When It Makes Sense to Buy a Home to Rent

On the face of it, selling some stocks with big gains now seems reasonable. The market is toppy; at the time of this writing, it is at a two-year high. Housing, on the other hand, just seems to be going lower.

This led one well-informed investor to ponder, “Should I sell some stock, buy a depreciated house, rent it out and make some money? Since I have a good job, I know I can get a mortgage. That expense and others will be deducted from my taxes. When the housing market finally goes up, I can sell at a profit.”

In short, the investor was thinking he could have his cake and eat it too -- get a tax deduction when he rents and make a profit when he sells. Whether or not this plan works depends, at least in part, on where he buys the house. A May 10 article in the New York Times addressed this scenario brilliantly, providing practical information as well. The answer is all about a scientific look at how much it costs to rent housing versus buying.

This is called the rent ratio. David Leonhardt, the author of the article, defines it as the price of an average home divided by the annual cost of renting that home. Leonhardt calculated the rent ratio for 55 metropolitan areas across the country. If the ratio is below 15, buying is a reasonable option. On the other hand, if the ratio is above 20, leaning toward renting might be more cost-effective.

For example, the rent ratio for Manhattan is 29.2, so it might not be such a good time to buy a condo there to rent for profit. Chicago has a rent ratio of 15, which might represent a better opportunity. (You can figure out your own situation using this calculator.)

Investors who are considering buying homes to rent are not unique in this housing climate. When high down payments are required to buy a house, first time owners and those trading up often are unable to make the initial outlay. Those that are able tend to be individuals that are opportunistic. This means they often purchase housing to make money rather than to live in it.

Of course, there are risk factors too. Will the investor unbalance his asset allocation by selling stock to buy real estate? Can the investor really get a mortgage, even with a large down payment, and then for what rate? Will he keep his job so he continues to have a steady income? What about his health; if it deteriorates, he could feel burdened by being a landlord and decide on a “forced sale,” meaning he might not be able to make as much as he had hoped for or even his investment.

Nevertheless, all of the above are unlikely occurrences and could, in part, be covered by some kind of insurance. This investor may, indeed, be on the right track. He knows he can’t control the market, but at least he has some power of management over his real estate investment. In addition, it is those that think in terms of opportunities instead of maintaining the status quo that make the greatest financial gains in life. Perhaps this individual is one of them.