How to Rent out Your First Home After Buying Your Second

There are a few reasons you may want to move into a second home and use your first property as a rental.

You may have a job opportunity far from your home. You may need bigger housing because your family is growing. Or you may need smaller housing because your family has finished growing.

No matter the reason, there are a few questions you have to ask yourself before deciding whether or not you can use your primary residence as a rental property.

What do you need to know before renting your first property?

These are questions you should ask before even starting to determine how much to charge for rent or how to market your property. That’s because the answer to these questions may preclude you from renting your property in the first place.

Does your loan have any owner occupancy requirements?

If you weren’t intending to rent your first home when you got your mortgage then you may not know whether or not you’re permitted to rent your property out at all or at least at that moment. Many mortgages come with occupancy minimums. And you’ll definitely want to do your due diligence on this issue because violating your mortgage agreement could constitute mortgage fraud, and that’s a big deal.

If you have a loan that’s insured by the Federal Housing Administration (FHA), it’s probable that you’ll have to have lived in the property yourself for some period of time before you can rent it, although some exceptions may apply. Conventional loans that follow stipulations laid out by Fannie Mae and Freddie Mac also tend to have owner-occupation criteria. And that’s in addition to whatever rules your lender has.

Does your homeowners association (HOA) allow renting?

If you live within a community managed by an HOA, then you’ll have to consult the rules that govern home rental. Some HOAs ban rentals, have a limit on how many units can be rented at any given time, exclude renters from some amenities, or may require a predetermined length limit on leases. This will impact your ability to find tenants.

What are your state and local landlord-tenant laws?

You’ll have to look into all the rental laws that you’ll have to abide by. You may want to consult with a real estate attorney to make sure everything’s copesetic before approving any tenants or drafting a lease agreement.

What changes do you need to make to your homeowner’s insurance?

You’ll have to let your insurance know your primary residence will no longer be your home and adjust your policy accordingly. You may have to get landlord’s insurance, which includes coverage for property damage, liability, and loss of rental income.

What are some other things to consider before renting your primary residence?

If you’re able to rent your property as far as laws and regulations are concerned, your next step is to start asking yourself questions and to consider logistics.

How emotionally attached are you to your primary residence?

Once your primary residence is going to be a rental property it’s going to be your business and not your home. Not thinking of real estate as a business is one of the biggest mistakes you can make as a real estate investor. It takes years for a business to become successful, and that’s exactly the sort of perspective you should have on your investment.

It’s important to be able to make decisions about your business from a rational rather than emotional place. Given that your primary residence is about to turn into your business, you need to honestly assess whether or not you’re going to be able to emotionally separate yourself from the property. Being an unemotional property manager is very important because getting upset at any repair or indiscretion will make your job far more challenging than it needs to be.

Are you ready to be a property manager?

Being an investor isn’t the same as being a property manager. Your duties will include finding tenants, screening tenants, and potentially evicting tenants; conducting maintenance, repairs, and addressing emergencies; handling the collection of rent and the security deposit; and handling legal, budgetary, and tax matters, even if that means hiring someone else to do all this for you. This all takes time, money, and resources. So, if you’re not up for it and you don’t want to hire a property manager because it’ll eat into your profits too significantly, then investing in property isn’t for you.

Have you looked into all the deductions you get to take on your taxes?

You have to report your rental income on your taxes, but you get to take the following deductions as well:

  • Advertising
  • Certain tenant-paid expenses
  • Insurance
  • Interest from your mortgage payments
  • Maintenance
  • Materials and supplies
  • Property taxes
  • Repairs
  • Utilities

Home improvements aren’t deductible and security deposits that you keep are taxable.

Will it be worth it to rent your property?

To determine if renting your property is worth it, you’ll have to figure out how much rent to charge, whether there will be a demand for your property, and how much work you’re willing to put into your investment.

How do you calculate rent for your property?

Look at properties in your area that are similar to your own and see how much they charge for rent. There are also calculator tools that can help you determine what your rent will be. You should also hire an appraiser to provide you with an accurate assessment of your property’s worth.

Rent should be a percentage of your home’s market value. Typically, that figure is between .8% and 1.1% of your asset’s value. If your home is worth under $100,000 you should charge closer to 1%. But if your home is expensive, say over $350,000, you want your rent to be less to attract more tenants. You’ll still want to keep in mind what others are charging for rent in your area to make sure your property is competitively priced.

If you want your rent to at least balance out your own monthly mortgage payments, you’ll need your rent to be at least what you’d be paying on a monthly basis. When putting together your budget, keep the cost of repairs, maintenance, taxes, fees, vacancies, and emergencies in mind to calculate rent and to determine if it’s ultimately worth it to rent your property.

How do you determine if there’s a market for your property?

As they say, “Location location location.” So, what’s in your property’s location that would make it desirable as a rental property? What’s the shopping, dining, and entertainment situation like? Is public transportation nearby? Are there industries or corporate headquarters that provide employment in the area? Is your property in a highly desirable location, like a city or vacation destination? How does your community compare to others in terms of crime, education, and family friendliness? Just because your home is being rented doesn’t mean it may not be rented by a family. Is your area on the rise or the decline?

