Selling vs Renting your House
So you have a house which you don’t need, what should you do? Sell the house, or rent the house? You have to consider what tenants you would have, the taxes, the cash flow, ROI(return on investment) etc. We at Estate Deal are going to help you decide which option is best for you.
Perhaps you bought/inherited a house, which is fine, but now you want to move to another house. Whether it is work or a personal reason causing you to move isn’t important. You are still faced with the same conundrum, to sell or rent the house.
Owning two houses can be profitable if you rent one of the houses. Keeping two houses can allow you to build a large cash flow over time, but how do you know if it is the right choice for you?
There is no right or wrong answer in real estate but, once you understand what your options are you can make the best choice for your particular situation.
We, at EstateDeal, are going to give you five steps that will help you decide whether to sell or rent your house.
Step 1: Will this property generate cash flow?
What is Cash Flow? Technically speaking
Income – Expenses = Cash Flow
This is the most important step in deciding whether to sell or rent your house. To put it simply, you are going to do the math (I know, I know, this was not your favorite subject in school but, all you need is a 5th-grade mind to understand real estate investment math).
Will this house produce a positive cash flow?
Hold on, we will explain: when this house is rented out and you deduct all the expenses associated with it will the property bring in a profit or a loss? If it’s not profit you should consider selling.
Now you might consider that income is just the rent and expenses only include the mortgage but that is FALSE. You see, for the expenses you have:
- Flood Insurance (if needed)
- House repairs
- Capital Expenditures
- HOA Fees(Home owners association)
- Snow Removal
- Lawn Care
- Property Management
- and more.
Most of these you can calculate by calling up someone and find out the cost:
- Insurance – call your insurance contact and ask for a quote
- Taxes – call your local county
- Flood Insurance –call your insurance contact
- Water or Sewer – call your local water department
- Garbage – call the local trash provider
- Gas – call the local gas provider
- Electricity – call your electric company
- HOA Fees – Call the HOA hotline
- Snow Removal and Lawn Care – talk to the local landlords or call a company to get a quote.
Not all of these apply to your property or the tenants may pay these expenses. In some cases there might be even more expenses. To understand what expenses you might have look at properties in your local area.
These create the more easily determined number but, vacancy, repairs, capital expenditure and property management are more difficult to estimate. This doesn’t mean you can exclude them. We are going to use averages, and then turn those into dollar amounts.
Vacancy: Your house is not going to be rented 100% of the time. Tenants come and go so your house if going to be vacant for certain amounts of time. We can’t give you the exact amount of time since it depends on the area, how good you are to getting new tenants etc. If you are unsure talk to local property management companies and ask for their vacancy rate.
Once you know the vacancy rate, as a percentage, transform that into dollars. For example for a 1000$/month rent, at a 5% vacancy rate you get 1000 X 0.05 = 50$. This amount you are going to include in your monthly expense.
Repairs: House repairs are difficult to estimate since there are many variables that come into play. An 80 years old house will have more repair costs than a house built last year. Same goes for a recently rehabbed house vs one untouched for 50 years.
Keeping this in mind we recommend using an 5% - 15% percentage going higher/lower based on the house’s condition.
To give an example if the house is old you use 15% of the rent(1000$/month). That means you add 1000 x 0.15 = 150$ to the monthly expenses.
Capital Expenditures(CapEx): These are the big items that need to be replaced every so often. It included appliances, roofs, driveway, plumbing or any other large item. It’s a commonly ignored item but this shouldn’t be overlooked. If you saved 100$ a month for 10 years but then you had to change the roof for 10.000$ you didn’t accomplish much.
Like repairs, capital expenditures are hard to estimate so we are going to use the same 5% - 15% average like repairs.
Property Management: Property management companies usually charge as a percentage of the rent and a rent out fee. The number change based on the area but in our area the fee is 10% of the rent and 50% of the first month rent when the unit is turned over. Now you also have the vacancy to consider but rather than calculating that we can just add 1% to the 10% fee and assume the extra 1% is going to cover the tenant turnover fee.
What if I’m going to manage it myself? Whether you plan to manage yourself or not we suggest you add the cost either way.
Putting it all together
Now you should have a list of all the expenses and income sources for the property so we are going to take a hypothetical scenario.
We have a house valued at 100.000$, the rent for it would be 1000$/month. Breaking down the number we determined the monthly expenses to be:
- Taxes: 100$
- Insurance – 50$
- Vacancy: -50$
- Repairs: -50$
- Cap Ex: 50$
- Property Management: 100$
- Total: 400$
So our monthly expenses for the house is 400$/month. This is also known as “Operating Expenditure”.
Finally we can calculate the cash flow. Oh wait, we still have to consider the mortgage.
Cashflow = rent – operating expenditure – mortgage(if any).
In this example mortgage is 0 so cash flow is 600(1000-400), 7200$/year.
Cash on cash Return on investment
7200$/ year might sound like a good thing but is it really?
Cash on cash return on investment is simply the ratio between how much cash flow we received over a one year period and how much money we invested. In other words:
CoCRoI = Total Annual cash flow /Total investment.
If you invested 5000$ into the house before putting it out for rent:
CoCRoi = 7200$ / $5000 = 14.4%
Is a cash on cash return on investment of 14.4% good? Well, over the past few decades the average was around 8% so I’d say 14.4% is a really good return. Additionally this doesn’t include the appreciation, the tax benefits or the loan pay-down but just by looking at the cash flow this is a better than average return. In the end you are the one that decides that.
Step 2: Return on investment
Consider how much you would profit if you sold the property right now(keep in mind you lose about 10% to agent fees and other sale expenses). If you wouldn’t be making too much it might be better to hold on the sale of the property and wait for the market to improve. This is especially true if the house will provide positive cash income in the meantime.
If by selling you make a good profit you might want to do that. For example selling for 100.000$ compared to 10years of rent at 1000$/month. That’s only a 1% return on investment.
Step3: What does the future look like?
An important factor to consider when deciding whether to rent or sell your house are the following questions: How do the next five, ten, or twenty years look like for your home location? Is the neighborhood improving or declining in value? If the future is looking dark consider selling now.
We can’t predict the future but take a look around your city, is it moving forwards? Are businesses moving into your area? Are homes takes cared of? You can’t know 100% but by analyzing the current trend in your neighborhood you can take a better decision whether to sell now or rent.
Step 4: Can you handle tenants?
Are you willing to be a landlord? Many people are not made for this kind of life. While some tenants are a dream to manage, others are hard to deal with.
This is a skill than can be learned and improved but new landlords often make mistakes. If you are willing to learn you might be fine.
Just because you own a house that’s up for rent doesn’t mean you have to deal with the tenants directly. There are professional property management companies around. He or she can cut the stress and deal with the tenants for you for, for a fee.
In the end, what will you do? Sell the house or rent the house?
Don’t make this decision right now. Look at the four steps we listed above, take your time and make the correct choice for you and your future.
If you decide to sell the house Estate Deal offers the best services: