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So we’re thinking about buying a rental home, either in our college town or the town 10 miles north of us. I’ve written here before that we were briefly landlords in the late 90s when we moved to a larger home and rented out our starter home. But we felt we didn’t have the bandwidth to be landlords, so we sold the place after a year. That was a major financial mistake.
Why are we considering this now? I won’t bore you with all the details, but we’re planning to have our daughter and her pets, with a paying roommate or two, live there while she finishes school and establishes herself in more steady work. We’ve been financially supporting her while she’s been recovering from serious injuries sustained in car accidents in 2022 and 2023. But paying rent, especially in the expensive part of California in which she now lives, is not only a drain on our finances as we approach retirement but also feels like flushing money down the toilet. We’d rather re-direct that money to an actual asset that could be worth something over time. Anyway, here are the practical questions I feel we need to research before we (possibly) take this leap in the next few months. (We’ll wait until interest rates drop, as predicted, this fall.) The questions:
Is there anything else I should put on the list?
“We have no particular desire to become landlords…”
So buy a good REIT like Public Storage (PSA) or Realty Income (O) and live life to the fullest!
In addition to the questions you asked there are a few additional concerns you may want want to address.
The IRS rules disallows business losses that involve related parties. If you are letting your daughter live in part of the residential rental property for no rent or less than fair market rental your tax deductible expenses would be limited. Given that you are still working if the non family part of the rental is a net loss that loss may be suspended under the passive loss rules based on your other income.
https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/personal-use-of-business-property-condo-timeshare-etc/personal-use-of-business-property-condo-timeshare-etc-1
You would be buying and (maybe/likely) financing a non-liquid asset that causes additional complexity in your personal returns that you may not want to deal with. My past experience as a CPA (retired) is any rental purchase will require a higher down payment percentage, a higher mortgage interest rate and higher insurance cost than compared with a house you buy for a home. Some HOA rules can prohibit or make renting a property a headache. If you have a tax preparer you may want to discuss your planning with her/him.
In your comment, she will have opinions about who she does and doesn’t want to live with, but we have opinions about the kind of tenant we (don’t) want, you recognize the additional potential conflicts. I observe that you as owner would bear dealing with the property should your daughter decide to move.
Life events can go terrible. Many people want a legal shield to protect themself from unlimited liability using the limited liability company form of ownership on rental properties.
A further thought I had was what are the housing plans for your husband and you for the long term? If you are thinking about aging in place maybe this is the time to find a single level house with the necessary accommodations for when/if mobility or other health issues arise and just gift your daughter the use the smaller house for her remaining college years.
I hope my thoughts help, Bill
Thanks, Bill. I can’t believe how helpful you all have been. I’m going to make a list of all the ideas/questions from these comments to discuss with my husband. I didn’t know about that tax issue, for example. I do know that we can’t use our IRAs to buy the place as an investment property if a family member is using it.
We assume that our daughter probably wouldn’t live in the place long-term. It is a strong rental market in our college town and the surrounding towns, and if we make a good decision about a property, it should be possible to find good tenants. Most rentals here are one-year leases, too—that’s just the norm.
My husband and I currently live in a condo—a flat with no stairs—that’s on the top (fourth) floor of our building. There’s an elevator, but sometimes it goes down, or if there’s a fire alarm or a power outage, we have to take the stairs. That’s fine in our 60s, but we had a hair-raising moment when we all had to evacuate the building due to a fire alarm, and we had to help our barely mobile neighbor down three flights of stairs. His wife said, “Just leave us. When we decided to buy on the fourth floor, we agreed that if anything like this happened, oh, well.” But obviously we weren’t going to do that!
Anyway, we actually really like our condo, which we bought new in 2019, but this issue does give us some pause for the future. There’s a new 55+ community being built in our town right now, and we’re not in any hurry to move, but we might take a look.
My wife and I have been landlords for 25 years. From 1999 to 2019 we lived in the lower three floors of our 5-story, 4-family brownstone in Brooklyn. After we retired and sold our brownstone and moved to NC in 2019, we used a portion of the proceeds to make cash purchases of 4 rental properties–two townhouses and 2 free-standing houses. Below are my thoughts about your four questions.
I agree with Steve that it can be better to rent than to buy. We were very fortunate to have purchased our properties just before Covid hit and have benefited significantly from the increases in rents and property values over the past four years. However, we just happened to be lucky and I won’t be surprised if our rental income fails to keep up with inflation in the near future.
GREAT comments, thanks! As for the mortgage debt, we can swing it while we’re both still working without much pain. Once my husband retires and our income drops, we’d probably consider pulling money out of one of our retirement accounts to pay off the mortgage. We don’t have enough non-retirement account funds to buy the property for cash, and it wouldn’t make sense in our current tax bracket to take money out. So it might just be for a few years.
The maintenance contract info is a great tip. I’ll look into that if we move ahead. We’re pretty well connected in the area and can probably find handypersons, etc., to be on call, but I need to research it.
Hi DrLefty, I am a little concerned about your purchase and management plans for your daughter’s residence/rental. Here’s why:
I would challenge your decision to buy rather than rent. Renting is definitely not throwing money down the toilet. Your fixed expenses and mortgage payment (even at the lower interest rate you are wisely waiting for) almost surely will be a lot higher than the rent would be. You must you must consider your fixed expenses and property tax, which is almost prohibitive in California. Now this is important: you can/should take the money you are saving by renting rather than buying and put it in the market or other liquid investment you are comfortable with.
