Finding a Tenant To Help With Your Mortgage
Live in the house of your dreams while a renter foots the bills
Last spring, Matthew and Jennifer Rumain set out in search of a three-bedroom house in the trendy University City section of West Philadelphia. Parents of a
4-year-old son, they were attracted by the neighborhood's good schools, young families, and turn-of-the-century architecture. But they soon discovered that all the suitable properties were out of their range. "We were being shut out of the housing market," says Matthew, a 28-year-old advertising manager. That is, until they found a 100-year-old, three-family brick Romanesque Revival for $270,000 — two-thirds the cost of similar single-family houses nearby.
A couple of years ago, the Rumains would have considered becoming landlords a crazy idea, but the economics of a hot real estate market changed their minds. Buying a multifamily house not only got them into a neighborhood they otherwise couldn't afford, it also provided them with enough rental income to cover most of the monthly mortgage payments.
The same scenario is playing out in Boston, Washington, D.C., Chicago, San Francisco, New York, and other big cities, where prices of single-family homes are going through the roof, spurred by urban revitalization and historically low interest rates. For homebuyers willing to take on the added responsibility, a multifamily can be the most economical path to the house of their dreams. In Manhattan, for example, the average 2003 sale price of a duplex was 31 percent below the cost of a single-family home (42 percent for three- to five-unit houses), according to Miller Samuel, a local real estate appraisal firm.
That's because most people don't want the headache of managing tenants, and many multiunit houses are more rundown than single-family homes, says Miller Samuel president Jonathan Miller. But if you go into it with your eyes open — and especially if you can do some of the repair work yourself — the rewards can far outweigh the challenges.
"From a financial perspective, there is little downside to owning a multifamily home," says Bradford Hall, managing director at Southern California-based accounting and consulting firm Hall & Company. In many cases, rents cover two-thirds and sometimes all of the monthly loan payments. And even before you buy, rentals pay off because banks usually consider a portion of expected rent payments as additional income. That means buyers of multifamilies are typically eligible for larger loans, making it possible to purchase a more expensive property.
There are tax advantages, too. For IRS purposes, the house is divided into the amount of space that the homeowner lives in and the space the renters occupy. For instance, if you own a 3,000-square-foot two-family and a tenant occupies 1,000 square feet, one-third of all expenses — mortgage interest, property taxes, utilities, landscaping, external improvements, and the like — are allocated to the rental unit and subtracted from rental income. Also deductible is depreciation on the unit (essentially an allowance for wear and tear), plus 100 percent of ongoing repair, maintenance, and replacement costs specifically earmarked for the rental, such as a new water heater, carpet cleaning, or fresh coat of paint.
With such an array of costs, many homeowners show a loss from their rental properties, which they can usually write off on their tax bill. "With a multiunit home, an individual can enjoy real income that pays their household expenses and a hefty tax deduction generated by that income," says Norm Bour, a mortgage broker who hosts The Real Estate and Finance Hour, a nationally syndicated radio show based in Southern California.
From MultiFamily to a Home of One's Own
While managing two rental apartments takes up a considerable amount of the Rumains' time, they don't mind so much because they view it as only temporary. In a few years, as their family grows, they plan to take over one of the rental units for themselves. And down the line, they may decide to convert the entire house into a single-family, in which case they'll be eligible for yet another tax perk: When it comes time to sell, the Rumains will get the full capital-gains tax exemption on profits of up to $500,000 ($250,000 for single filers), as long as they use the entire house as their primary residence for at least two of the five years preceding the sale.
Another long-term approach is to convert the rental apartments into condominiums, a move allowed in most neighborhoods zoned for multifamily houses, and sell off the individual units. That's the strategy Kevin and Jennifer Deblear are considering. The couple recently purchased a two-family 1905 Queen Anne for just over $300,000 in Boston's Dorchester neighborhood, where an average single-family home costs more than $400,000. "If we condoed and sold one apartment, it would likely pay back our whole mortgage," Jennifer says. "If we sold both apartments, we might be able to buy a single-family house in the neighborhood that was out of our reach when we purchased the house we're in now."
As property values continue to rise in urban areas once deemed "transitional," multiunit houses will increasingly look like can't-miss bargains. "We feel fortunate," says Matthew Rumain. "The job market stinks, and you never know what will happen in life. But we now have the security of knowing that we can pay our mortgage, raise and educate our child well, and live in the kind of home we can be proud of."
Landlord Reality Check
Becoming a landlord isn't for everyone. "It's a full-time job," says Vito Simone, a broker at Simone Real Estate in Baltimore, Maryland. "You have to be prepared to deal with regular maintenance, emergency repairs, calls from tenants at all hours, and sometimes you'll have to give up your days off to work on the house." But the ultimate challenge for any landlord is finding agreeable tenants who will pay the rent on time. Your chances improve if you follow these guidelines.
Conduct a thorough background check on prospective tenants. Examine their credit; talk to former landlords and current employers, and, if possible, visit them in their homes. Order credit reports from one of the three major credit-reporting agencies: Equifax, 800-685-1111; Experian, 888-397-3742; and Trans Union, 800-916-8800.
Trust your gut. Someone may look great on paper, but if your personalities clash, you're asking for a world of hurt. Remember, you'll be sharing your home with this person.
Put it in writing. A signed lease protects both landlord and tenant if problems arise. The document should outline the term of the rental, the monthly fee, occupancy limitations, whether pets or smoking are allowed, deposit requirements, and who is responsible for general maintenance and utility payments.
Avoid the headache of screening prospective tenants, collecting rent, and fielding complaints by hiring a reputable management company. Most firms charge 7 to 10 percent of the monthly rent.
Don't be a do-it-yourselfer unless you're certain you can handle the job. Hiring a professional plumber or electrician should ensure the job gets done right the first time, keeping tenants happy and saving you the hassle of repeat repair visits.
Cover yourself. Purchase a comprehensive homeowner's policy covering losses caused by fire, weather, burglary, vandalism, and personal-injury claims. Also buy extended service warranties for appliances installed in rental units.
Anticipate the unexpected. Tuck 10 percent of each month's rent into a separate bank account to cover repairs related to the rental.