Will the Silver Tsunami affect your property?

The Silver Tsunami is the term used by real estate professionals to talk about the increase of homes for sale thanks to Baby Boomers beginning to sell their properties. The number of owner occupied homes on the market is expected to increase by 27% by 2037 as a result of the Silver Tsunami. This change will be experienced first with 920,000 owner occupied homes going up for sale between 2017 and 2027.

The areas that will be most directly affected by these changes will be those areas that are already affected by the presence of Baby Boomers. This includes vacation areas where Baby Boomers own second homes, retirement communities, and cities like Pittsburgh and Cleveland that find themselves with a disproportionately high Boomer population because younger generations moved out and never returned.

If you reside in any of these areas, you may find yourself having to compete with a glut of potential rental homes or homes for sale, which may edge you out. This is particularly the case if you live in an area that’s already less attractive to Millennials, who make up 37% of homebuyers, according to the National Association of Realtors 2019 Home Buyers and Sellers Generational Trends Report. You also need to keep in mind that property owners without mortgages will have more flexibility when it comes to setting their rent and, therefore, will make for stiffer competition.

How do you figure out if it’s worth it to rent your property?

Once you know how much to charge for rent and have determined whether or not there will be enough demand to keep your property occupied and keep vacancies to a minimum, then you have to ask one final question: will it be worth it?

The answer to this question varies from person to person. The pros are that you can make some income, pay off your mortgage, and earn further equity in your home. That’s in exchange for all of the responsibilities that come with being a property manager. If you’re onboard with all that, then it’s time to figure out if your rental income will bump you up into a new tax bracket, whether or not you’ll be hiring a realtor or finding tenants yourself, and if you’ll form an LLC.

Will you form a real estate holding company (REHC)?

When you start investing in real estate, it’s useful to research legal entities since they will provide you with legal protections and tax benefits. Many people who intend to invest in real estate properties start limited liability companies (LLC) for this very reason. Even if you’re a landlord who owns just one property it can still be useful to start an LLC, particularly a multi-member LLC, that has a detailed operating agreement/umbrella policy.

The advantages of this sort of legal entity are:

  • LLCs are easy to run. They have the fewest number of compliance requirements. You don’t even have to have meetings, or the recommended operating agreement itself (although you should have one).
  • The legal protections offered by an LLC significantly reduce your liability–especially with a solid operating agreement.
  • An LLC files taxes using an 8825 (rental property form for a partnership), which is audited less frequently than a Schedule E (rental property form for an individual/sole proprietorship).

What do you have to do if you’re going to transfer a property with a mortgage to an LLC?

Transferring a property with a mortgage to an LLC requires some considerations. Don Ganguly, founder of INVESTimate®, ponders this issue with Brooke Pollard, Attorney at TLD Law.

What are some alternatives to long-term rentals?

At some point along the way you may have decided that long-term rentals aren’t ideal for your situation, either because your property might work better as a short-term rental or because you don’t want to use your property as an investment in the first place.

What do you do if you want to use your property as a short-term rental?

There’s a lot of advantages to short-term rentals if your property is in a highly prized location, like in a popular city or a resort destination. Like a long-term rental, you’ll have to check with your mortgage lender, HOA, local and state laws, etc to see if your property is eligible to be a short term rental.

If, however, you’re permitted to use your property for short-term rentals and your property would be in high demand, then you can move forward with figuring out how to calculate how much you should charge people using a service like Airbnb.

With Airbnb, maintaining a rental property becomes a lot like a part-time job. Airbnb provides you with clients and paperwork, while all you have to do is maintain the property and make sure it’s inhabitable.

What if you just want to sell your property quickly?

If you decide or discover that you’re unable to rent your property and want to quickly unload your real estate without much work, consider using an iBuyer. An iBuyer is a company that uses technology to make bids on properties.

The advantage of working with an iBuyer is that you’re able to sell your property much faster than traditional routes, which you may want to do if you’ve already got your second property. The downside is that you’re likely to get a below market price on your property in exchange for ease of use and speed.

Do you still want to invest in real estate?

Let’s say you want to invest in real estate but, after some introspection and/or research, discover that your primary residence just won’t do. You can still invest. You can do a 1031 exchange to get an investment property without paying capital gains taxes. A 1031 exchange is when you use the profits from the sale of your primary residence to purchase a property of equal or greater value within a predetermined period of time.

You can also invest in publicly traded real estate investment trusts (REITs), which are companies that own and manage different types of real estate. Most REITs are traded just like stocks. REITs come with the advantage of being a passive form of real estate investment as well as being highly liquid, meaning that they can easily be converted into cash.

Bottom Line

Renting your first property after you’ve bought your second house is the same as renting any rental property. The only difference is that you have to determine whether or not it’s actually worth it because already owning a property isn’t reason enough to rent it. If you decide it’s worth it to rent your first home, then everything that would make you good at managing any property will make you good at managing the property you already have.

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