Home or condo? That depends. By the way, it’s not necessarily true that appreciation on a house will be greater than it would be on a condo. As you say, since your daughter doesn’t seem to care about “the outside” and I presume would not be interested in caring for a yard, why a house, which takes much more management expertise than a condo. A new roof can easily set you back $20,000. Other large one-time costs are air conditioning/heater, appliances and often painting/new carpet for a new renter. I agree renting should be less of a problem in a college town, but there will undoubtedly be some lost rent (indirect cost) between old and new renters. There would also occasionally be some tenant damage (pets, which I would avoid) that goes beyond the deposit.
You should be able to find a good fixer, but you will also have to find reliable (and honest) vendors for larger jobs. Since you say you are not savvy about repairs, you are vulnerable to unscrupulous repair people who will figure that out and think you are giving them a “blank check.” Your fixer should be able to alert you about that. Also, if you do buy a house, given that you will be unsophisticated owners, it should probably be a newer one so that repairs are less likely.
Given that you say you are inexperienced, you probably should use a realtor. I would try to use the seller’s realtor—he will be very motivated to reach a deal because of the double commission.The laws and local guidelines are often complex and a good, experienced realtor can make sure you are not going to step on a land mine. Extremely important: You will need to be familiar with new regulations and familiarize yourself with any rent restrictions like rent control. The seller’s broker no longer sets the commission. If you decide to buy with your own broker, you now can negotiate the size of his commission. You won’t need a lawyer because in California you are protected by the title company that stands in for both the buyer and seller. If it’s a house, you need to find an inspector who will alert you to any big problems. If you find any (there always are), you may be able to have the seller reduce the price by the amount of problems or, better yet, have the seller take care of them.
It is critical that you and your daughter are on the same page regarding the renting criteria. You don’t want to find a good renter and have her torpedo your good fortune.
I’ve owned many small residential properties in California and know from where I speak. You should expect problems—there always are—involving maintenance and repairs and difficult renters. Prepare to have some of your precious quality time interrupted from time to time.
I put my money where my mouth is. I am thrilled my son is renting rather than having bought in LA and is investing the difference in the market. Remember, you can always make a decision to buy, but once you do you’re stuck.
Sorry for the negative vibes but better safe than sorry.
Great perspective
This is all great info. Thanks so much for writing. I always think of you when it comes to rental real estate, so I’m glad you saw my post.
We have no particular desire to become landlords, and if we do buy a property, it will just be the one and for specific reasons that are more family-related than money-related. Our daughter has had a rough time. She needs a place to live, and we don’t especially want her living with us. (We love her but we don’t think it would be good for our relationship or quality of life.) Her continuing to rent is going to be a problem because she has iffy credit, is only partially employed, and has pets. Let’s just say that if she applied to be your tenant, you probably wouldn’t want her (though she’s delightful in other ways).
She lucked into the place she lives now nearly two years ago in that her roommate already had the lease, so she didn’t have to qualify or have us co-sign. But her lease is up on Nov. 1, and she wants to move and her roommate does, too. So the current situation is going to end.
We’ve been guarantors for her apartments in the past, and we don’t love it. (On the other hand, being stuck with a lease for a year isn’t as bad as being stuck with a mortgage.)
So how this possibly pencils out: We buy a house or a condo and put 33-50% down. We’re not paying her rent anymore, and we add a roommate or two (depending on the size of the place) who is paying rent. We make sure the mortgage, etc. is about what we’d be saving on our daughter’s rent plus the rent from another tenant(s). So we more or less break even, and she has a stable living situation.
You make a good point about a condo and a HOA that takes care of exterior maintenance. We live in a condo ourselves with such pricey HOA dues that we’re leery of this, but the couple of condos we’ve looked at for possible purchase have modest HOA dues compared to ours. They also have small yards (she has a small dog, so this would work) and a garage.
Anyway, a lot to think about, and thanks for taking the time to share your experience.
Glad you wrote back, because now I understand your predicament a little better. You can buy, but hope to just break even and not count on a positive cash flow.You are right about HOA’s. They have a lot of power (i.e., tyrants) and can even ask for an “emergency” cash infusion (for a big unexpected large expense like a system-wide plumbing redo) when they’ve mismanaged their finances. But you’ll often find that the dues are tolerable when you compare them to the average monthly cost of the fixed expenses and maintenance of a home. If you have a specific question or two and think I could help, just write again and I’ll respond as best I can.
Steve
We were hit with a $10000 roof assessment by our HOA 6 months after purchase. No disclosure in our pre-purchase diligence.
When we purchased our two townhomes we asked about the ages of the roofs and who was responsible for repairs and also had them professionally inspected. We considered that part of our due diligence.
Thank you, Steve!
No expertise here except renting out a vacation home years ago. One thing I learned, don’t underestimate the overall expenses of maintaining the property.
What would happen if you have a place and after it’s all settled the roommate or tenant leaves? Could you handle the loss of revenue?
I’d opt for a condo even with HOA fees simply to avoid or minimize outside property issues.
How long would you hold the property even if your daughter left?
Given she will be living there, I would involve your daughter in the selection of a property.
All great points, thanks!
Interesting thought. I mentioned on another thread that we’ve considered owning property again. We have been landlords successfully with one property at a time, but now retired and nomadic including globally, not sure we care for the hassle. One thing would push us over the edge is if our college senior nephew were to take a job or enter a graduate program in a place we’d be happy to own in. He has a good head on his shoulders so we’d be happy to rent to him and possibly to whatever roommate he wanted.
I’d offer three comments.
First, given the above context, probably no surprise that I like the basic idea.
Second, who says you have to rent to roommates? You can just choose a place sized for your daughter and avoid that aspect altogether.
Finally, I wouldn’t be so fast to write off a property manager. To me it’s worth paying a good one to handle the details.
Interested to read other views and how your plan develops.
Great points, thanks!