Should I Rent or Should I Sell?

To paraphrase the Clash - "if you sell it may be trouble, if you rent it could be double!"

Recently a number of my clients have come to me with this question - "Shouldn't we just rent our home for a year or two, rather than try to sell it in this market?" The answer to the question, of course, depends on your specific situation, but for the vast majority of homeowners ready to move on, the answer is an overwhelming 'no'.

There are a number of considerations for determining if renting your home is your best choice, some of them financial and some of them psychological.

Playing 'Landlord' for 4 years would only result in a 4% increase in your current home value.

The most obvious reason to rent your home is to avoid "taking a loss" when selling in this market, and in the meantime collecting rent to offset the monthly mortgage payment. Some of my clients have even used the expression "we want to wait until the market returns to normal." I've got news for you, the market has returned to normal.

What isn't normal is double-digit home value appreciation year-over-year. We've faced an adjustment from over-inflated home prices, brought on my unsustainable lending practices and a desire to "make a great investment" (which has clearly back-fired).

So you need to be a landlord for 5 years?!

If you decide to rent your home for the price to come back up, you need to be prepared to be a landlord for a longer haul than you might think. You want to chase rent for a year or two and then sell for a great price improvement? It ain't happening, and yesterday's Housing Report at BusinessWeek.com agrees.

The short explanation is that home prices won't begin to climb again until 2012. Overloaded home inventories will continue to put pressure on home prices for the next 2-3 years, potentially even dragging prices down before they begin to perk up again. If unemployment continues on a poor trend, there will be more mortgage defaults, and inevitably, more foreclosures and short sales. At the same time, mortgage rates don't have much room to go down, but they've shown a willingness to trend up!

We've seen about a 10% decrease in home prices in many Chicago neighborhoods in the last 6-9 months, Business Week estimates that national prices could decrease as much as 17% in 2009. Does that mean we'll see another 7% drop in Chicago? I don't believe it does, but it isn't looking great for a bump up either.

Home values historically have climbed 4-5% a year on average. If those prices drop or stay steady until 2012, and then begin a slow climb again in 2012, aren't we looking at 104% of current prices in 2013 at best? 108%ish in 2014? Where will you be in 2014?

Your money can be put to better use. Your mind can be at ease!

Are you going to play landlord on your $300,000 home until 2014 so that you can sell it for $324,000? Couldn't you do something with that money for the next five years, maybe even something that makes better than 1.6% a year? Heck, you could put it in a renewable 24-month CD for 5 years and it'd be worth at least $335,000.

If you did sell now, and put the money somewhere better (perhaps even into your new home), here's what you'd miss:

• Finding renters for your place now.
  
• Finding renters for your place next year, and again, and again, and again...
• Paying your mortgage, monthly assessment, property taxes, and homeowners insurance in the months that you're collecting rent, and worse, when your place is vacant.
  
• Making collection phone calls for your delinquent renters.
• Answering the phone at 2 in the morning because the toilet is over-flowing, or your renters are locked out - again!
• Cleaning the toilets, re-painting the walls, and repairing broken items when your first renters move out and the next move in.
• Doing all that again when the next renters move out.
• Updating your home 5 years from now, when it is time to sell, because your granite and stainless no longer say "upgraded", but instead say "standard" or even "over the hill" and buyers expect a deal on a worn home.
  
• Making the choice of sustaining several months with no rental income when you decide it is time to sell, or worse, trying to sell a home that's full of renters who don't care to de-clutter, sanitize, and stage in anticipation of showings to prospective buyers. You didn't think they'd make it as beautiful as you do, did you?
• Get that dreaded call from the Condo Association - "we're going to levy a special assessment to repair the roof/tuck-point the building/rebuild the back stairs. You can just write us a check for $5,000".
  

You don't want to miss out on the joys of landlording, do you?

Taking my own advice.

My wife and I were faced with this same decision in the last several months, and we decided NOT to be landlords. The downside and the unquantifiable risk overwhelmed the idea of picking a stronger market in which to sell. What's more, we performed this same analysis and discovered that although we might even be cashflow positive with prevailing rental rates, the correct financial decision was to remove the condominium from "our books" and put that money to greater use.

In the end, we actually sold our home for a little more than we paid 4 1/2 years ago, we eliminated the stress, and we recaptured our equity to put in a more favorable investment. Even if we had "lost money" on our sale (quotes intended!), it still would have been a overwhelming net positive decision.

What's Going On In Our Real Estate Market

First of all, let's talk rates. Here's a graph of the National Average Contract Mortgage Rates for the last 45 years.

Copyright © 2008 Mortgage-X.com
Source: www.mortgage-x.com
Reprinted with permission

If someone tells you that "rates are kinda high these days", just grin and nod. Many of my friends , family members, and clients have purchased and financed their homes in the last 3-5 years. That's great for them, you can see that rates were at an all-time low during that window. It's no coincidence that they bought and re-financed then, is it?!

