When you first purchase a home, you’re probably not thinking about the possibility of turning it into an investment property. However, soon into the tenure of your new abode, you may come to the realization that you hope to be in it only for a few years. Life can also bring about sudden changes that will require you to find another home sooner than expected.
Conversely, if you are considering purchasing real estate during less certain market conditions, a starter home that can be later turned into a rental property can provide you with financial protection and flexibility.
During dynamic and uncertain periods, having the option to rent your home can be an invaluable safety net, so there’s no time like the present to learn how.
Continue reading for expert tips on how you can best determine if this strategy is right for you and what’s involved. We’ll review how to turn your starter home into an investment property, even if you don’t have any experience with real estate investing.
Table of Contents
- Reasons to Turn Your Starter Home into a Rental Property
- Key Topics to Understand
- What to Consider When Purchasing a Starter Home
- Becoming a Landlord
- Investing in a Larger Home
- Balancing Time as a Landlord and Homeowner
- Closing Thoughts
Reasons to Turn Your Starter Home into a Rental Property
The biggest benefit of turning your home into a rental property, especially for “accidental homeowner landlords”, is preventing a large loss when faced with the following scenario:
- Your home was recently purchased at an all-time high market price
- Comparable sales prices have since significantly dropped
- You need to sell your home sooner than expected (e.g. due to a relocation)
- You will likely take a loss if you attempt to sell your home in a short timeframe (i.e. your mortgage is “under water”, meaning it is currently valued at a lower price than what you owe)
- You will not qualify for tax incentives as a result of the short ownership period
Another common scenario is that you need to move elsewhere temporarily but want to hold on to your home to resume your permanent residence in a few years (e.g. overseas employment tours; visiting academic appointments; educational pursuits; sabbaticals; out-of-market entrepreneurial ventures; temporary downsizing; living near an infirmed family member; etc.).
Of course, renting one’s home can be especially lucrative for those fortunate mortgage-less homeowners, who have highly sought-after properties in great condition, in highly competitive rental markets.
The ability to rent your home during similar circumstances provides the following benefits:
- Prevents the homeowner from selling at a sizeable loss
- Grants property owners time for the market to rebound before selling
- Provides passive income from an appreciating asset
Trends Favoring Turning Primary Homes into Rental Properties
- Demand for single-family rental properties have continued to rise in many markets, having recently hit all-time highs
- Rental rates for single-family residences have continued to increase, though at a slower pace of late, in many cities across the country
- Individual properties in more mature neighborhoods can be a more attractive alternative to BTR (Build-to-Rent) Communities
- The continued trend of US workers and their families moving from urban areas to suburban areas seeking larger, detached single family homes with remote working space
- Higher rents can be obtained from transient workers who don’t want the commitment that comes with homeownership and who will pay a premium for “ease-of-mobility”
Key Topics to Understand
The most common question homeowners have when contemplating renting their current home in hopes of upgrading to a larger home is:
How is it possible to afford two mortgages at once?
The answer is straightforward if you conduct the proper research, run through accurate expense scenarios, and have a desirable property in a prosperous community. In other words, if the numbers work out, you will likely be able to qualify and afford two mortgages.
If you need to be approved for a mortgage on your second home, keep in mind that your application will be deemed as more risky by lenders. Three factors to assuage lender concerns are:
- Provide a rental income appraiser form (e.g. Fannie Mae Form 1007), that demonstrates earning potential for your rental property by using rents from three nearby, similar rental units
- Have enough savings (typically 2% of the unpaid mortgage balance of the rental home) to cover mortgage payments when your rental property is temporarily unoccupied or when current renters miss payments
- Hire a reputable property management firm to handle your tenant screening, rental collection and increases, and maintenance, if you lack landlord experience
In an ideal situation, owning an investment property allows you to own an appreciating asset, while earning consistent, passive income, without having to spend a significant amount of time or money.
However, there is more to consider besides the nominally expected monthly rental income and underlying expenses.
Before signing any tenants or applying for a second mortgage, there are several key topics you need to understand and research fully for your exact situation before proceeding:
- Check the Occupancy Clause in your mortgage agreement for any restrictions
- Research rental rates for comparable properties in your market
- Identify the necessary upgrades and associated costs to your property for the rent you need to charge, and to prevent any unexpected costly breakdowns
- Confirm which specialist service partners you will need, e.g.: marketing (real estate agent; rental listing sites; etc.); legal (e.g. tenant application process; tenant lease agreement; property management firm, real estate attorney; legal insurance; etc.); maintenance (e.g. DIY approach; property management firm; readily available network of trusted trade pros; lawn care; etc.); financial (e.g. tax accountant; depreciated tax deductions; potential capital gains tax; etc.) and insurance (e.g. additional umbrella insurance; LLC registration; etc.).
