Turning the Tables

In a down market, cutting your real estate losses doesn’t have to
mean losing entirely

It may seem strange to remember the dot-com meltdown of the late 1990s as a better time. But with the real estate market around the country in dire straits (thanks to the subprime mortgage fiasco and a soft economy), some people are feeling nostalgia for the era of investors being saddled with nearly worthless Internet stocks. “In the dot-com era, you could make a phone call and that was it,” says Errold Moody Jr., author of No Nonsense Finance. “As everyone has seen, if you’ve got a piece of real estate, you can’t dump the thing with a phone call. You’re going to have to wait a long time, or you’re going to have to reduce the price by a substantial margin.”

Sadly, too many potential home sellers around the country are in that very bind, faced with the prospect of taking a big loss — if they can even find a buyer for their house. But there are other options for those who simply can’t stand the idea of selling their home, which is usually their largest asset, for a fraction of the price they paid. Perhaps the best option is to wait out the real estate cycle and rent your property while you wait for home values to rise again.

Make Sense of the Dollars

But before you rush to take out a classified ad in the newspaper, real estate experts caution that there’s a lot of thinking and calculating to do. The first question to ask is whether renting out your home makes financial sense in the long term.

Mike Larson, a real estate analyst with Florida-based Weiss Research, suggests that you first talk with local real estate agents, who should be able to give you a realistic idea of the rent your home can command. “Then compare that with what you’re paying for principal, interest, taxes, and insurance on your existing mortgage,” Larson says. If the rent you could collect is equal to or higher than your mortgage and related expenses, it may be worth pursuing. But if you’re significantly in the red each month, you may want to consider just selling your house, even if the current market value is below your ideal price. “It might be better to just take the loss on the sales price — say it’s $10,000 — versus having a $300-a-month negative cash flow, in which case you will eat up that $10,000 pretty quickly,” Larson explains.

The potential tax implications that come with renting also make a visit to an accountant mandatory. Many experts predict that home values may not rebound for quite some time — meaning it may be as long as a year or two before they even begin to bounce back, let alone reach their former highs. That creates some potential hiccups for homeowners who are thinking about renting while waiting for the market to improve. A big one is the IRS rule that allows married couples to pocket a $500,000 profit tax free ($250,000 for single people) on the sale of their primary residence — which is defined as the place someone has lived for the past two consecutive years, or two of the past five years. If you rent out your house long enough, you could forfeit that benefit. “The government can turn around and say that wasn’t your principal residence,” says Rob Harrington, founder and chairman of OptHome, a company that provides consumers with a variety of real estate information. “Therefore, if there is any gain down the road, they’re going to want you to pay taxes on it.”

Sweat the Small Stuff

Not all considerations revolve around money. One trouble with renting is that it’s hard work, particularly if you’re trying to be a landlord from hundreds of miles away. For those who haven’t done it before, finding good tenants, running credit checks, writing up a lease, and ensuring that regular maintenance is done are all daunting tasks, let alone being on call 24 hours a day. “The real fun time is when you get a call at 3 o’clock on a Saturday morning that someone has flushed their pet mouse down the toilet,” says Moody. Of course, hiring a management company to take care of potential problems is an option, but it’s one that will cost in the neighborhood of 5–10 percent of the monthly rent.

Fortunately, there are some financial trends that make renting a more appealing possibility. Ilyce Glink, who runs the Web site ExpertRealEstateTips.net, believes it’s inevitable that mortgage rates will come down from the high levels of the first half of 2008. She adds that the Federal Reserve, which sets interest rates, seems intent on acting aggressively to buoy the economy. As mortgage rates go down, refinancing becomes more attractive, which, in turn, can make renting an even better option. “When you refinance, maybe you could restructure into an interest-only loan or a 30-year or 40-year fixed rate that really lowers your monthly costs,” Glink says. “That would allow you to rent your house for a little less or to make enough profit on it that you would break even or do a little better.”

Given the proper planning, then, renting can be a good option while waiting for home prices to reach a point where you do want to sell. Then again, according to Peter Friedman, a real estate attorney in Philadelphia, it may also be worthwhile to consider giving renters an option to buy. “What the option to purchase does is lock in a price for a buyer, and it can also provide incentives for the [tenant] to buy the house,” says Friedman. “Those incentives could include credits for rent paid, which could be applied to a down payment.”

Friedman sees this as a win-win for buyers and sellers. Potential buyers can live in a home to see if they like it enough to actually purchase it, and then apply the rent they pay to the price of the house. This can be particularly helpful for first-time home buyers, who may not have enough saved up for a reasonable down payment. For the homeowner, this sort of arrangement not only increases their chances of selling, but also could help them to negotiate a better price. These days, that sounds like a really good deal.

Give Yourself an Edge

Sure, it’s a tough market for real estate these days, but that doesn’t mean nothing is selling. “I would remind people that there are going to be 4 or 5 million homes sold this year,” says Ilyce Glink of ExpertRealEstateTips.net. Here are some suggestions from real estate pros for improving the chance that your home is one of them.

Be realistic. Every homeowner probably remembers the value of his or her house at the peak of the real estate boom. Do what you can to forget that number when it comes to setting a price today.

Know the competition. Buyers have plenty of options, so as a seller it makes a lot of sense to know exactly what you’re up against. “Sometimes it’s price. Sometimes it’s just condition, or curb appeal, or friendliness or colors inside the house,” says Rob Harrington, founder and chairman of OptHome.

How long listed. The length of time a home has been on the market matters, particularly in how a buyer perceives it. Talk with your real estate agent about how to clear your property’s listing history if it has been on the market a long time.

Consider incentives. Real estate attorney Peter Friedman believes that offering incentives — whether some sort of warranty on a home purchase or payment of some or all of the closing costs — is a way to make your home that much more appealing. — C.W.