As discussed in several of my previous posts my husband’s career forces us to move pretty regularly. This presents an opportunity for personal growth and has allowed us to experience life in several states/cities. Though the “pros” are numerous there are certainly “cons” to these frequent moves too. One of the more difficult cons (for me to accept) is the inability to build equity in the form of a primary residence. Though I don’t think homeownership is the picturesque “American Dream” it’s often made out to be, I do think there’s something to be said for the inability to put down roots and build equity.
Renting and moving several times each decade often comes with large security deposits, egregious “move out” fees, and lots of restrictions. Trying to find an affordable home in a desirable neighborhood can be difficult. Throw two large dogs into the equation and our options for rentals are usually few and far between. In fact, we’ve been in several cities where our affordable options were none and we were forced to look outside our “ideal budget” for housing. So, this time, we decided to buy.
That’s right. I’m moving in 18-24 months and I bought a house. I’ve broken one of the cardinal rules in the marriage of personal finance and home ownership. Before you write off all of my other financial advice it’s important I disclose the plan for my new home. Upon our departure from the west we will turn our current home into a rental property.
Becoming a landlord wasn’t what I originally pictured as part of my plan for passive income, but these are my lemons and I’m making lemonade. If you’ve considered purchasing a property to turn into a rental there are a few things I’ve learned and hope to share for your consideration. The first step in this decision was to establish what others were looking for in an “ideal” rental.
My husband and I have no children, so things like proximity to good schools and extra bedrooms weren’t naturally priorities in our search for a home. However, the demographics in our desired neighborhood(s) quickly lead us to a search for three or more bedrooms despite our lack of immediate need for the extra square footage. If you plan to turn a property into a rental it’s very important you are aware of what you can buy with your budget and what others in your area are searching for, not what you want.
Once we established the “type” of property we were looking for we needed a budget. There were several ways we could have gone about establishing an ideal price point. I chose to search for rental listings in the area to see what similar homes in the neighborhood were renting for each month. Once I knew an approximate price range we could expect to bring in for rent I narrowed my search results on the app I used to search for properties. I also confirmed my expectations for rent potential with a local property manager.
Knowing what I could expect a four bedroom home to rent for each month I established a maximum mortgage payment. Normally, if you’re searching for housing I recommend your monthly payment (principal, taxes, and insurance) equal no more than 25% of your income. In this particular scenario we needed the mortgage payment to equal less than 20% of our income to ensure the profitability of the rental. Which leads me to my next point, you need to make a profit.
I know this might seem like common sense but it’s very important that this property is cash flow positive to ensure you aren’t responsible for it on top of your other obligations. We don’t intend to live off of the passive income from the property for decades so our need for a high profit margin in the short term is low. How profitable the rental should be each month is widely debated among the experts in this space and isn’t as easy to determine as you might think. At the very least the expected rent should cover the mortgage, taxes, insurance, and annual maintenance of the home.
Annual maintenance can vary widely depending on the age of the home and where it’s geographically located. Commonly, I recommend the 1% rule for maintenance which means you can expect to spend 1% of the value of the home each year on basic maintenance. Keep in mind that maintenance (especially on a rental property) can be very expensive. You might quickly exhaust the annual 1%.
Finding a property to buy which satisfied my minimum requirements, our rental budget, and profitability potential wasn’t easy. In fact, I don’t love my current home. Sure, it’s nice to have a place to call my own but this certainly isn’t my forever. In fact, I preferred it that way. I know many people who own rental properties and I’ve heard many horror stories about the wake of damages left by subpar tenants. At the end of the day this home is an investment and having an emotional attachment to an investment is not wise.
So for now, I’ll enjoy a space we can call “ours” and prepare the property for tenants in 2022.