According to real estate data service Zillow, rents in the Seattle area are projected to rise at the highest rate in the nation. The region’s 7.8% increase in 2016 far exceeded pricey San Francisco, whose eye-popping rent increases in 2014 and 2015 made rental housing all but unaffordable to wage earners hoping to move there. Those increases have certainly contributed to the influx of renters moving to the Seattle area in recent years.
This robust rental market, together with general home appreciation, can present some opportunities for Seattle homeowners today. Those who are able to move to more expensive homes would do well to consider retaining their present residences, converting them to rental property to provide income. While many move-up homeowners must sell their current homes to get the cash for their new homes, there are many who do have the ability to buy while retaining their former residences. Here is why this could be a good financial strategy.
Let’s assume that your home today has a mortgage of $350,000 at 4% or less (you have taken advantage of today’s historically low rates, haven’t you?) Your monthly payment should be around $2,300 including taxes and insurance. Let’s assume also that your home is worth $500,000 today.
If you can get $2,500 rent (the median for the Seattle area), your tenant will be covering the mortgage, insurance and taxes. You will actually receive a tax benefit because you will be able to claim a “paper loss” through depreciation. We don’t have time or space to go into the mechanics of depreciation in this article, but just know that you may be able to claim a loss on your taxes, even though the property breaks even. Speak to your tax advisor for details about how this works in your case. This can reduce your income tax burden, effectively giving you some positive cash flow.
Part of the great appeal of residential income property (like your rental home) is that it has a strong tendency to increase in value—in other words, it appreciates. With the strong demand for housing, prices in the Seattle Metropolitan area increased 15.3% in 2016 and are projected to rise another 6.9% in 2017.
This means that if your $500,000 home rises in value 5% in 2017, it will be worth $525,000. And if the established trend continues, over $550,000 the next year. Your equity will have increased from $150,000 to $200,000 in two years—a 33% increase.
The increasing rents in the Seattle area mean also that you will be able to get more rental income from your property as the market increases. While you may be reluctant to raise the rent on that nice Jones family who now live in your home, the natural turnover of tenants means that you’ll be able to get more rent for your property when the inevitable turnover of tenants occurs. This means that your cash flow will increase.
For those homeowners who don’t have enough cash available to make a 20% or larger down payment on their new home, keep in mind the option of making a smaller down payment and paying mortgage insurance for a year or two. The mortgage insurance can be dropped once the new home has appreciated to the point where the loan amount is 80% of the home’s appraised value or less.
This kind of strategy is not suitable for all homeowners, for obvious reasons. But for those who can do it, retaining the former residence and converting it to income property can be a good—and highly profitable—investment.
If you’re on the fence about whether you can rent out your current home or you should simply sell it, you may be a move-up buyer. The best way to identify where you are and what you can do about it is to download our free ebook by clicking this link or the button below.