Turning private residence into rental property

Turning private residence into rental property

Bruce SteinetzPro Member
Member since 2022 · 27 posts · 9 votes

Hello fellow, investors.
I am trying to help a friend, who is thinking about converting his private residence into a rental because he is moving to a different city. I would like to hear what other investors experience has been in doing this.  He is trying to figure out if it would be better to 1) rent the property to generate cash flow (he has a very low 2.6% interest rate);or 2) to sell the property and take the equity and invest it in a larger project such as a down payment for an apartment complex,or 3) a third option would be to do a cash out refinance to use the considerable equity to use as the down payment for the apartment building while still renting the private residence.(in this last option, there would be far less free cash flow, because of the higher borrowing costs coupled with a higher mortgage Interest rate)

A question he has with option 1  is the mortgage company restricts the loan to owner occupied.  He probably could proceed with at risk that the bank may call the loan.  He would like to know what the likelihood of that option unfolding. Please list any negative consequences that he should be aware of. 

thanks

0Reply
143 views

Most Popular Reply

Drew SygitBusiness Member
Property Manager · Royal Oak, MI · Member since 2012 · 13k+ posts · 9k+ votes
10mo
Quote from @Bruce Steinetz:

Hello fellow, investors.
I am trying to help a friend, who is thinking about converting his private residence into a rental because he is moving to a different city. I would like to hear what other investors experience has been in doing this.  He is trying to figure out if it would be better to 1) rent the property to generate cash flow (he has a very low 2.6% interest rate);or 2) to sell the property and take the equity and invest it in a larger project such as a down payment for an apartment complex,or 3) a third option would be to do a cash out refinance to use the considerable equity to use as the down payment for the apartment building while still renting the private residence.(in this last option, there would be far less free cash flow, because of the higher borrowing costs coupled with a higher mortgage Interest rate)

A question he has with option 1  is the mortgage company restricts the loan to owner occupied.  He probably could proceed with at risk that the bank may call the loan.  He would like to know what the likelihood of that option unfolding. Please list any negative consequences that he should be aware of. 

thanks


 Doesn't sound like they have a lot of experience.

What's their support network like, so they have guidance?

How organized are they?

How much risk are they willing to live with?

There's no way ANYONE can give a solid answer with what you've posted!

See this reply in the discussion

9 Replies

Jump to latestLatest
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    10mo
    Quote from @Bruce Steinetz:

    Hello fellow, investors.
    I am trying to help a friend, who is thinking about converting his private residence into a rental because he is moving to a different city. I would like to hear what other investors experience has been in doing this.  He is trying to figure out if it would be better to 1) rent the property to generate cash flow (he has a very low 2.6% interest rate);or 2) to sell the property and take the equity and invest it in a larger project such as a down payment for an apartment complex,or 3) a third option would be to do a cash out refinance to use the considerable equity to use as the down payment for the apartment building while still renting the private residence.(in this last option, there would be far less free cash flow, because of the higher borrowing costs coupled with a higher mortgage Interest rate)

    A question he has with option 1  is the mortgage company restricts the loan to owner occupied.  He probably could proceed with at risk that the bank may call the loan.  He would like to know what the likelihood of that option unfolding. Please list any negative consequences that he should be aware of. 

    thanks


     All of the above can be correct, or all of the above could be incorrect. It is really difficult to provide any type of response without knowing the persons financial picture etc. If they live paycheck to paycheck having a rental can add a lot of stress, if they are sitting on buckets of money, then keeping as a rental is fine. Do they need the money for a kids college or anything else? So many factors can impact it, its tough to say what the right decision is because the answer depends on the person

    7e investments53 Reviews
  • Member since 2024 · 158 posts · 88 votes
    10mo

    Here are a couple points of consideration for your friend.

    1. Check to see if there was a duration where the home needed to be primary residence.  Sometimes the terms allow you to rent it after owning for a certain period of time.

    2. If it is turned into a rental, the insurance will need to be changed to landlord insurance and generally if insurance is in escrow you will have to notify the bank of the change.

    3. If the property has appreciated a significant amount and it has been a primary residence for at least 2 years, there will be no taxes on the gain (up to $250K) if sold within 3 years.  The tax savings may tip the math to option 2.

  • Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    10mo

    @Bruce Steinetz Most mortgages that I've seen require the owner to live there for a year, not the duration of the mortgage.  Somebody I know bought 7 properties 1 to 4 units as an owner occupant, essentially moving into each one for the first year plus, then buying a new property and moving there. It serial primary residence ownership, and perfectly legal.  It allows for the best interest rates and the lowest down payments.  I myself have done primary to rental as well the reverse rental to primary, and have had multiple primary mortgages twice.

    If it were me I'd keep the house and its low 2.6% mortgage.  Since 1960, there has only been one time where interest rates were that low, and we may never see those rates ever again.  In 1981 mortgage interest rates were were in the high teens.  I signed a contract that I would buy a property at 16% interest fixed for 30 years, and was glad when we settled at only 15% fixed for 30 years.  I would caveat the keeping of the property with the need for good property management, and the growth projections for the area.

