Homeowners Turning Into Reluctant Landlords

Many homeowners, stuck with an underwater property that they can only sell for a loss are renting the property instead, hoping the price will rebound in a few years. Is this a good move? Probably not.

The WSJ did a nice article on this. According to the Journal:

"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."

So why isn't this a good idea for most people? There are several reasons:

First, many homeowners are renting out their homes in the expectation that real estate prices will bounce back sometime in the next three years. That's wishful thinking for much of the country. In the last real estate recession that started in 1998, it took almost ten years for housing prices to rebound to their 1987 levels in hard-hit places like Boston. And the current real estate downturn is significantly deeper than that one. It may take 10-20-30 years for some housing prices to rebound. Don't believe that? Remember, the Nasdaq is still 50% below it's closing high in 2001. Large bubbles often take decades to recover.

Second, because homeprices have dropped so much, so have rents. So homeowners are stuck with high mortgage payments that can only be partially subsidized via rents. It's doubtful most rents will generate enough income to even pay the mortgage. If you can't sell your property for what you bought it for, don't expect to be cash flow positive if you rent.

Third, a property has many more costs than just the mortgage - insurance, repairs, utilities, etc. These will put you deeper in the hole.

Fourth, renting a property is often a nerve-wracking and time-consuming endeavor. A property owner must list the property, screen the applicants, collect the rent, evict tenants that don't pay rent, fix damaged property, etc. Bad tenants can be a nightmare and are not just confined to low-income properties. I know a couple in a luxury condo that rented their unit to a couple they thought were nice, clean, etc. The couple completely trashed the condo. I have another friend who rented her place and it flooded with the tenants there. The repairs, including mold removal will cost over $100,000 and the insurance company is claiming the tenants should have been aware of the flooding and is refusing to pay for the bulk of the repairs.

You could hire a property management company but that will increase the expense and will make you more cash-flow negative.

The best advice, get rid of the property via a short-sale. Take the loss upfront and move on. This is especially true if you are in a different city or far away from the property. Managing a property long-distance is a recipe for disaster.