Though on the surface there appears to be a lot to consider and understand – and there is – we recommend keeping these property traits and circumstances in mind to determine if being an “accidental homeowner landlord” would be a good fit for you:
- Your property is new or close to being a “Turnkey Property”, meaning the house has key amenities of a modern household, and all systems (e.g. roof, plumbing, electrical, foundation, HVAC) have proven to be reliable and are in good condition, with ample remaining lifespans
- Your home is located in a desirable neighborhood that commands high rental rates from a large pool of high-quality tenants
- Your property is located in a jurisdiction with equitable laws that are fair to both landlords and tenants, in particular fair to landlords and tenants who are responsible, respectful and law-abiding
- Your property resides in a jurisdiction with stable and fair property tax rates, municipality fees and utility rates
- You have access to a trusted partner (e.g. a reputable real estate agent or property management firm) that understands the legal requirements of the tenant application process and can help you attract responsible and reliable tenants
Additional Traits of an Attractive Market for an Investment Property
- Low-density suburban markets with high multifamily occupancy rates
- Markets with growing employment opportunities
- Markets with high cost-of-living, where homeownership is out-of-reach for a large percentage of the population, especially single family properties
- Proximity to hubs of high-paying professional jobs
- Proximity to high quality and convenient public transportation, such as commuter train systems
- Proximity to universities, government agencies, and higher education institutions
Though every circumstance and market is different, being in an “ideal situation” will dramatically increase your chances for a good experience, while dramatically decreasing your chances of encountering legal disputes or damaged property.
Increasing one’s chances of landing an “ideal situation” is especially important for homeowners who have little room for error as they face several challenges simultaneously, such as:
- Homeowners with little DIY home maintenance skills and experience
- Homeowners with busy lifestyles and long commutes
- Homeowners unfamiliar with local rental and property laws
- Homeowners with minimal cash reserves to cover the expenses of unexpected costly home repairs
- Homeowners offering a rental property with many known issues and aged appliances and systems
- Homeowners trying to do everything themselves for the first time (e.g. finding tenants; maintenance; rent collection; lawn care; etc.)
What to Consider When Purchasing a Starter Home
When you’re a first-time home buyer and in the process of purchasing a starter home, take what you can and can’t afford into consideration:
- Can you make a large down payment?
- Can you afford a high mortgage payment every month?
- Can you establish a sufficient maintenance slush fund to cover unexpected repairs each year?
We also recommend taking a creative approach when searching for a property, such as considering purchasing a duplex with plans to rent out one of the units. This is a popular method of “house hacking”, which is a term that describes when a homeowner generates extra income to offset living expenses.
Another innovative house hacking approach would be to build an affordable detached ADU on your property to earn supplemental rental income.
Working closely with a real estate agent will help guide you through this stressful, yet exciting process. They can help you decide what kind of loan to consider, especially if you’re upfront about your future rental plans for the house.
If you’re planning to rent your home in the near future, they may suggest applying for a 15-year mortgage. This type of loan will allow you to put down as little as 3%, and for a first-time homebuyer, this is especially attractive, as it is often challenging to have sufficient funds for a larger down payment, as many loans require 20%.
Applying for a 15-year mortgage allows you to pay the house off faster, and if you’re renting it, you can potentially increase the rent to cover the cost of the mortgage and still earn a profit. Once the house is paid off, the rent payments will increase your profit and allow you to update the house when needed over time.
After you’re approved for your loan and have moved into your new home, you can begin your renovations. If you’ve already committed to turning this home into a rental property, take that into consideration when renovating your house.
With future rental plans in mind, we strongly recommend focusing on home improvement projects that will improve the overall durability of the interior (e.g. floors, countertops, doors, etc.), which are easy to clean and maintain.
You’ll want to keep the paint colors neutral, decide whether the renters need to bring their own furniture, and make sure all appliances and bathroom fixtures are in good condition. If they aren’t, make sure to replace them. Updating the home before it is placed on the rental market, will save you time and can allow you to have your renters move in when you have everything completed.
Additional Ways to Make Your Investment Property More Valuable & In-Demand
- Add a modern prefab ADU to your property (if allowed by your local jurisdiction)
- Renovate your home with tenants in mind
- Create and lease storage space
- Increase the number of bedrooms for larger families, including multigenerational households
- Add sought-after amenities preferred by high quality tenants, e.g. electric vehicle charging stations; home office space; modern kitchen appliances and style; low-maintenance but appealing outdoor spaces; etc.
Becoming a Landlord
Becoming a landlord can be a challenging skill to master if you are unfamiliar with the responsibilities or lack experience. Though you’ll eventually learn the ins and outs along the way, preparing yourself beforehand will be in your best interest and will help prevent costly legal mistakes.
