It’s a big question for a lot of homeowners in the market right now. Maybe you’ve owned your home for 5-10 years or more. You’ve seen significant price appreciation and rental rates are going up in your neighborhood as well. You’re wanting to make a good decision and are feeling a pull towards turning your home into a rental investment property instead of selling it.
Owning rentals can be a great real estate investment, but it’s not for everyone. So, be sure you know why you’re doing it and the math behind it.
Homeowners down the street are currently finishing remodeling their home. They’re going to put it on the market as a rental. Let’s say they can get $2,500 a month in rental income on the home for $30,000 a year in collected rent. That’s pretty good money, but they don’t get to pocket all of that. They have a small mortgage on the home ($100,000) and pay roughly $900 a month to cover their mortgage payment (including taxes and insurance). So, that takes their monthly net income down to $1,600 a month after paying the mortgage. That’s still pretty good. But, a property management firm takes another 10% ($250), plus another $100-$200 a month to set aside for maintenance reserves. So, that $2,500 a month quickly turns into $1,150-$1,250 per month. Not bad, that’s still $13,800-$15,000 a year in revenue. Then you have to pay Uncle Sam taxes on that rental revenue. Though you can deduct many of your expenses and depreciate the asset there will still be a hit on that revenue. Let’s just say it nets out at 10% if you have a good accountant. So, the true net income would be somewhere around $12,400-$13,500 per year.
Or, you can sell the house. The house down the street is valued around $375,000. It has been owned for well over 2 years. So, there will be no capital gains tax to be paid. There’s no ongoing maintenance and no headache if they sell the home. The owners have that $100,000 mortgage on the home. There will be a couple thousand dollars in closing costs and then real estate agent commissions. If they use a broker like me (I only charge 1% to list a house) they’ll only have $14,250 in closing costs ($3,750 to me and $10,500 to the buyers agent). Add in $2,500 for closing costs for good measure for a total of $16,750 in selling costs. The homeowner will walk away with $258,250 after paying off their mortgage and paying all selling costs.
$258,250 is a good chunk of change. That’s worth 19 years of rental income that the owner would get right now. 19 years of property management and headaches, updating the home every few years, replacing carpet and repainting, replacing broken appliances and fixing backed up sewers. Or $258,250 right now. You could invest that $258,250 at a moderate 5% return and it would be worth well over $650,000 in 19 years. You do the math.
If you’ve owned your home in the Denver metro for several years you’re sitting on a big chunk of change. While owning rental properties can be advantageous, the math does not always work in your favor. There are times when owning rentals is great idea, but it’s always a good idea to do the math.
*Note: the numbers described in this example are hypothetical. The future value of a $258,250 investment over 19 years performed on a simple investment calculator. Consult your accountant or financial advisor for investing advice.