Should I rent out inherited property?
I inherited a $200,000 home. I am in good enough financial standing that I do not need to sell the house to cover my living expenses and current mortgage. Would it be a good idea to keep house as a rental, even if I use a property management company? Or, should I sell the house and invest the money elsewhere?
This is a Finance 101 question about comparative rates of return. Here is how I would calculate it. I assume you own the inherited home free-and-clear (no mortgage).
Make a careful calculation of your net annual return from the house. Take the gross rent; subtract property taxes, insurance, management fees, any utilities not passed along to tenants, and all maintenance costs. In addition to repairs and ongoing expenses like landscaping, subtract a fraction of the major maintenance you know will be necessary some day. (For example, if you think the house will need paint every 10 years, use 1/10 of the cost of painting as your annual cost. Ditto 1/20 the cost of a new roof, etc.) After all estimated expenses are totaled and subtracted from gross rent, you'll have a number. That is the net return on your $200,000 investment.
Let's say that number is $8,000. This is the return, before income tax, that you can expect annually. Notice that it's 4%. In addition to current income, project how much the value of the house will appreciate (a guess: 3%?). Then, take into account your risks -- vacancy, deadbeat tenants, fire, tornado, what-have-you -- and decide if you are cut out for being a landlord.
If you can do better than 7% with equal or less risk, sell the house and invest the $200,000 elsewhere.
Don’t mistake renting a house with traditional investing. Everyone who becomes a landlord eventually learns this truth: owning rental property is a part-time job. Even with a rental manager, you are responsible for upkeep, taxes, maintenance, and satisfying your tenants. This is not the same as collecting dividend or interest checks from your portfolio.
Another point to remember is that leverage is key to most rental profits. In the usual scheme, you mortgage the property and get business deductions for both the interest paid and depreciation. Your rental income makes the monthly mortgage payment and, eventually, renters pay down the mortgage for you. The tax breaks magnify the financial results.
In your case, the right answer comes from comparing those two options. You can rent the property or you can sell the property and invest the proceeds. Selling is likely easier, but the financial returns will be based on how you might invest the proceeds. $200,000 invested in a diversified investment portfolio might earn $15,000 in annual income and growth over long periods. Cash flow may be higher from renting (especially without a mortgage), but you still face taxes, insurance, upkeep, and possible tenant calls in the wee hours. I can’t estimate the potential returns for you, but I can caution that renting is often harder than it looks.
No matter what, you have $200,000 that you didn’t before. Good luck.
As a financial planner, I encourage clients to accumulate wealth and generate income through both long term investments in real estate and the stock market. In reading through the responses posted by other advisors, it appears that you have received plenty of sound advice regarding the pros and cons of owning rental property. One suggestion that I have not seen, however, is that you consider posting your property on AirBnB. While not all rental properties are good candidates for listing on AirBnB, if your property is well suited to short term visitors, the cash flow generated from an AirBnB property can be significantly higher than that from a traditional long term rental property. It can also be a relatively low risk way to wade into the rental property market, and many AirBnB hosts enjoy the experience.
Just some additional food for thought!
As investors, our goal is to have our money create passive income. Over time, you should hope to have enough investments to replace the income you earn from working with this passive income. Once you accomplish that, you have reached financial freedom! Owning a rental property is a great way to grow passive income.
However, you need to find out if this property is a good investment, and if you are willing to become a landlord. Some people do not want the aggravation of having to manage their property. If that's you, you should cash out.
If you are still willing to invest into rental properties, find out if you have a good investment. Calculate your ROI by finding out what you could rent the place for and subtract the future maintenance cost of the property, property management fees and vacancy. Take your assumed net income and divide it by $200,000. If you are able to get 5%+ on your investment. I think you should keep the property. Real Estate is a good diversifier of financial market investments and has good tax benefits. Having a mix of both would help you reduce investment risk.
I hope this helps.
Deciding on whether to sell real estate has many factors. The location of your property and the corresponding value. Location would be attributed to what type of real estate market. If it is a home for $200,000 then it does not sounds like you are not in a high growth market. Do you live close to the property or will you have to travel to the property for maintenance, etc. Or what is the condition of the home. How much will you potentially need to put into it to upgrade or maintenance costs. I have worked with clients who have owned rental homes or apartment buildings and after a through analysis their returns were much lower than they realized. I would advise you to consult with a financial advisor or your CPA to evaluate your potential return on a rental.
On the other hand, you would have a broader array of investment choices with much higher diversification investing in more liquid investments. You could even have exposure to real estate within REITs along with other asset classes that would give you a more stable predictiable cash flow.