Before 2003, when were rates lower than they are today? Scanning our graph, we see that the answer to that question is sometime around 1966. Remember how great we thought rates were then!? Yeah, me neither....

There's all sorts of talk about "stagflation", that's when economic growth is close to zero, or negative, and yet we have inflation. A Reuter's article yesterday sited domestic manufacturing and U.S. construction data adding "to concerns the United States is in a period of weak growth accompanied by high inflation."

All of this is pointing to this month and this season and this year being strong opportunities to getting your dollar to stretch farther than it has historically, and farther than it may be able to in years to come. Unless the U.S. and Global economies can find an opportunity to resurrect steady growth, or the Fed can find a way to slow inflation, we should expect to see interest rates continue their ascent.

July and August are traditionally slow for the Chicago market, and this year is not an exception. That said, you can see from the statistics in the right margin (provided by chicagocondosonline.com) that the median condo price in Chicago is $320,000, up 10% from the beginning of the year. On the other hand, new listings and closed listings are down notably, and average market time has increased by 4%.

There continue to be people that need to move or that are simply ready to move. For those homeowners looking to upgrade, or for first-time homebuyers, there are some real opportunities on the market. Taking advantage of deeper inventory, and acting while interest rates are still low will be in your best interest.

On the other hand, there are homeowners who are looking to move into a smaller home who will find this a challenging time. Selling a bigger home and buying a smaller one at a time when home values have not seen appreciation will limit the investment upside of your transactions. That said, if it's time to move, your best bet is finding a skilled and experienced agent to help you navigate this tricky market.

Remodeling - Cost and Value

Lately many of my clients have been thinking about taking on small home projects, updates, and general remodeling. Most of them ask me if the project will increase the value of their home - whether they be homeowners considering marketing their home for sale, or be they home shoppers wondering if they should purchase and improve.

The answer - yes, home improvement will increase the value of your home. But the real question is, by how much?

Home improvement projects generally will not return the full amount of your investment, but will improve the marketability of your home. If you spend $20,000 on your bathroom, for example, you may only increase the value of your home by $12,000 - $15,000, depending on the project. If the project addresses real concerns - aesthetic or functional - that investment may garner a $12,000 return, but may also sell your home two months earlier, saving you a couple mortgage payments and the stress that comes with having your home on display seven days a week for months at a time.

To determine what a project will return requires a bit of artful estimation and a little science in the form of general statistics. Every year Remodeling Magazine releases their Cost vs Value Report. This is a must read if you're contemplating improving your home. The basic data can be downloaded for a region or major city by completing their form here.

You should consider a home project - remodel or addition - under the following circumstances:

1. You are looking to market your home now or in the near future and a particular room's limitations or condition will turn off prospective buyers, making it difficult to sell your home. This is especially true if you are in a hurry to sell.
   
   
2. The improvement is required to sell your home. In some cases, building code requires that something be improved in order to simply meet the local code. Some localities in Chicago's western suburbs, for example, require a city or village inspection before a home can be conveyed. In these instances, it may be required that you improve a home system (like a furnace or garbage disposal) in order for the transaction to take place. Another example would be the improvement of a deck or porch to meet city code. Chicago substantially upped the requirements for attached decks in 2004. If your deck isn't up to code, many inspectors will point this out to home buyers. If the city makes the discovery, they will condemn the porch immediately, requiring the homeowner or condo association to take (expensive) action.
   
   
3. You will get enjoyment out of the home improvement, and aren't necessarily looking to recoup the full investment. That is to say, if you are moving into a new home, or you are not planning to sell your home in the immediate future, and the improvement is something you can enjoy for some time before moving again.

The projects with the greatest return on investment are exterior ones, like replacing siding or adding a deck. If you are a single-family homeowner, these may be worth improving. On average, the full cost of siding replacement is recouped in the home sale. If you're a condo owner, I don't recommend improving the exterior of the building out of your own pocket! However, the Association may want to consider these improvements.

Interior to your home, the kitchen and bath have the greatest potential of increased value, while the home office has the least. According to the report, a major kitchen remodel can recoup approximately 80-90% of your investment. Interestingly, a mid-range kitchen remodel recoups more of its cost than a high-end remodel. This certainly has to do with material costs.

Keep in mind, however, that if your market competition has high-end kitchen finishes, you may not want to do a mid-range improvement. You may expect a higher rate of return, but your neighbors with gorgeous kitchens will increase expectations for your prospective buyers, and they will count your new kitchen as a negative, not a positive.

Home office remodels should be done only if the homeowner needs it for his/her own function, or if it is an obvious and significant detriment to selling the home. These projects tend to return less than 60% of the money invested.



Cost versus Value citation: “© 2007 Hanley Wood, LLC. Reproduced by permission. Complete city data from the Remodeling 2007 Cost vs. Value Report can be downloaded for free at www.costvsvalue.com.”