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Monday, September 21st, 2009
THE RELUCTANT LANDLORDS
(The Wall Street Journal) With housing prices still in the dumps, many Americans are finding themselves in the uncomfortable position of landlord.
Some have been forced to relocate for a job and can’t sell their houses. Others have moved, but are holding on to their previous homes, hoping for prices to rebound before selling. Many are finding that rent checks don’t come close to covering their mortgage payments.
Hard data are scant on how many homeowners are renting out their homes, but anecdotal evidence suggests numbers are up. In one indication of the trend: More homeowners are converting their homeowners insurance to landlord policies that cover the additional risks of leasing out a home. Allstate Corp., the second largest home insurer in the U.S., reported a 27% increase in conversions in the first quarter from the previous year.
“The number of rental homes available is greater today than it was a year ago due to the foreclosure crisis,” says Mike Nelson, current president of Rental Home Professionals Inc., a multiple listing service of rental homes owned by the National Association of Residential Property Managers in Chesapeake, Va.
In Frederick, Md., Realtor Jim Bass says that because of rising demand, a couple of months ago his real-estate group started offering property-management services, tending to the rented homes of absent owners. Mr. Bass says a client recently rented out his 4,700-square-foot house after failing to sell his home, which he listed for $790,000. Now a tenant pays $2,995 per month—a shortfall of $2,000 from the $4,995 mortgage payment. The homeowner “feels that two years from now, the market will improve to the point where he can recapture that,” Mr. Bass says.
Experts generally advise against becoming a landlord in hopes of recouping lost home value. In some hard-hit parts of the country, such as Florida, Nevada, Arizona and parts of Ohio, prices may not climb back to mid-2000s levels anytime soon. Landlords have to pony up money each year for property taxes, insurance, maintenance and repairs. Meanwhile, demand for rentals in many parts of the U.S. isn’t strong: Apartment vacancy rates nationally are the highest in more than two decades and rents are falling in some areas, compounding the difficulty of finding a good, steady tenant.
Homeowners who owe more than a house is worth in very depressed areas may be better off selling even in a short sale, whereby the bank agrees to accept less than the full amount owed on the mortgage, says economist Edward Leamer, director of the UCLA Anderson Forecast. Your credit rating takes a serious hit, but, he says, “better to take your losses and move on.”
Kyle Becker, 27 years old, and his wife didn’t feel they had much of a choice in becoming landlords. The couple and their infant son moved from Columbia, Mo., to Winchester, Va., last year so that Mr. Becker could attend pharmacy school at Shenandoah University.
Before they moved, they listed their three bedroom, two-bath ranch-style home in May 2008 for $139,000. They had bought it in 2005 for $110,000 and put $30,000 into roofing and siding. By February, they hadn’t received a single bid.
“We had only seven lookers over the course of a year,” Mr. Becker says. Meanwhile, the couple was paying $1,200 a month in rent for a Virginia house. Last spring, the Beckers finally leased the Missouri house for $675 a month—$225 less than their mortgage payment.
Because the home was no longer owner-occupied, Mr. Becker was unable to refinance his 6.1% mortgage when 30-year rates dipped below 5% briefly.
If he had to do it all over again, Mr. Becker says, he might have chopped the price of his Missouri house, where sales have been stagnant—with the exception of “distressed” properties in some stage of default.
The calculation isn’t the same for all homeowners. Those who have paid off their home or have a small mortgage balance may be able to wait out the market. And there are pockets of the country—Houston is one—where home prices haven’t fallen as hard. Some homeowners may want rental income to supplement retirement savings.
Still, they may be shocked by the costs. Teshika Holmes, 36, says she received no bids for her three-bedroom house in Huntsville, Ala., after a job loss forced her to relocate to Montgomery, Ala. She’s renting it out for about $800 a month.
Ms. Holmes hired a property manager who charges 10% of the rent. Typically rates run from 3% to 12%. She also pays an increased premium of $500 a year for landlord insurance. Among other things, a landlord policy covers the loss of rental income if a fire makes the house uninhabitable. It costs about 25% more than a standard homeowners policy, according to the Insurance Information Institute.
Ms. Holmes says she has negative cash flow each month from her Huntsville house, but the rent allows her to stay current with her mortgage and preserve her good credit. “The only thing I wanted was the house note paid,” she says.
Some homeowners are renting out their homes because they live in areas where a handful of distressed sales have skewed home prices downward. Economists say homeowners who have equity in such homes may be right to delay selling, as sales have started picking up. However, they should be realistic: Sales of lower and moderately priced homes are recovering faster than homes at the upper end, and prices may not rise that much in the short term.
David Richter, of Chicago suburb Wheaton, Ill., says he rented out his home because he was receiving low bids. “There were plenty of lowball bidders,” says Mr. Richter who moved to a smaller home in Wheaton. “We have enough equity that we felt we were better off riding it out.”
Before doing that, homeowners should consider the financial realities. Generally, utilities, maintenance and repairs run higher with tenants than when the owner occupies the house. Collecting enough rent to cover the note on a home purchased at the height of the housing boom may be impossible.
Rental income is taxable, but can be offset with business expenses–including mortgage interest, real-estate taxes and homeowners insurance–and depreciation. Expenses in excess of rental income also can be deducted, up to a limit.
Renting for an extended period can eliminate or diminish the value of capital-gains tax exclusions. Federal tax law requires you to live in the house at least two years of the previous five in order to qualify for the full capital-gains tax exclusion upon sale of $250,000 for a single person or $500,000 for a couple, with some exceptions.
Karen B. McIntyre, 46, a certified financial planner in Lower Gwynedd, Pa., a Philadelphia suburb, says she and her husband have been renting out their former home after they bought a newly built home nearby because of its better location and excellent price. “We may also lose some of the capital gain exclusion, but expect the increased selling price (of the older home) will make up for the decrease in capital gain exclusion.”
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