September 3, 2009

Reluctant landlords, then and now

Having gone through the transition from homeowner to landlord during the early 1990s California housing bust, the concept of "reluctant landlord" is a familiar one to me.

In fact, not only were we reluctant landlords, but we completed the entire process that many are now just entering (though most of them probably think it will end quite differently) by closing the book on that ill-fated home purchase via a short-sale after having rented the place out for a year or two and watching its value continue to fall.

Believe me, it's a lot easier to throw in the towel when you no longer live there and are far less attached to the place. In fact, after a while, you can grow quite cold toward your former home, looking at only the numbers involved and quickly forgetting about the memories that were made there.

Depending upon the particulars - how large a downpayment was involved, how much the property is underwater, the chances of someday returning to live there, etc. - the decision to change from reluctant landlord to short-seller (or sender of jingle-mail) can happen very quickly, often times prompted by a phone call from your tenant informing you that they won't be renewing the lease.

That's what did it for us and it was a remarkably easy decision to make...

Of course, if we had waited another six or eight years, we would have seen the price rise back up to what we had paid for it and then, astonishingly, peak at almost double what we paid, but, in retrospect, it was the right decision.

Hanging onto it would have been a cash drain for years, a place that, today, Zillow says is actually worth less than what we paid for it in 1989 and, amazingly, recent sales of comparable homes at put the value closer to our short sale price in 1995!

Anyway, this fine WSJ report tells all about the new breed of reluctant landlords.

With housing prices still in the dumps, many Americans are finding themselves in the uncomfortable position of landlord.

Some have been forced to relocate for a job and can't sell their houses. Others have moved, but are holding on to their previous homes, hoping for prices to rebound before selling. Many are finding that rent checks don't come close to covering their mortgage payments.

Hard data are scant on how many homeowners are renting out their homes, but anecdotal evidence suggests numbers are up. In one indication of the trend: More homeowners are converting their homeowners insurance to landlord policies that cover the additional risks of leasing out a home. Allstate Corp., the second largest home insurer in the U.S., reported a 27% increase in conversions in the first quarter from the previous year.

That's funny - we managed to get our property taxes reduced due to the plunging home value, but we didn't even think to convert our homeowners insurance policy.

That 27 percent figure may be wildly underestimating the actual number.

Here's a pretty typical scenario, highlighted by the "wait a couple years for prices to rebound" approach that most homeowners naively adopt, as we did:

In Frederick, Md., Realtor Jim Bass says that because of rising demand, a couple of months ago his real-estate group started offering property-management services, tending to the rented homes of absent owners. Mr. Bass says a client recently rented out his 4,700-square-foot house after failing to sell his home, which he listed for $790,000. Now a tenant pays $2,995 per month - a shortfall of $2,000 from the $4,995 mortgage payment. The homeowner "feels that two years from now, the market will improve to the point where he can recapture that," Mr. Bass says.

Experts generally advise against becoming a landlord in hopes of recouping lost home value. In some hard-hit parts of the country, such as Florida, Nevada, Arizona and parts of Ohio, prices may not climb back to mid-2000s levels anytime soon. Landlords have to pony up money each year for property taxes, insurance, maintenance and repairs. Meanwhile, demand for rentals in many parts of the U.S. isn't strong: Apartment vacancy rates nationally are the highest in more than two decades and rents are falling in some areas, compounding the difficulty of finding a good, steady tenant.

In some ways this is like refusing to sell that stinker of a stock that has tanked - it's a lot easier to defer a decision than to make one (i.e., to take your loss and get on with things).

Of course, for many people who put virtually no money down and where plunging prices have long since made their downpayment disappear, the decision shouldn't be that difficult.

Homeowners who owe more than a house is worth in very depressed areas may be better off selling even in a short sale, whereby the bank agrees to accept less than the full amount owed on the mortgage, says economist Edward Leamer, director of the UCLA Anderson Forecast. Your credit rating takes a serious hit, but, he says, "better to take your losses and move on."

Funny story - about a year ago (June 2008) I was at an investment conference to speak on a panel about financial blogs and met Dr. Leamer.

He kind of chuckled when he read the name of my blog on my name tag.

He then went on to make a nearly hour long presentation about how we were not going to enter a recession and about how the credit crisis and housing market troubles had about peaked.

Another example that sounds pretty typical:

Kyle Becker, 27 years old, and his wife didn't feel they had much of a choice in becoming landlords. The couple and their infant son moved from Columbia, Mo., to Winchester, Va., last year so that Mr. Becker could attend pharmacy school at Shenandoah University.

Before they moved, they listed their three bedroom, two-bath ranch-style home in May 2008 for $139,000. They had bought it in 2005 for $110,000 and put $30,000 into roofing and siding. By February, they hadn't received a single bid.

"We had only seven lookers over the course of a year," Mr. Becker says. Meanwhile, the couple was paying $1,200 a month in rent for a Virginia house. Last spring, the Beckers finally leased the Missouri house for $675 a month - $225 less than their mortgage payment.

Because the home was no longer owner-occupied, Mr. Becker was unable to refinance his 6.1% mortgage when 30-year rates dipped below 5% briefly. If he had to do it all over again, Mr. Becker says, he might have chopped the price of his Missouri house, where sales have been stagnant - with the exception of "distressed"
properties in some stage of default.

When we were landlords, the rental income was about $800 a month and the mortgage was around $1,100 or so. Add in all the incidentals and this quickly becomes a drain that you can tolerate for only so long.

Once you get that phone call about having to find a new tenant, it becomes an easy decision to stop making the mortgage payment and start working on a deal with the bank.