In the first installment of this two-part series, we discussed how tax guidelines will change when you convert your home into a rental property and transition into becoming a landlord. Now we take a look at the non-tax considerations of becoming a landlord.
HOA regulations. If you live in a building or community that has a homeowner association (HOA), you need to check the rules regarding renting out the property you own. Some HOA boards enforce strict rules when it comes to renting out units on the property, as they prefer the original owners to occupy the space. They typically believe that owners will be more invested in the maintenance and preservation of the property than renters. Furthermore, certain mortgage lenders require a ratio of required owner-occupied units in order to back new mortgages. In response to this, many homeowner associations either impose a cap on the amount of units that can be rented out, or enforce very strict rules that can make it difficult to rent to tenants.
Tenant rights and laws. Being a landlord can be taxing physically, emotionally and financially. Although many of the expenses to list and repair an apartment may be tax deductible, these activities can take a great deal of time. Further, a property that might be suitable for you as an owner-occupant may not actually meet code for a rental. Stairs are a common example — grading and safety rails may need to be improved. As a landlord, be sure to comply with local laws and utilize escrow accounts to hold security deposits.
Should you be faced with a situation where a tenant does not pay rent, you may have to start an eviction process, which often takes months and may involve costly legal fees. Furthermore, certain states, such as Massachusetts, have very strict tenant rights and laws that can make it very difficult for the landlord to win in the event of a dispute.
Cash flows. One the most important considerations to make before choosing to convert a primary residence is to estimate your projected cash flows. To calculate how much rent you may earn, check rental estimates in your area. There are several ways to do this; you can search on websites such as Craigslist and Apartments.com to find comparable rentals in your neighborhood. There are also rental analysis websites, such as Rentometer.com or Ziply.com, which will provide you with rental averages based on the number of bedrooms and location.
Once you determine the range of rental income you can expect, calculate your monthly expenses for the property. Generally, this includes a mortgage payment, taxes, insurance, interest, maintenance, and utilities. If you’re going to be moving out of the area, you will likely need to pay an individual or a management company to take on some of your landlord or maintenance duties, so factor in those costs as well. Finally, if your emergency fund is not yet fully funded, incorporate a portion of your monthly expenses to building up those reserves.
Before showing your rental to prospective tenants, it is wise to hire an inspector to evaluate your property before you rent it out. You should get an estimate for how much it will cost should you need to complete any upgrades or repairs to get the house either up to code so you don’t face any legal issues, or simply to improve the condition of the property in order to command a higher rent.
Once you’ve compiled your expenses and projected monthly rental income, factor in depreciation deductions and other tax deductions to reach a projected after-tax net cash flow. Every investor will have a different required rate of return, but you should feel comfortable that your net income will be worth the risk and time involved in being a landlord. If your projected profit margin is too small, then even a smaller repair like a hot water heater could take months in order to break even.
After calculating all the associated costs and considerations of converting your primary residence to a rental property, evaluate whether the income and upside potential of holding onto the property over time is sufficient to cover the added time and financial risk. Not all neighborhoods are created equal — renting in a desirable location will increase your pool of reliable tenants and reduce the risk of vacancy. Based on the ultimate cash flow projections, you should be ready to make the final decision to remain in your current home, sell it, or convert it into a rental property.
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Converting a Residence to a Rental: Cash Flows and Other Considerations originally appeared on usnews.com