You will need to decide upfront which business responsibilities (e.g. tenant screening; leasing agreement; rent collection; etc.) and which maintenance responsibilities you prefer to manage yourself. Remaining responsibilities will need to be outsourced to a reputable property management firm.
The most important skill for a homeowner landlord to possess is knowing how to find the perfect tenant for your property. This especially pertains to adhering to tenant screening laws, as:
- Evictions are Costly
- Discrimination Fines are Costlier
Speaking with and learning from local landlords and real estate agents will help you set realistic expectations upfront for your specific property and neighborhood. Keep in mind that property management firms can typically charge in the range of 10% of the monthly rental rate, depending on their level of service.
However, most property management firms allow clients to select a range of services that are best suited for their specific property and situation.
Here are two disparate rental scenarios where one is better suited for full service property management services (e.g. tenant screening; payment collection; maintenance; handling tenant complaints; etc.) and minimal management services (e.g. tenant screening).
Rental situations better suited for comprehensive property management services include:
- You are based far away for the rental property
- You will be too busy to handle tenant requests, including maintenance repairs
- You are not qualified to make maintenance repairs (e.g. no experience; no industry connections; etc.)
- The property is older and is likely to require major upgrades and repairs
- There is a strong likelihood that you will experience high tenant turnover
- You do not have the temperament to deal with interpersonal conflict (e.g. late payments; tenant requests; maintenance disputes; neighbor complaints; city complaints; etc.)
Rental situations better suited for minimal property management services include:
- Property is new, in stellar condition or has been recently upgraded throughout
- You leave nearby and can easily visit the property (e.g. live next door in a duplex)
- You are well-skilled at home repairs and have a network of reliable home improvement professionals
- You are well versed on landlord-tenant laws, including tenant screening and landlord responsibilities
If you are willing to take on both roles landlord and maintenance person, be sure that you know and understand the basic homeowning skills. Consider becoming fluent in some of the skills below:
- Electrical Skills
- Plumbing Skills
- HVAC Maintenance
Investing in a Larger Home
As the time approaches for you to start looking for a new home that is more suitable for your lifestyle, create a checklist of your wants and needs. The starter home that you recently purchased may have met your needs at that time, but for your next home you will likely have a more expansive list.
Before you begin house hunting, realizing what’s important to have will be crucial in your search. If you have children, you’ll want to find a safe neighborhood with other kids and a good school district. If you prefer everyone has their own room, you’ll need to focus on areas that have a lower average cost per square footage, especially if you also want an extra room for an office or guest room.
Purchasing a larger home can be quite an undertaking both financially and operationally (i.e. seemingly never-ending maintenance). Larger homes typically, of course, command higher prices, so make sure to work closely with your bank and a local real estate agent who knows your desired area well.
Make sure you can live within your means and aren’t pushing the limit on how much you can spend. Moving into a larger home may cause you to have to invest in more furniture to fill the space and you will have more to clean.
Also be sure to research historic utility costs, especially if you are moving to a different climate zone. You may find monthly costs to keep your house cool and your grass green during the summer months shockingly high in some markets, for example.
Balancing Time as a Landlord and Homeowner
Owning a family home while investing in a rental property can sometimes become overwhelming, but balancing your time between the two will help you immensely.
Creating a set schedule on days you will clean or update your current home and days you will focus on the rental property will help you to stay organized. If you live in an area where there is snow, you’ll need to decide if you want to hire someone to plow the driveway of the rental house, or if you’ll do it yourself.
The same goes for lawn maintenance. Do you want to take care of the lawn at your rental home or do you want to hire someone? If you choose to do it all yourself, schedule time during the week to go care for it.
Being the landlord and the primary maintenance provider can assure you that the house is being taken care of properly and that nothing is going unnoticed.
If you find that owning investment properties is something you thoroughly enjoy, you may consider investing in more rental properties. Whether you choose to invest in starter homes, fixer-uppers, or even apartment buildings, this may something that can become a career.
Over time, you’ll become more familiar with the process, determine whether you want to hire property managers, or handle all the properties on your own.
More Recommended Real Estate Reading
- What is a Turnkey Home in Today’s Market?
- Want the Best Mortgage Deal? Study APRs vs. Interest Rates!
- 8 Common Mistakes Made When Budgeting for a New Home
- Homebuyer Beware: The Perils of Flipped Homes
- 7 Expert Tips on Using Virtual Staging to Sell Your Home Quickly
- What to Consider When Purchasing an Older or Historic Home
- 5 Examples of Older Homes Returning Maximum Profit with Renovations
- 4 Ways to Maximize Your Home’s Value
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