Transcript
What am I going to do with my current home when I’m moving to a new one? Should I sell it or potentially rent it out?
We’re going to look at renting and take into account some rental considerations, and we’re even going to analyze some numbers. I’m going to pull up and show you a pro forma how you could do one of those for yourself to get a good idea: is this home could it be a decent rental or not?
First, you should ask yourself: is this home meant to be a rental? That is a critical question to ask yourself. We deal with a lot of clients who are making that move out of state to a new place or even across town like, “Evan, I really want to be a landlord.” Absolutely wonderful. My wife and I, we own a lot of rentals ourselves, absolutely enjoy it. It can be very rewarding, but it’s not always meant for everyone necessarily.
And then, if you’ve decided you want to commit to it, not every home is meant to be a rental, so you really gotta ask yourself, “Is this home meant to be a rental?” Just because we happened to buy it three, four years ago when our family moved to that new location and we loved the home, doesn’t mean it’s just meant to be a rental. We don’t want to become landlords more by convenience than by choice, so we’ve gotta analyze it. And that’s really where I want you to think when you’re analyzing a home as a rental: you want to think objectively, not subjectively.
Three major things that you kind of want to think about with being objective:
1.) You want to gather comparable rental data. That can be online; there’s plenty of sources for it. You can just say “homes for rent near me,” bunch of different sources that you can pull to start getting an idea of what comparable rentals go for. You want to make sure those homes are comparable. If you own a three-bed, two-bath house, you want those rentals to be similar. If you own a single-family home versus a condo, you don’t want to necessarily be comparing too much against condo rentals versus single-family homes. So, you want to get some comparable rental data.
2.) Then you want to create a realistic pro forma, which we’re going to hit on here on the next slide. This is where you run the rough numbers yourself to see, “Hey, could this rental really be worthwhile?” Sometimes folks tell me, “Evan, man, I can rent my home out for $2,000 a month.” I’m like, “Awesome!” And they think, “I’m making two grand a month.” Well, we start deducting out things. What are those things? We’ve got to deduct out. We’ll talk on. But once you deduct it all out, they find out that they’re actually negative, or it might only be a hundred or two hundred bucks. Is that worth the risk? We’ve got to run those numbers to see if it’s worthwhile or not.
3.) Lastly, you always, especially when you’re moving from your home that you’ve been living in, you have to compare your home against an actual rental investment for the same area or anywhere else that you could go invest that money.
When you know how to do this rough pro forma that we’re going to talk on here and you take that and apply it to some other rentals, that really helps you make the decision.
As I always say, a very common scenario that we work with with a lot of military families that are PCSing and making that move around the country, they might have bought a home that was really fit for their family. Let’s say they had four or five kids, they bought a six-bedroom house or something like that, really nice, top granite countertops. And then we really dig into it and notice, hey, that’s not necessarily meant to be a real rental for that area.
That’s not a common house that rents out very well, so it might not be the right property. But they still really want to be a landlord, so we figure out how to transition that to another investment property in the area or somewhere else, maybe where they’re moving to next so it can be close to them, but making that analysis.
But sometimes folks actually buy a nice home, let’s say it’s a three-bed, two-bath, that’s the most common built home out there, and in the area you’re in, that is a pretty good rental. Great! Once you do this analysis, you’ll be really comfortable knowing, “Alright, I want to be a landlord, this is the house that I want to have as a rental, and it makes sense, and we already own it, we don’t have to worry about anything.” Wonderful, that’s the whole goal of this analysis.
So, think objectively, not subjectively, especially when you’re taking into account rental considerations.
Now, running those numbers for the rental, here’s the main deal. You can take a photo of the chart we have for you here, but this is a rough pro forma that you’ve got to create for the home that you’re thinking you might want to rent out.
Going down the line here, first you want to make sure that you take into account the estimated income for the home.
Now, you can do this on an annual or monthly basis. I typically recommend, hey, you want to do it on a monthly basis and then convert it to annual so you see both, or do it as an annual basis and then convert it back to monthly so you get a good feel for what that looks like in both cases.
Once you’ve looked at some comparable rentals in your area or talked with a real estate agent or property management company and you’re like, “Okay, hey, this home could rent for about $2,000,” wonderful. You know $2,000. Some folks assume that’s it. Well, now we’ve got to start knocking off deductions.
The first thing, right in that income category, is you’ve got to account for potential vacancies.
Even if it’s a single-family home and it’s 100% rented or 0% rented, you’ve got to take into account some potential vacancies in the long run.
If you rent that home out to a family and they’re there for 2 years but then they leave and you take 2 months to get it ready again, right there you’ve got one out of 12 months that are technically vacant, so you’d have around 8% vacancy rate.
So you want to account for that, that’s typically going to be 5 to 12%, depending on what you’re trying to rent out. Now, that’s going to equal, for you, your total potential income.
Now, we want to start deducting out the expenses. Right out the gate, property management.
If you’re going to rent your home out, even if you’re going to manage the rental, we always recommend you still account for property management, either you actually pay for a property manager to help take care of the property or you make sure that you account for paying yourself.
How many times do I know folks have decided, “Hey, I want to be a landlord,” and they’re renting it out and they tell me, “Evan, I’m making so much, here’s my return,” and they don’t account for property management because they’re like, “Oh, I’m doing it myself, it’s easy, it’s only maybe a call every couple months.”
I get that, but what happens if something happens to you or you just decide you don’t want to be a landlord and you decide you have to start hiring a property manager?
