4-27-18: Should I buy the home I rent?
Question of the week: Should I buy the home I rent?
Answer: This question has a reverse side as well, “Should I sell my rental property to the tenant?”
I have 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, 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 consideration both tenants and landlords should consider, rent control. In more and more cities throughout the state, and at the state level, the rent control movement has been gaining momentum. I will not use this space to present the case that rent control does the exact opposite of what it is intended to do, however it is something to consider if you are a tenant or landlord.
From the landlord side, if you have owned a single family home as a rental in an area that appears somewhat likely to be under rent control you will want to consider all options for the future. This includes the option of selling the property, getting out of the landlord business and paying your taxes, or selling the property and going through a 1031 Exchange to purchase a rental property in an area where there is less of a chance that rent control will be enacted. If the option that appeals to you most is selling the property, contact your tenant. If the tenant does want to, or cannot, buy the property then start the process of putting the home on the market.
From the tenant side, if rent control goes into effect your options down the road become somewhat restricted as there will likely be fewer units on the market for you to rent when the time comes and the rent you will be paying will likely be significantly higher. If you are in an area where rent control appears to be likely and you have been thinking about purchasing a home in the somewhat near future, say one to two years, then consider moving up that time frame. Call a mortgage professional (I would be an appropriate call…) to get pre-qualified and determine your purchasing power. I can also provide a ballpark price range for the home and if there is a near match and you like the home you have been renting then contact the landlord and make an offer. If the landlord does not want to sell then you know your price and we can hit the open market to see what is available.
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.
Have a question? Ask me!
Not great but very good. That was the news this morning from the Commerce Department when it released its first estimate of GDP growth for the first quarter of 2018. The estimate showed economic growth of 2.3%, below the 2.9% growth for the final three months of 2017 but higher than the 2.0% estimate many expected. Part of the slower growth was a slowdown in durable goods purchases, namely vehicles, perhaps a hangover from the huge amount sold post hurricane season in Texas and Florida. By beating expectations the news is slightly mortgage rate unfriendly.
Costs going up. The cost of employing the average worker climbed the fastest in a decade in the first quarter, increasing 0.8%. Add to this extremely low unemployment, layoffs near a five decade low and some scarcity in qualified labor and the expectation is for wage inflation to start to impact prices for consumers. This is not friendly news for mortgage rates as higher costs and inflation lead to higher interest rates.
Rates for Friday April 27, 2018: The benchmark 10-year Treasury note broke through the 3% mark for the first time since December 2013, in doing so dragged other fixed rates on bonds and mortgages up as well. With very strong employment markets and solid economic growth, what looks like peace potentially breaking out on the Korean Peninsula, there is nothing currently on the horizon to cause rates to drop. We see rates climb again this week from last Friday and it is apparent we have broken out of the prior range; now the question is when will rates level out? We could see rates increase another one-quarter of one-percent before this happens.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:
30 year conforming 4.49% Up 0.115%
30 year high-balance conforming 4.75% Up 0.125%
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.
Pretty remarkable footage of South Korean President Moon Jae-in and North Korean leader Kim Jong Un meeting at their border today and shaking hands. This is historic and appears to heading to being this generation’s version of the Berlin Wall being torn down. There is historic correlation between the Berlin Wall and the separation of Korea.
Korea had been ruled by the Japanese since the 1910’s when it invaded and occupied the county. North Korea and South Korea were created in 1945 as part of the treaties ending World War II, with the Japanese removed from the peninsula and Russia and the United States occupying the peninsula, Russia the northern part and the United States the southern part—the dividing line the infamous 38th parallel. This was the same manner in which Germany, and Berlin, were divided after the war with the exception that France and England joined in those divisions.
In 1950 the North Korean Army sent troops over the 38th parallel and the Korean War began. The armed conflict ended in 1953 when an armistice was signed by the representatives from the United Nations, North Korea and the People’s Republic of China. The armistice has been in effect these past 65 years but no peace treaty has ever been signed between the two countries, meaning they have continued to technically be at war.
The world watches and hopes that the Korean leaders are able to walk the path to peace and put an end to the tensions and potential for more armed conflict.
Have a great week,
Dennis
