Should we buy the home we rent?
Question of the week: Should we buy the home we rent?
Answer: With the scarcity of homes on the market, many want-to-be homeowners who are renting my find their new home in their current home.
A follow up to this question is from the landlord’s side, “should I sell my rental property to my tenant?” With the changing landscape for investment property owners in California, political pressure for rent controls, erosion of landlord/property rights as seen during and post-pandemic, combined with many older landlords seeing that their children likely do not want to inherit investment properties, selling rental homes and realizing the cash from the sale makes more sense than exchanging the property for another rental. (In 2021 WR&MU asked and answered “Should we exchange our investment property or sell it and pay the taxes?”)
Another factor that comes into play are landlords who are currently renting their former primary residence and may be able to take advantage of the primary residence capital gains tax and avoid the long term investment capital gains tax.
A few years ago, I had a client who contacted me the other day about wanting to sell a home she rents out because the tenant has given notice. She is nearing the end of the time frame of living in a home two out of prior five years to avoid capital gains and the time is perfect. I asked if she contacted the tenant about purchasing the home, however the tenant is giving notice because they had already entered a contract—otherwise did not think of asking to buy the home or they would have.
This was a missed opportunity for both parties. When they decided they wanted to own their own home the tenant should have informed the landlord, who gladly would have worked with them to see if the right price and terms could be found, saving each party a lot of time and expenses.
What are the opportunities for the landlord and tenant in having the tenant purchase their rental home from their landlord?
From the landlord side, there are several advantages to selling to your tenant.
For most landlords selling their rental property the status of the tenant is a primary factor in how the process will proceed. If it is a single-family residence then the buyer will almost always be looking to owner occupy the property, so the property needs to be vacant.
Typically, the dwelling should be vacant during the marketing period to maximize the ability to show the property to the most buyers and encourage offers. If you have a long-term lease with the tenant you will need to wait until the lease is nearing termination and provide notice that the lease will not be renewed and the tenant must vacate. If the lease is month-to-month you will need to give the tenant a 30 day notice to vacate. Depending on your tenant at this point it can get sticky if your tenant decides to not vacate on time. In California, the tenant has significant rights to delay vacating the property and can prolong any eviction process for a very long time. Several times over the years I have witnessed landlords paying tenants to vacate properties to get the process over and property vacant for sale or closing.
If you tenant is cooperative and does vacate the property you will continue to have costs, mortgage, taxes, insurance, maintenance, until you close escrow with a buyer, without receiving any rent. Depending on many factors you could have a vacant, non-revenue producing property for two, three, four or more months.
Speaking of maintenance, when selling to the tenant there may be some repair work requested by the tenant-buyer following a home inspection, however there will not be the costs of preparing the home for showing. No landscaping for curb appeal, refreshing flooring, painting, or other touch-ups most sellers go through before marketing their home to try to maximize value.
When selling to your tenant you have a bit more control of the escrow period, which can be especially important if your intention is to purchase a new rental property, rolling over your proceeds in what is known as a 1031 Exchange to postpone capital gains taxes. When participating in a 1031 Exchange there are time frames to identify your “up-leg” and close on that transaction, if you miss them then your gains from the sale of the property are subject to capital gains. If your sale is an open market sale with two or three other transactions that you have little to no control over it is more difficult to extend the closing date of the sale of your rental property if you need more time to find and close on your up-leg.
Your costs of sale can be significantly lower selling to your tenant than going on the open market. You can have more control over timing of the transaction. If you are considering selling your rental property it is advisable you contact the tenant to see if they are willing and able to purchase the home.
From the tenant’s perspective purchasing the home you have been renting also has several advantages to going to the open market.
One big plus is you do not have to pack, move and unpack. You will not have the added expenses that occur when you move, new shower curtains, dustbins, pieces of furniture, lamps, fixtures, etc. Of course, now that the home is yours you may want to make some changes, however we have found most tenants who purchase their rental home make fewer changes and spend less than those who move into a new home.
Familiarity is another major benefit. If you like your neighbors and neighborhood, you become a homeowner and still go to the same store for groceries, walk to your local coffee shop to meet friends, go to the same schools for your kids and the same dog park with Phideau.
Utilities, seemingly a small thing, but no getting set up with gas, electrical, cable. Dealing with timing to meet vendors or pay deposits.
Not every home is perfect, even if you purchase a newly constructed home there can be, and usually are, some issues. Purchasing the home you have lived in for a while you already know the quirks and issues, some of which your landlord may be willing to fix as part of the transaction.
A major plus, it does not always happens but usually does, is the tenant-discount. Because the landlord does not have to have the property vacant, require your cooperation to show the property if on the market while you are still living there, nor spend the funds to get it “market-ready,” we typically see some discount to market for the tenant-buyer. Some landlords have refused to offer any discount and see their tenants leave the property instead of purchasing the home and the landlord later regrets trying to maximize price instead of maximizing combination of total costs and efficiency of the sale.
One more bonus of buying the home you rent…you don’t have to move! No packing and unpacking everything you own!
If you are in a residential rental relationship, as landlord or tenant, and are considering severing that relationship by selling or buying please contact me and I can assist you with options and other professionals who can assist you.
To schedule an initial meeting by phone or Zoom, click here for my calendar, please feel free to forward to a friend or family member!
Have a question? Ask me!
Rates for Friday May 10, 2024: A nice, perfectly boring week in the markets with no major news, or comments, resulting in significant buying or selling. As a result rates are flat from last Friday,
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:
30-year conforming 6.625% Flat
30-year high-balance conforming 7.125% Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.
Happy Mother’s Day to the moms! My life has been blessed with two incredible mothers, my mom who passed away when I was in high school, and my wife Leslie who forged a wonderful bond with each of out daughters very early in their lives. Now adults, they are very close and communicate frequently about everything. Our daughters are very different personalities and women, and in each can be seen wonderful traits the inherited, or learned, from their mom.
I hope you are honored, spoiled, and pampered on your special day!
Have a great week,
Dennis
Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog
