Is your college kid really prepared to be a landlord?
Our youngest son, fresh from two years of teaching abroad and now looking for a job in San Francisco, called recently with his latest housing outlook. After crashing on couches and spare bedrooms with family and friends, he’d found a basement unit for $1,200 a month near the University of San Francisco.
“It’s not really an apartment,” Chris said. “More like a couple of large rooms of a big home. The former tenant moved upstairs, so the new guy gets the basement. I’ve looked for weeks, and it’s the cheapest thing I could find.”
That big number for rent near a university brought back memories of the research we had done more than a decade ago when his siblings began heading off to college. I kicked myself for not borrowing some cash to buy a college rental when the first child enrolled at an out-of-state school because the neighborhood around the university appreciated significantly. In addition, we discovered a huge lack of off-campus housing for faculty and staff.
So, when the third kid took off for school, we bit the bullet and found a cute home just a few blocks away from the college. The first year worked out great, but the second year was a disaster. When our son got a chance to study overseas, the tenants he recruited turned the place into an “Animal House,” complete with fake fraternity parties and all-night keggers. The neighbors were furious and the cops had it on their routine cruise route. We painted the place, replaced the carpets and sold the house the following year. Any savings from dormitory living and home appreciation was more than lost on repairs and the anxiety of dealing with the cops and the surrounding community.
So, if your child is headed off to a quaint little college town and you are going to spend the next few weeks wondering about the possibilities of a college rental vs. the costs of room and board in an on-campus dorm, the first question should center on maturity. Will your kid be able to handle the maintenance and responsibilities of the house and recruit responsible roommates willing to do the same? Remember, their primary job is to go to class.
If your kid passes the first test, then take a look down the road. How many years do you expect your child to live there and, if she transferred, would you want to rent to students who are not family members? Many accountants advise parents with college kids to estimate what home prices will be when the child’s coursework is done. Will that market appreciate at all, or at least remain even? Surveys show most college markets (75 percent) show modest appreciation, while others (major cities like San Francisco) are unrealistic because of high purchase prices.
But just how much appreciation is necessary to make the numbers work? It used to be that a popular rule of thumb was if the house appreciates as much as the parent’s annual tax bracket, the deal may definitely be worth doing.
For example, if you are being taxed at 28 percent and feel the investment will appreciate 28 percent in the time you hold it, it could be a nice option for everybody involved. These days, while a few areas might produce that degree of appreciation, that long-term goal seems far too optimistic. However, lower interest rates have helped to counter appreciation and make some situations more workable. The 6.5 and 7.0 percent loans are now 3.5 and 4.0 percent.
For example, let’s say you found a home in a college town that costs $275,000. You would make a down payment of at least $27,500. If you finance the remaining $248,500 at an interest rate of 4 percent over 30 years, your principal interest payment will be about $1,186 a month. Toss in taxes, fire insurance and a few light bulbs and you will be looking at $1,300 a month.
That’s not too bad, especially if you can get three other mature students to pay $500 a month rent, not including food and other essentials. Students could probably eat and live in a dorm for less, but this way they have an alternative to noisy halls, and the parents have a fairly secure, four- to six-year venture.
Typically, the student manages the building while mom and dad reap the tax benefits and appreciation that come from owning a rental home. A big decision is how to treat the college home as far as Uncle Sam is concerned. It could either be a second home or an investment property.
Also, there is the initial problem of handling the down payment and monthly expenses in addition to skyrocketing tuition fees. But all are contingent upon the student-landlord passing the responsibility test.
Next up: Creative ideas for turning a community eyesore into a college rental.
Tom Kelly, former real estate editor for The Seattle Times, is a syndicated columnist and talk-show host.
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