Have an Exit Strategy: Know Whether You Will Rent, Sell, or Break Your Lease When Orders Arrive (because they will!)
by Karina Gafford
Vague recollections of a his-and-hers closet, a cosy upstairs den, a carefully planted set of fruit trees, and the expensive, but sturdy metal shelving we installed in the garage one month prior to receiving PCS orders spring to mind on occasion of yet another house left behind for the sake of the military. This particular house, however, remains with us--not physically, though the appeal of investing in a large RV that I can easily park in the nearest base fam camp sounds increasingly appealing each time I begin packing up a new home to PCS, but financially.
With a one week turnaround time to report to our next duty station, the thought of selling this home never even crossed my frantic mind. Sending my dear husband on a picture taking mission throughout the house, I quickly set-up my first account on MilitarybyOwner, hoping desperately that someone needed a rental just as quickly as we needed to vacate this first home we had bought together near Fort Jackson in South Carolina. With pictures posted--including a proud photo of the sweet onions and blueberries I had managed to grow in a self-built, raised garden bed--I nervously shut my laptop screen, hoping that another military spouse would see the carefully cultivated crops and decide to rent from us immediately to help ensure the continued growth of the little plants (everyone is entitled to their own wishful thinking). Putting all thoughts of finding a tenant aside, I quickly moved to begin our packing preparation.
Having an Exit Strategy
The reason the thought of selling never even crossed my mind upon receiving orders was not only because the turnaround time left us with little time to consider showing the property, but also because we pre-planned our exit strategy from the home prior to even moving into it. We purposely bought this house with the specific intent of eventually renting it out to another family when the military decided that it was time for us to move. Moving with the military is inevitable; having an exit strategy for the home you are buying or selling should be a part of your PCS strategy, too. Before you consider buying, make sure to speak with a real estate agent who can offer the best advice on your options for buying to rent or buying to sell in your new local market. MBO has real estate agent partners throughout the country who specialize in helping military families make this challenging decision.
An Exit Strategy for Renters
Renting rarely poses a significant barrier to moving upon receipt of either PCS, long temporary duty assisgnment (excess of 90 days), or deployment orders, as the Servicemembers Civil Relief Act (SCRA) provides a break lease option for military families through a military clause. Under this act, military families can end a lease exactly 30-days after the date of the next due rental payment, provided that they have given written notice and a copy of the orders to their landlord. The landlord is then legally obligated to treat the termination of the lease as if the servicemember had fulfilled the entire length of the lease. The landlord, therefore, must return whatever portion of the security deposit that remains after the landlord has taken out any reasonable property damage payments just as he would at the end of a normal lease period.
Falling into the Trap of Buying to Keep When You Plan to Move and Sell
Too often, however, military families purchase beautiful homes that will fit the needs of their family perfectly for a period of two years, or however long the military permits, only to later realize that their vision of a perfect home does not quite meet the standards of a sellable home in their particular market. Your quaint kitchen with chic white cabinets and perfectly matching white appliances simply may not fit the trend of black cabinetry, stone countertops, and stainless appliances that a house in the price range in which you intend to sell may demand that year. If the cost to upgrade your kitchen to the level required to sell in that market seems prohibitive because it lies too far outside of your budget, you may find yourself with a rental home instead of a sold home.
Further, many families who do aim to sell do not expect the hefty price tag that can show up at the closing table to sell the property just a mere few years after buying the home. For a family who purchased a $200,000 home with a 30-year, 0-percent VA loan and all closing costs, including the VA-funding fee rolled in, may have paid closer to $208,000. When moving three years later, the family may still owe in excess of $200,000. Assuming that the price point of the home remained relatively the same, the family may find that by the time they pay for broker fees, real estate agent fees, a home warranty, title insurance, a termite inspection, and any other fees that the prospective buyer may require in order to close, such as an allowance for new carpet or paint, the family may find themselves owing somewhere in the realm of $10,000-$20,000. Ouch! Having a solid exit strategy prior to entering into a costly endeavor should help avoid such a painfully expensive situation.
The real estate company with whom we worked during our first PCS together helped us outline exactly how to avoid falling into the perfect-for-us homebuying trap that ensnares many military families. Though we knew we wanted to buy a home that we could eventually rent out, we did not articulate this to our agent at first, as it did not occur to us that she would show us quite different homes with the change in requirements. So, I recall days spent touring cosy, older homes in elegant cape cod and colonial styles. The homes in the styles and neighborhoods we admired required some tender loving care (read: new floors, paint, new kitchens, remodeled bathrooms, and that does not even begin to address some of the structural issues we encountered). With all of the naive optimism of recent college graduates, despite both having full-time jobs and both attending graduate school, we assumed we could capably manage these "projects" in our spare time. No problem.
Buying to Rent Involves a Far Different House Search Process
Our real estate agent, a woman much more aware of the local market than either of us could even begin to fathom regardless of our endless amounts of online research about the area, finally figured out our intent: Buying to rent. Given that our purchasing plan differed from our original intent, she outlined new specifications for homes that included different neighborhoods, different school districts, and different amenities for the house that renters, not buyers, sought when house shopping in that particular area. Most importantly, however, with her clear guidance, we ultimately purchased a brand new, vinyl-sided home in a style that only the term "cookie cutter" can truly encapsulate.
