There are numerous reasons to move – a better job in a different area, a growing family, keeping up with the Joneses, just to name a few – and if you’re in a financial position to keep your old home as an income property there is definitely an upside. Rents in many markets are at all-time highs. Rising home prices and tighter lending standards are keeping countless would-be homeowners from pulling the trigger. And there’s nothing better than having someone else make the payments on an asset you get to keep.
That’s why moving into a new home and renting the old one out has been a leading wealth-generator for the American middle class for decades. If you’re planning to follow that path, however, there are a few things to take into consideration.
The first hurdle is financial. Every lending scenario is different; state rules augmenting federal regulations are inconsistent across the country; and banks have different underwriting standards. However, in most cases in order to qualify for a loan on a second property, you’ll need at least 20% down as well as enough cash in reserve to cover both mortgage payments for six months. In addition, even if you plan to rent the old house out that arrangement won’t be seasoned until you’ve been doing it for two years. Consequently, the old mortgage will count as debt when the bank calculates debt-to-income.
One of the biggest advantages of converting a home you’ve lived in into a rental is that you know the home. Odds are you’ve completed repairs, built some things, and improved and remodeled to some extent. A corollary disadvantage, however, is that the fixtures and finishes that we tend to prefer for our own homes are often a liability in a rental. Aesthetic is still important. It has to look good to prospective tenants. But function is much more important than form – unless you’re the kind of person who likes to be woken up at 3 am because there’s something wrong with a toilet.
Owning real estate is a classic part of the American dream, and there’s something about owning multiple properties that feels, from the outside especially, like a tangible, even glamorous kind of wealth. It is also a kind of wealth that requires a lot of attention. (Some professional landlords refer to it as “buying a job.”) That might be tongue-in-cheek, but there’s a lot of truth to it, and it pays to study and learn rental property management like it is a job. There are numerous excellent forums on the Internet (e.g. biggerpockets.com) where a prospective landlord can absorb a wealth of information from people who are in the trenches dealing with real-world issues on a consistent basis.
Drawing the Line
There is one critical concept in rental property ownership that many new investors fail to recognize, and that is the difference between owning a property and having rights to it. To fully grasp this concept, I divide the unit (a house, let’s say) into two conceptual parts – first, a usable structure, and second, an asset. You, as an owner, retain the asset portion. But you lease the use of the property to the tenant, and as long as that tenant abides by the contract your rights to the property are severely limited. It’s not yours anymore; it’s your tenant’s.
This is important to understand, especially if you’re moving some distance away because it can be tempting to leave some things there. (Why not, right? It’s your place.) But unless your lease specifically guarantees access to the belongings you leave in storage at the property, you can have problems. In almost every part of the country your access to those belongings will be limited; in some places it will be basically nil.
The vast majority of first-time landlords look at homeownership as a preparation for managing a rental property. But getting things fixed is only a small portion of the job. Owning a rental is a business, and it requires adequate administration in order to be run well. That means that in addition to worrying about whether the toilet is flushing, you need to worry about things like marketing, contract preparation, accounting, and the legal issues and procedures relating to eviction.
When you move out of your old home and into your new one, your insurance agent will tell you that you need a Dwelling policy on the rental home. (A dwelling policy doesn’t cover anything inside the house; it just covers the structure itself and provides liability like a homeowner’s policy.) In addition to the dwelling policy, however, there are insurance issues in a rental property that a homeowner just doesn’t need to worry about. Things like what can happen to you if your tenant’s dog bites someone and what renter’s insurance does. Those issues are well worth confronting before you even market your home for rent, since doing so can guide you toward more responsible tenants who will do a better job of preserving your asset.