Sell, Rent or Stay? Homeowners Losing Equity Try to Plug the Gap : Real estate: Declining home prices lead many dejected sellers to become reluctant landlords.
About 18 months after deciding he’d rather rent out his New Jersey condominium than sell at a loss, the owner was already evicting his third tenant.
The family had stopped paying, kicked holes in the walls, spilled paint on the carpets and had a barbecue in the kitchen, said real estate agent Bob Costantini of Gloria Nilson Realtors in Hamilton, N.J. “The whole vinyl floor was melted,” he said. “This is the nightmare that most people face when they sit down to think about renting.”
Costantini’s client had bought into a booming real estate market, only to have dreams of double-digit gains dashed by low-ball offers when he was ready to sell. Like many homeowners who wouldn’t or couldn’t take a loss, he became a reluctant landlord.
Home prices fell 5% in New England and 3% in the Pacific states during the past five years, according to the Conventional Mortgage Home Price Index compiled by the Federal National Mortgage Assn. and the Federal Home Loan Mortgage Corp. Home prices rose just 12% for the nation, barely outpacing 8.2% cumulative inflation since 1990.
While selling an investment at a loss is never easy, homeowners often become downright temperamental about factors unrelated to their property’s market value. These factors can include the size of their mortgage payments, and a flagstone patio that took all last summer to lay down.
But unless the loss is more than 7% or so, excluding real estate agent fees, sellers can easily justify taking a loss--especially after considering the possibilities of uncollected bills, maintenance problems and more complicated taxes. The most compelling argument, though, is the time value of money.
Take the example of a woman who buys a home for $100,000 in cash. When it comes time to sell, the highest offer she gets is $95,000, nowhere near the $115,000 she was asking.
If she were to reject the offer and hold out for 12 months, even in hopes of just breaking even, her money will be tied up in the house instead of reaping investment returns elsewhere. A 30-year Treasury bond, for instance, would pay about $6,650 in interest on that low-ball $95,000.
By renting the house for, say, $700 a month, tenants would pay $8,400, or about $2,000 more than what the government would have paid her for holding the bond. That additional $2,000 may make renting more attractive, but “you have to factor in what your costs would be as a landlord,” said David Needle, who’s trying to sell his three-bedroom home in Berkeley.
“You have to throw in x amount to figure if pipes break, and that sort of thing,” Needle said. “There’s also the time factor of screening people, and going through an agent you probably have to pay too.”
Of course, renting is sometimes a dejected seller’s only option. “If they don’t have the money to cover the closing costs or the money to cover the mortgage costs, realistically they can’t sell,” Costantini said. “The only option is to rent.”
And although some sellers want to rent while waiting for another real estate boom, others just find it an attractive option. “For us it was simple math,” said Anthony Simone, who moved his family from upstate New York to the suburbs of Washington, D.C. “We could have sold it, but we would have lost money. I was pleased to discover that I could keep the asset and increase my tax deductions.”
Depreciation is an accounting method that measures an asset’s decline in value over time. Taxpayers who already itemize to write off their mortgage interest payments often can use depreciation on rental property to lower the tax bill.
Taking a depreciation tax write-off on a home also has a downside, Simone said. “When it comes time to sell the house, the depreciation you’ve taken increases the amount of exposure you have to capital gains.”
If the owner of the $100,000 home takes the tax advantages of depreciating her property by $20,000 and later sells it for $120,000, she must pay capital gains taxes on a $40,000 gain rather than a $20,000 profit, according to Leslie Naschek, a senior manager at accounting firm KPMG Peat Marwick in New York.
Coping with such tax complications can also deter sellers from becoming reluctant landlords. “The rental option is a last resort,” Costantini said.
Needle said he has already dropped his asking price “to get the property moving.” Even if he sells at a loss and watches some of his equity melt away, he said, “it really would be much less of a hassle just to sell the thing.”
At least, he won’t ever have to deal with the prospect of a molten floor.
