“I’m thinking of keeping it and renting it out.”

Two years before we were married, my wife and I purchased our first home at age 23. It was a two-bedroom, one-bathroom condo with about 1,000 square feet, and it turned out that our total monthly cost of owning was less than it would have cost to rent the same property at that time. It was always in the back of our minds that when we outgrew the property and moved on to buy our next home, that we’d keep it and rent it out.

That was, until the day came when we outgrew the property and wanted to move on to buy our next home. And the reason our game plan changed was this: We analyzed all factors and came to a decision that, at the time, was our soundest financial choice. Here were the questions we asked:

  • What is our monthly cost to carry this property?
  • How much can we charge to rent the property?
  • Aside from our fixed monthly costs (association fees, property taxes, insurance and mortgage payment), what other incidental costs could arise? Repairs, the cost of evicting a tenant, carrying the property during a period of vacancy between tenants, etc.?
  • What is the market value of the property if we sell it instead? If we do, what are the resulting net proceeds?
  • What are the tax implications of selling the property now? Of retaining it as a rental property? Which is more advantageous for us?
  • If we keep this property and rent it, what are the long term objectives this will help us accomplish?
  • If we sell this property instead, what are the immediate and long term advantages?
  • If we keep this property, how will it impact our ability to borrow to purchase our next home? In other words, will the expense of this home have an affect on our debt-to-income ratio for qualifying purposes on our next mortgage?

Since we had run through this exercise to examine our own scenario and make a decision, I’ve helped upwards of 200 clients analyze and make the same decision. I would say this is an incredibly common question that we get asked, but that wouldn’t be entirely true… generally it shows up in our initial conversations with a client, as we’re beginning to develop a strategy for their move, more-so as a statement: “I’m thinking of keeping it and renting it out.”

Sounds like a great idea. “Lots of other people have investment properties, so I should too. My cost to carry it is $1,500/month, and I can rent it for $1,800/month, so I’ll get $300/month cash flow.”

It’s not a bad train of thought by any means, and in many instances as we analyze it with our clients, it does make sense to retain and rent. But many times it doesn’t. And the reasons that it doesn’t generally have far less to do with the “my cost to carry versus the rent potential” factor and more to do with all of the other factors that I’ve mentioned in the questionnaire above.

In our scenario, the reason that it made more sense for us to sell the property than it did to retain and rent it was because during our term of ownership, values had increased significantly in a short period of time (about 3 years), and all market indicators pointed toward this value being a high water mark that we may not see again for a long time. (Side note: this was in 2006, and to this day, values have not recovered to the value at that time.) We felt it was far better to cash out, take the equity and apply it to our next purchase, which in turn made our new home more affordable than it would have been otherwise.

I tell you what our decision was only to point out that there are a myriad of factors as to why you may want to hold and rent, or may not want to hold and rent. Using the line of questions above, along with guidance from your financial advisor, accountant, and real estate agent, will help you make the best decision in your scenario.

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