principal

Steps to Renting: Becoming a Landlord

Posted by

2

If you remember my previous post about generating additional income, it was quite a long time ago in which I wrote:

My wife and I have talked about renting out our current apartment to generate additional income. But we encountered three problems that have so far prevented us from making any success on this:

  • 1. we like it here and we don’t want to move yet;
  • 2. we still wouldn’t make any residual profit from renting our house out without paying off part of the mortgage principal (something we don’t have enough cash yet to do); and
  • 3. we can’t decide where we’d like to live other than here. Contribution $0. Potential contribution estimated at $100.

So if you like a rental income property (and who doesn’t?), what do you need to get started? Mmm… it’s hardly like we’ve made a start. So let me list the things that I think I would need:

1. Renovation:

We seriously need to do the tiling work in several rooms: the bathroom, where the tiling is beginning to separate from the walls due to the contraction and expansion of the concrete in summer/winter, and the poor workmanship when the place was finished. I also suspect that we need to replace one of the air conditioners in the study.

2. Redecoration:

We’ve got walls painted in a variety of colors, and it’s been a few years. It’s likely that our tastes aren’t exactly the same as our renters. So we’ve probably got a bit of painting to do, as well as other minor repairs.

3. Insurance:

Not sure how to handle that. I know that you can get landlord’s insurance… but what happens if the tenant absconds or worse? Can that be claimed?

4. Finances:

Since our property is mortgaged, the yields are just not very attractive since rents are fairly low in this neck of the woods. We know that we would have some gross profit, but there’s also a landlord’s tax of 10% on the income. So not sure how that would work. I think the only solution would be to pay off some or a lot of the principle. Still a good return on money invested.

5. Renting:

Finding good tenants would be a priority. The neighboring landlord rents his apartment, the tenants there have been anything but reliable. Dirty, filthy,… with problems paying rent. I think tenant screening would be essential to prevent this, even if it meant the apartment being empty longer.

With a sound plan, it might work. Still a few kinks to work out. I do know that the area is very desirable, with lots of chances to find tenants. Of course, that means we’d have to move! A chance to find a new area.

Selling a house: Would you take a 100% profit?

Posted by

This recent story on the Guardian Newspaper website caught my eye about negative equity. Virginia Wallis responds to a Q&A from ‘KJ’ who writes about her worries about negative equity, and unfortunately underlines the problems that house purchasers face in a bullish market that turns negative. Unfortunately the writer’s response isn’t that helpful or accurate…

Go and read the story, since I can’t repost it here. In summary… KJ bought a house very near the peak of the market in 2007 for £154,000. Obviously she’s worried now that prices are falling, and is thinking of selling up. The respondent unfortunately seems to have poor math in the article, missing out on £2000 in the calculations. … She put £8000 down in the first place, and the other 95% was a mortgage.

Where did she get the 10%?

In sum, here’s a lady who bought near the top of the market. With the terms she employs in the article, like ‘invested’, and ‘valued at £185,000’. Now she’s panicking over a 10% variable rate (I have no idea why or how she came up with 10% pa). Top rates these days in the U.K. are about 6.5% to a little over 7.2%. It would be quite a jump to 10% (unless she’s saying something I don’t know). Australian rates are another story though.

She ‘believes’ her flat was worth £185,000 in February, but has no independent way to verify this assumption. All such ‘values’ are only theoretical until someone ACTUALLY puts down the cash. However, the current offer she’s got is £167,000. In such a difficult market as this, she’s actually lucky. She’d actually be sitting on a gross profit of nearly £21,000. Of course, early redemption fees would eat some of that, as would transaction fees. Still she’d make a reasonable profit on her ‘investment’.

Is this a place to live?

It seems though that we have what we might term a ‘weak’ card. I don’t see how if she were actually living on this property she would be thinking like this. It seems that she may really have ‘invested’ in the property as a buy-to-let, and may be unable to rent it out at the moment. With the threat of higher interest rates, lacklustre rentals, and a likely profit, she may be willing to cash out. If she were the owner, would she be thinking like this?

Why does she have to remortgage?

She writes “I have to remortgage in January 2010 and am panicking over the possibility of negative equity”. I would guess that she’s is currently struggling to make the mortgage payments at the moment, if she is living there. She is naturally concerned that rates are rising (they are), and they could go much higher (remember that rates have been at historical lows in MANY countries), and her mortgage is an ARM with favorable upfront terms (likely and common scenario) due to reset in 2010 at much higher rates than a year and a half ago. It seems unlikely she may be able to meet THOSE payments, never mind the payments that might result from additional rate rises between now and then.

From the tone of the letter, it seems that this ‘house-owner’ was seeking to make some kind of profit in the short-term while taking a longer term gamble that would allow her an exit strategy before the three years were up. It seems she has been wrong-footed by the market, and is now seeking an early exit. But will she succeed in taking a profit?… Let’s see.

100% profit, that ain’t bad?

Why? There are early redemption fees (approx. 3% of the mortgage amount), a likely stamp tax of 1% on the amount of the property, ie. approx. £1,670. It’s difficult to assess other fees on transaction costs, but they could easily range from £2500~£6500 plus fees of £500 for lawyer fees. Then you have removal fees, too, and other sundry costs of setting up a new home. Suddenly that fat profit of £21000 is looking a lot smaller! You could be paying out £13,000 or more in expenses, fees, and taxes. You’d still have a net £8,000 on your initial investment of £8,000. Which would be a return of 100% on a year and a half. Not too shabby. But certainly a lot less than KJ was hoping for when she gambled on the market.

That calculation only includes exit costs. To assess the true profit, you’d have to include the transaction fees, duties, and other costs that she incurred to get into the transaction in the first place. I wouldn’t be surprised if she spent a similar amount on the set up costs of the property transaction as she does getting out of it. Goodbye 100% profit!

What would you do? How would you get out of this mess?