With the rise of mortgage interest rates, it feels as if there is a fever pitch of discussion right now on what everyone should do with their existing 3% interest rate mortgages that they locked in during 2020-2022 if/when they want to move to a new home.
Some feel stuck in their current home forever. Some feel like their only option is to turn that home into a rental.
Honestly, both of those are somewhat extreme viewpoints, but I'm going to address the latter today. The math of the situation will say that having debt at a 3% interest rate on a (historically) appreciating asset is a great hedge against inflation. Add in the tax benefits, and renting out your property sounds like a home run, right?
Ehh, maybe best case scenario math is one lens to evaluate if you should turn your home into a rental property. Read below for additional considerations:
Run the numbers.
Ope, sorry, looks like we're already back at math, but let's look at some less-than-ideal math this time. If you bought at the peak of the market in 2021, even with a 3% interest rate, you probably do not have a cash flowing rental (making more $ than its costing you). The tax benefits, equity gain & potential appreciation of the property may still make renting out your home worth it as a long-term investment, but make sure to understand those numbers (and consult a CPA) before you commit.
Real estate is not a very liquid asset either, so if you do decide to keep your home as a rental, but the ongoing expense is slowly draining you financially, it may not be an option to sell quickly if you need to.
Maintenance.
Unlike investing in stocks, rental properties constantly require maintenance, even with a property management company, you will need to manage the maintenance, especially larger items like hail damage or flooding that require insurance claims.
Even small maintenance fees can add up, if you have a rental property that has high tenant turn-over the cost of annual cleaning, paint touch-up and replacing broken/old fixtures can add up to thousands. When you have a large rental portfolio, these fees do not hit as hard since you have many sources of rental income. But if you have a rental portfolio of just one property, this may wipe out all your income for months. Make sure you have a financial buffer to manage the ups and downs.
Risk.
Providing a home for another person is not a risk-free endeavor. You assume the risk of vacancies, tenant disputes & property damage. Again, if you opt for property management that company may be partially liable but as the owner of the property ultimately it will be your responsibility to manage and resolve these issues.
I always use the example of flooding to help explain this – if your rental property floods you will need to manage that property damage on top of helping your displaced tenant find a new home. Not only could you go months without collecting a rent check, but you may also have an insurance deductible and your displaced tenants temporary housing to pay for. Never forget that being a landlord is a very human business, you are providing a home for someone which means you are also partially responsible for their wellbeing.
Landlord-Tenant Laws.
The laws surrounding landlords and tenants are constantly changing, are you willing to stay up to date to make sure you are compliant? Not to mention there are fees to initiate & maintain a rental property license. I walked through some of the financial risks above, but there is also the legal risk of being sued (which is a financial risk as well, lawyers are not free!)
Similarly, your property may not be in rentable conditions according to the city/state laws and prior to placing a tenant, you may need to make updates to your home to meet rental code. Managing inspectors requirements can be incredibly frustrating and time-consuming.
Emotional Capacity.
A home is a financial consideration but also a very emotional consideration for some. For example, if this is your first home that you brought home a new baby to or a fixer upper you poured all your evenings and weekends into, it may be very hard to see a tenant move in and treat the home differently than you did. Managing a rental property is an ongoing commitment, with many ups and downs. Be prepared to manage many different types of tenants over the years with varying degrees of care and attention to your home.
Ultimately, there is potentially a financial win waiting for you if you decide to become a landlord, but there is always a cost for that win. The cost of being a landlord is adding complexity to your life, it is not a passive investment like stocks. Make sure you are prepared for this additional complexity & that the payoff is worth it to YOU.
After all, what's the point of making additional money if it is not getting you closer to living your ideal life? For me, there's nothing more exciting than growing and managing my rental portfolio. But it has not been, and will never be, a clear path to immediate success. It has added both exponential anxiety, happiness, and financial security to my life. Worth it for me, but most definitely not for everyone!
xx,
Claire