    And if you have equity in the former residence that you would like to capture, then get a second mortgage that doesn't disturb the low interest first. While selling the personal residence and getting $250,000/$500,000 capital gains tax free is a great tax benefit, a second mortgage proceeds would be tax free barrowed money and the mortgage payment would be deductible rental expense on Schedule E   

    • Bruce SteinetzPro Member
      OP
      Member since 2022 · 27 posts · 9 votes
      10mo

      @David Krulac . Thank you for your very thoughtful response. I'll have him look at the terms of his mortgage a little bit more carefully. But I am hearing from multiple people that the rental restriction is the first year only. I agree that the 2.6% interest rate may not come around in our lifetime again.

      thanks for the suggestion of the second mortgage or HELOC option

  • Arman AhmedPro Member
    Real Estate Agent · Columbus Cleveland Dayton, OH · Member since 2024 · 2k+ posts · 961 votes
    10mo

    @Bruce Steinetz

    This is a common crossroads. In practice, many investors keep the low-rate loan and rent the home first to preserve cheap debt and flexibility, then reassess later. Owner-occupied loans typically allow you to move out after a year, and banks rarely call loans solely due to a move, but the risk isn’t zero, so reviewing the note and confirming with insurance is important. Selling can make sense if the equity can clearly outperform the rental’s cash flow and appreciation elsewhere, while a cash-out refi often hurts near-term returns because higher rates reduce flexibility. A simple way to decide is to compare the rental’s true cash flow and long-term upside against what the same equity could realistically earn in another deal, factoring in risk, time, and management effort.

  • Theresa HarrisPro Member
    Member since 2019 · 15k+ posts · 11k+ votes
    10mo

    I agree with Allison about point 3-how much has the home appreciated since they bought it?  Saving the cap gains tax can be a big one.  Also how much does it actually cost them to hold the property and what could they rent it for?

  • Benjamin AakerPro Member
    Rental Property Investor · Brandon, SD · Member since 2015 · 1k+ posts · 1k+ votes
    10mo

    It depends on whether he wants to be a real estate investor. If he doesn't have the mindset of a real estate investor, then he should sell. If he does, then for his first property, I recommend selling and buying a new property near where he is living. 

  • Drew SygitBusiness Member
    Property Manager · Royal Oak, MI · Member since 2012 · 13k+ posts · 9k+ votes
    10mo
    Quote from @Bruce Steinetz:

    Hello fellow, investors.
    I am trying to help a friend, who is thinking about converting his private residence into a rental because he is moving to a different city. I would like to hear what other investors experience has been in doing this.  He is trying to figure out if it would be better to 1) rent the property to generate cash flow (he has a very low 2.6% interest rate);or 2) to sell the property and take the equity and invest it in a larger project such as a down payment for an apartment complex,or 3) a third option would be to do a cash out refinance to use the considerable equity to use as the down payment for the apartment building while still renting the private residence.(in this last option, there would be far less free cash flow, because of the higher borrowing costs coupled with a higher mortgage Interest rate)

    A question he has with option 1  is the mortgage company restricts the loan to owner occupied.  He probably could proceed with at risk that the bank may call the loan.  He would like to know what the likelihood of that option unfolding. Please list any negative consequences that he should be aware of. 

    thanks


     Doesn't sound like they have a lot of experience.

    What's their support network like, so they have guidance?

    How organized are they?

    How much risk are they willing to live with?

    There's no way ANYONE can give a solid answer with what you've posted!

  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    10mo

    @Bruce Steinetz, as others have mentioned here, multiple factors could make all of these a viable strategy. If he chooses to just sell the property, he might be able to utilize a 121 exclusion, which allows you to take the first $250k ($500k if married) of the profit tax-free. It must have been his primary residence for two out of the previous five years of owning the property to qualify for the exclusion. This is almost always my first choice - if it's tax-free, take it! Even if you then go and buy another property to rent. Reset that profit clock!!

    Many times, primary residences don't make the best performing rental properties. But, in this case, the interest rate is a huge factor. And converting it into a rental can let them dip their toes into the world of landlording to see if they like it.

    If he converts the property to investment and sees how it performs as a rental, he would still have a couple of years to utilize the 121 exclusion if he chose to sell within the required time frames. In addition to this, he would also qualify for a 1031 exchange if he converted the property to investment, which allows him to defer all of the tax on profit and depreciation recapture if there is any after the 121 exclusion. This way, he could use the additional tax to reinvest in other investment property/properties or even larger ones, like multifamily. If he holds it longer and no longer qualifies for the 121 exclusion, then he could still defer all of the tax in a 1031 exchange.

    The 1031 Investor5140 Reviews
Join the conversationCreate a free account to reply, vote on answers and follow this thread.