When I’m on a listing appointment where the seller owes more than the property is worth, and they lacks the hardship required for a short sale, the conversation usually ends up with the seller asking, “Tim, what are my options?” My response usually begins the same, “Well, I’d like to see you avoid foreclosure.” And assuming the seller wants to or needs to avoid foreclosure, (do to security requirements for their job for example), then there are really only two options: sell it and contribute whatever cash is necessary to close, or rent it. Thus the “Accidental Landlord” syndrome is born.
Most would-be sellers and especially those who’ve been relocated to another area due to a job change or corporate relocation really don’t want to be a landlord. They recognize that due to their high mortgage, there will be a shortage every month that they’ll have to make up (the difference between the rent collected and the mortgage, insurance and tax payment); that the tenant could be hard on the home or worse be a nightmare and stop paying leaving them to pay both mortgages until they evict the tenant, fix the property and re-rent it. Even if the worst case scenario doesn’t play out, there are bound to be repairs and vacancy between tenants. They also have a new job, a family in the resettling process and since they live far away, how can they check on their property? On the other hand, the thought of putting in tens of thousands of dollars to sell and close wasn’t exactly in the budget either – assuming they’ve the ability to do so. Should I stay or should I go…?
So what happens to a seller like this? In my listing appointment last week, I advised the seller that if he had the money to cover the costs to sell, he should sell. Sure, if he kept the property long enough the tenant could pay off the mortgage for him and he’d be building long term security by holding on to his home as a part of a diversified portfolio. But there are many factors to consider. Currently his gain is tax free; (yes even though he now owes more than the home is worth, he still has a big profit from what he paid for the property). Once converted to an income property, this benefit goes away and the profit is treated as income and taxed as long term capital gain.
He also has to consider his long term strategy. If his goal is to sell as soon as he can do so without contributing money, he’s just holding on in the hopes of appreciation, right? There’s really no other scenario in which he can benefit. If prices stay flat or worse decline, he’s in even worse shape. So how much does his home have to go up before he recoups the cost of selling today plus carrying costs? First is the “under water” money he has today, plus the selling costs and commissions. Then there’s the lost money of running a negative every month. In other words, if he has to contribute $500 every month to the payment after rent, he incurs a $6000 annual loss. How many years then, will it take for the property to appreciate enough to cover the shortage today and an annual loss of $6,000? Using pretend numbers let’s say he needs to recoup 10% to come out clean, pay off the debt and cover selling costs, but he’s also adding 1% annually to that number because of the monthly negative. You can see that in 5 years the property has to appreciate 15%. If it takes 10 years that number jumps to 20% just to break even with where he is today, and then there’s the taxes owed on the gains.
Professional real estate investors never buy property based on a hope for appreciation, they buy for cash flow. If a home doesn’t cover costs and expenses, they simply won’t buy it. This is why I counsel the seller to sell if he can. If however, he does not have the money to “buy himself out”, then he has no real option but to become an “Accidental Landlord” and carry the home. Should I stay or should I go? Sometimes, you’ve just got to stay.
I just happened to cross by your website and find it very interesting. I own a townhouse in Thousand Oaks and the value now is at a point (according to zillow) to go “under water”. I currently have it rented to a friend, but am pouring a lot of money into it every month. I would like to discuss the property with you. Please email me.