As two history majors, words cannot express how much "cookie cutter" fails to fulfill the inner homeowner desires of my husband and I, and yet in the six years in which we have owned the light-green-vinyl-sided-with-black-shutters-house (it is important to recall the colors in order to not inadvertently walk into the neighbors house by mistake), we have experienced something akin to landlord bliss. Call it arrogance, but this relatively peaceful landlord life came by design; only an inquiry regarding an overly large water bill as a result of a sprinkler leak even reminded me that this property ever requires oversight. That oversight, however, comes from my property manager, and not I. Given that I neither live in the area to handle the maintenance, nor do I possess what I perceive as the sufficient amount of direct confrontational skills to ensure both the proper upkeep of a a property and timely rental payments, I chose to hire a property manager. Should you choose to do the same, the MBO Business Directory is divided by base to help you find property managers in your area.
As our agent explained, a brand new home that met a perfect inspection report served as an ideal solution for a home in which we could comfortably live for the duration of one assignment, and then rent out to other families later. We determined a target market based on the income, rentals available on the market, average rental rate, and more selectively, what rentals were in high-demand but low quantity.
Financial Planning for Buying a Rental House
Based on our findings, we transformed our search. We identified the monthly rental rate that met our target market--what can our prospective renters afford as opposed to how high an amount we qualified for, or what we could afford for the the two years during which we would live in the property. Once we determined the monthly amount, we then worked backwards to calculate the monthly estimated mortgage, hazard housing insurance--an amount lower than traditional homeowner's insurance as it accounts only for the property itself and not for the belongings inside--and property tax payment.
The property tax payment, it should be noted, differs based on whether the home is a primary residence or a rental property. In the case of the former, the rate is lower, and this is the rate that a military family in a buy-to-later-rent-house would pay; however, once the home is no longer occupied by the military family, and assuming that the home does not remain the primary residence of the family under the family's home of record, then the tax rate for the property reverts to the higher rate for a rental property. It is imperative to report the conversion of the home from a primary residence to a rental to the local tax authority; otherwise, hefty fees and criminals charges could result. When we calculated our tax payments for the purpose of renting, for example, we calculated a rate based on us as primary residents at first, but then later as a rental property. For our house, this meant that taxes increased from approximately $1,300 as a primary residence to $2,800 as a rental per year. Only thanks to our agent did we take the higher figure into our calculation when finding a home at an appropriate price point for the rental target market we aimed to reach. The extra $1,500 translated to roughly $125 extra per month that we aimed to include in our rental rate.
With a budget and target market in mind, we quickly narrowed down our search. Our target market severely lacked 3-bedroom house with a garage, a fenced yard, and a den in a family-friendly neighborhood near a popular new shopping center and good schools. A home to live in and then rent did not mean stainless steel appliances, granite counters, or quaint historic features as we would have liked; historic generally means old, which means high-maintenance, and high-maintenance is not rental property friendly. A rental property is a business; consequently, each maintenance cost comes directly out of the profits of the business. A home that required minimal maintenance, therefore, seemed a better fit.
Maintenance of a Rental
Knowing the status of each system and appliance in the house--new!--meant that we could place each item in a tentative calendar slot for when it will likely need replacing. Appliances in a rental property, for one example, generally last an average of five years; therefore, knowing that the appliances will likely require replacing in five years, it is a good idea to budget and save for this hefty purchase. Carpet in a rental property, for another example, generally lasts an average of three to five years.
The large systems, such as the HVAC and the roofing, meanwhile, can cost substantially more than replacing an appliance or carpet. To help maintain the life of an HVAC system, quickly place the system on a bi-annual maintenance place where a serviceman will inspect and maintain the system each spring and fall. An HVAC maintenance plan represents a nominal cost when compared to the replacement of an HVAC system, which can cost as little as $5,000 or as much as $20,000, depending on the size of your home. The bi-annual maintenance that helps significantly extend the life of your HVAC system should cost around $200 or less. For your roofing system, check with the builder to ensure that the roof holds a twenty-five year warranty to mitigate the replacement cost that a ten or fifteen year roof may incur. Hopefully by the time the pricy invoice for a new roof comes across your desk, you will have long paid off your mortgage and can easily afford the bill with the fruits of years of managing the rental, the monthly rental income.
Conclusion
Many other factors can go into the consideration of whether a rental property is a good purchase for your military family, such as the importance of buying a rental home with a conventional loan instead of an FHA or VA loan, the tax implications--both positive and negative--in buying a primary residence home to eventually rent, and then the emotional impact of the long-term management of such a property. If you are considering purchasing a home to buy and then rent, make sure to talk to a real estate agent, a property manager, and a tax advisor in the area in which you plan to buy. You can find local individuals through MBO's Business Directory. Regardless of whether you choose to buy or rent, though, make sure to have your exit strategy lined up before you ever sign a contract!