Do I Sell My Starter Home Or Rent It Out?

Conventional “wisdom” has always said that young adults should buy a starter home as soon as they graduate college and get a job, and then move to a larger one as their careers advance. That way, they avoid “throwing away money” on rent. To explain the fallacy of this belief will take another blog post in itself, but today we’ll stick with a question many people ask when they’re transitioning to a larger home:

Do I sell my starter home or rent it out?

Obviously, there are times when a person’s circumstances allow for only one option. For instance, if your only way of getting a down payment for your upgrade house is to sell your starter house, then you will sell. On the other hand, if you have negative equity in your home, you will either have to rent it out or stay in it.

This happened to my wife and me. Before we married, I encouraged her to buy a townhome to live in while I finished school. I figured we would sell it when we got married, but the market dropped, and when we were ready to sell, the value had decreased to the point where it was worth less than the amount she owed on the mortgage. So now that I’m a landlord, I can attest to both the pros and the cons.

Here are five things to consider when you’re thinking about renting out your starter house:

1. If you can refinance at a better rate, do it before it gets reclassified as a rental property. Mortgage rates on rental properties are 1% - 1.5% higher than on primary residences.

2. Using a management company is more expensive than most people anticipate. I’m not saying you shouldn’t use one; I’m just saying you should know what the costs are before you get ready to sign an agreement. The typical arrangement calls for the management company to pocket the entire first month’s rent, plus 10% every month as their management fee. That means you will be assessed 110% on the first month, and 10% every month after that.

3. Be careful in determining how much rent to charge. Don’t think you can arrive at an appropriate rental amount by adding $20 to your total expenses; you will wind up in the hole. Most people forget that they have a homestead that will go away and dramatically increase their property taxes. Also, realize that your tenant isn’t just paying you for a place to live, he is paying you for your sweat equity in maintaining the property, whether you’ve hired an agency or not. Also, remember that when your tenant moves out, not only will you have to pay to have the interior cleaned and painted, but you will lose money any month the property is not inhabited.

4. If you are not using a management agency, you may get lower quality renters. People who can’t qualify to rent through an agency seek out inexperienced landlords who get themselves into trouble by renting to tenants who don’t pay the rent, cause damage to the property, disturb the neighbors, and create any number of other problems. Get references from your tenant and check them.

5. Repair expenses could be more if you use an agency. If your tenants have a problem, they will call the management company, who will then call in a repairman to fix it on your dime. This can be just the kind of convenience you want, but if the problem isn’t really an actual problem, this could be expensive.

For example, I once got a call from an irate tenant who had just moved in and was furious with me for renting her a house with a broken oven. I drove across town to find that her daughter had leaned against the oven, it made a loud beep, and then the door wouldn’t open. She had accidentally activated the childproof lock, which I deactivated by pressing and holding a button. Because I manage the property myself, all this incident cost me was my time and gas, but if a management company had a repairman come out, it would have cost me at least $100 for a service call.

Whether using an agency is right for you depends on how much time, money, and patience you have. You may want to manage the property yourself if you are fairly handy at fixing things and you have the time to take care of any problems that arise. If you are busy and managing the property yourself is too much of an inconvenience, a management company can be well worth the extra cost.