You need to have a bit of a cash flow every month,” says Corbett.
Tenants can be just as picky as buyers, says Ameer, and there are costs to turning a property, like repainting, cleaning carpets, replacing flooring, and repairing any damage or wear and tear. Landlords tailor rentals differently than they do their own homes.
“Sometimes you have to decide if it’s better for you to sell and take a hold onto the property and rent it out for the long term knowing there are expenses with every new tenant,” says Ameer. “You have to take care of these things otherwise you won’t get as much rent.”
Question No.4: If you’re underwater, is a short sale worthwhile?
If your house is underwater, you may need to bring money to the table at closing. The amount you owe can determine whether it’s worthwhile to rent your home and take advantage of the housing recovery or pursue a short sale. Since home prices appreciate about 3% per year on average, it’s probably worth it to rent a home with an LTV less than 110%, says Blomquist. Doing a short sale could hinder your ability to buy another property.
For higher LTV homes, a short sale may be a good option because banks are willing to approve short sales even if you haven’t missed a payment, says Blomquist. Also consider that the law exempting homeowners from paying taxes on debt that’s forgiven expires in 2014, which may provide additional incentive to cut your losses.