You want to account for that from the start. Typically, that’s going to be anywhere from 8 to 12%, and there can be some other costs in there, but we usually say, “Hey, 8 to 12% range that you want to account for on property management.”
Account for it, no matter what, if you’re doing it yourself, treat that as you’re essentially paying yourself, in a sense.
Next, property taxes and property insurance.
Now, these things could be bundled into your mortgage, which we’re going to talk on here a little bit when we say, “Hey, you’ve got to deduct out your total financing cost.” For a lot of folks, if they have a mortgage that’s escrow that’s put in their monthly payments.
But if you really want to break it out to a perfect pro forma, look at your statements or look up online for your taxes and insurance and take into account those two costs on their own line item within the expense category for your pro forma.
Next, HOAs and association dues.
You’ve got to take those into account because typically, you’re not going to push that off and have a tenant pay for those. These are costs you’re going to have; you want to add those in.
Utilities.
If there are any utilities that you as the owner are responsible for, you want to account for them here. If you have a single-family home that you’re renting out, most likely you can get all those utilities pushed to the seller and the seller will take care of them if they’re putting them in their name.
But we’ve seen instances where it’s like the owner’s still paying for the trash, maybe the water, especially if you happen to buy a duplex, triplex, quad, sometimes there’s a common area electricity deal that you’re still going to have to take and pay for, so you’re like, “Oh man, Evan, I’m making $2,000 a month, but there’s that $50 light bill a month that I know is common and the tenant’s not going to pay for, you’ve got to account for that, it makes pretty big deduction, $600 a year makes a difference, so you want to account for those utilities that you as the owner are potentially responsible for.
Next, repairs and maintenance.
Now, this varies a lot based on condition, age of home, and different factors, so we usually say 5 to 15% of the income that you’re getting from the rental property you want to account for that for repairs and maintenance, and those are big costs, right?
So, if you have something that goes out, this is like, okay, my furnace goes out, we’ve got to fix it, there’s a leak in the roof, we’ve got to fix that. However, what it doesn’t account for are capital expenditures that we’re going to talk on here.
So, if you do a true pro forma, maintenance and repairs are not replacing a roof or replacing an HVAC, it’s fixing them. And generally, we see that 5 to 15% pretty reasonable, if it’s a new home, newer fixtures in the house and stuff, then usually it’s on that lower end, if it’s an older place, you might need to be ready for that 15% mark.
Other potential expenses that can vary across the board depending on your situation, we put the little hyphen on there, which really is like, could be accounting lawn maintenance, that kind of stuff, if you’re going to take care of it, you need to just make sure you add those expenses in.
Now, when you add all those expenses up, you take to make sure you can find out your total income pre-financing.
You say your total potential income that we got from the top after we accounted for some vacancies and deduct those total estimated expenses that you have, that’s going to give you your income pre-financing, right?
Especially if you have a mortgage on this home, this is going to tell you, hey, here’s roughly how much income it is, let’s say it was $2,000 you think the rent’s going to be after vacancies and stuff and all those expenses we just talked about total up to 800 bucks, then cool, my estimated pre-financing income is going to be $1,200.
Well now I got to account for that principal and interest payment that comes next, which is why we have it on here but we also have one more expense right before that that we want to account for, that’s capital expenditures.
If you look at a typical pro-forma, they’re not going to account for capital expenditures typically in the proforma. That’s usually an off pro-forma sheet that some will tell you so you got to be really careful you got to make sure if you’re evaluating a property some people leave out the capital expenditures – that’s replacing in the roof, replacing siding, windows, HVAC, that kind of stuff. Stuff that’s real that can knock you out. But in the pro-forma when you valued property, people usually kind of conveniently leave those off.
For you evaluating it as an investment deal, you want to account for that. So that’s where, for example, that capital expenditures we add up the total value of some of those major expenses let’s say the roof’s $10,000, the HVAC is $10,000, let’s say there’s $30,000 in capital expenditures that we might have over the next 30 years.
Let’s say then we break that down to where we know “hey we got to account for about a 1,000 bucks a year for capital expenditures over the long haul.”
That’s a very simplified way of looking at it, but if some of your stuff might be replaced sooner than later. You might want to up that number, so you want to account for it to make sure that you know you’re ready for them when that time comes.
That’s probably the biggest silent killer I see folks get hit by when they’re investing in real estate.
Then we want to deduct out our financing cost – does this rental make sense – so you deduct that principal and interest payment, or if you didn’t put taxes and insurance up higher and you have those lumped into your mortgage and you want to deduct them now, it’s perfectly fine.
But the whole point is we want to get down at potential net income being a true representation of how much cash that you think you’re going to have from this property if you rent it out, because the cash is the main thing that matters.
Even if you’re paying down, remember with that mortgage you’re ideally paying down some of the principal, so you’re building equity – which is technically a return, but it’s not actual cash that you’re getting right away.
So this pro-forma gives you a good idea of what your true cash is on that rental that you want to take into account.
Then, you can add back in that principal reduction if you want to see “hey I’m making a little better return.”
But for most folks, you want to know “hey if I rent this out am I going to have to be putting money in each month or do I potentially get some money out?”.
This is the basic analysis that’ll get you there. If you want some more advanced stuff, please reach out to me. More than happy to go over scenarios where you can get this as detailed as you like, but this is a good basic – especially if you’re looking at your single-family home or duplex, triplex, quad – deciding to try to rent it moving to your next location.
My name is Evan Kaufman, your VA loan originator, helping military families move all across the country. Thank you very much for your time. Take care.
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