Here’s another email from a reader asking for some suggestions on a financial situation.
Please read below and give him your thoughts…
I’ve been thinking about purchasing a 3BR condo in my daughter’s college town and renting it for the long term. The college is tight for their on campus housing slots and actually have to resort to a lottery for housing each year since they mandate freshmen must live on campus the first year. My daughter did get into a dorm but most of the kids do wind up living off campus after their first year.
This almost seems like a no-brainer, although kids can be hard on their living space which is something to consider. I found a brand new 1800 square foot condo very near campus for 250K. I believe I could get 2100/mo. or 700/student/mo. which is comparable to what the university is charging for a dorm room (about 700/mo. for 9 months of the school year). I figure a property manager is about 200/mo. and assume about 300/mo. for property taxes and insurance. I would probably pay cash so no mortgage interest to consider but I might relook at that, (a point readers could debate). Assume HOA is around 200/mo. and maybe throw in another 200/mo for maintenance and repairs.
One downside I see is resale, simply because you are somewhat limited with market options. You either sell it to another investor who wants to do the same thing or maybe you get someone who works at the university who wants to live there but other than that, most people probably don’t want to be living in a space like this surrounded by college kids.
It could be harder to rent in the summer months since you are limited to a lesser student population attending summer school so that could mean all expense and no rent for 3 months of the year. So, if I assume I can clear 1K per month but only for 9 months of the year and then if I assume I pay cash and I think about what my 250K per year might earn over 10 years, that may be an interesting comparison. At this point, I am not factoring in the 3 months of out of pocket expenses if it doesn’t rent. Let’s see:
For a simple calculation, I won’t increase the rent in the first 10 years and assume that covers anything I have not thought about in terms of expenses during this time. So, I net 90K over 10 years in rent and if the property appreciates 2.5% per year, then it is worth 320K. If I sell it after 10 years then I pay 20K in commissions or net 300K. So, I made 90K in rent, 50K in appreciation and I have not factored in any depreciation benefits and other tax write-offs.
If my 250K was invested and earned 7% per year over 10 years, it would roughly double to 500K or 250K increase. When I think about all of this, I don’t know if it is worth it. I have no rental property so I’m not sure how much benefit I get from depreciation and other write-offs. There is no guarantee I will average 7% over the next 10 years by keeping the money invested but do the write-offs and depreciation net me an additional 100K+ in benefits over 10 years if I did get that kind of return on my invested money?
These would be some of the things I would need to consider. I am sure there are others I have not thought about since this is not something I have ever done before.
Anyway, let me know what you think.
Numbers do not look great especially if you can make 7% comfortably elsewhere. I look for places that go for 135k and rent for 1400 for full 12 month leases. The taxes are only 100 in NC and Hoa is 190. I also have it property managed so I only make around 7 or 8% so your scenario may net only 4%. Also these kids are extremely hard on the places so repairs can creep.
A couple of quick points.
– Transfer risk of summer months to tenants using a 12 month lease. This is probably market practice in the town anyway, but you can confirm.
– How far do you live from the area? I think $200/month for “management” of a brand new condo is very conservative. Seems like your daughter could handle this for the first several years.
– Does the school have a good football team? I do not have empirical data, but I think prices rise when team is playing well and fall when team is terrible. In other words, it is a good time to buy when team is NOT playing well and a great time to sell when the team is playing well. Ultimately, you make your money when you buy – so do not over pay.
– In lieu of the brand new condo, see if you can find a single family home that is more of a timeless design and within walking distance to campus. The “new” condo is nice now but may not age well.
Good luck.
Great points and yes on the football team. Penn State!
This does not meet the 1% rule. Many real estate investors start w this.
I’m confused by the “only could rent it 9 months a year.” Every college apartment/condo I or my friends ever rented was rented for the year — if we went home/elsewhere for the summer, we still had to pay rent for the place.
I’d set it up so that your rental year ends/begins shortly after graduation (if graduation is in mid-May, then the rental year ends May 31 with a new year starting June 1). You’ll have no problem finding tenants who need a place for the upcoming year and are willing to live on-campus/pay for the summer months (even if they’re not there) to ensure they have a spot for the academic year.
Thank you, that is really good to know. Being new at this, I was not sure what to expect. I really appreciate your insights!
I completely agree with Chadnudj. Having recently graduated college myself, all off-campus housing operated on year-round leasing -beginning around the end of May each year.
Did you consider the option of financing at today’s rates? Put 30-40% down, and leverage your initial investment for an overall better return. Leave the balance in the stock market. You’ll see less cash flow during your ownership, but will build up a little principal. Obviously, you have to account for the interest expense. I’d wager, with a good interest rate, you can make money on the spread (but it is a wager).
Great thoughts and certainly worthy of consideration. Thank you for your sharing.
We did this too! However we found a 2-3 BR single family dwelling. When our oldest was a freshman, one of her new friends parents had wanted to go in with other parents to buy a house for their student to live in/share with another student. We met the parents, and my husband was interested in doing the same. By December of that year they had changed their minds. So we struck out on our own to purchase a house by mid-April. Our second child is living there now, a college junior. We are 4 hours away and do much of maintenance; hiring out plumbing/HVAC calls/lawn care. We do a 12 month lease; & some break it — (we do not penalize for that) as it gives us more opportunity for maintenance & upkeep. We have had some summer renters also, who end up taking classes over summer & need a place til their next accommodations open.
Sounds like a great situation. We are on the other coast so that does present some additional challenges for us.
If the market has a lottery, there will always be parents willing to do the same thing in buying for their kids. Vet the tenants well. Grad students should be more mature than Freshmen.
I would agree with several of the other comments here. Looking at the condo alone purchased for all cash, the return wouldn’t meet typical numbers. However, your calculations are also quite conservative based on the assumption of only 9 month rent. I would look at the possibility of leveraged to increase your return as mentioned as well, but my additional comment would be to consider that this allows you to pick up a few units rather than just one for the exact same cash layout. Rates are quite low so your costs would not be much higher especially if you use a mortgage acceleration technique. Lower entry price, same benefits of appreciation times two or three, mortgage pay down by the tenants, increased tax benefits. Also, even if you can’t get a full year rental term there are other ways you could capitalize on it for the summer…perhaps reduced rate for use as storage or VRBO type of rent. Students can be hard on a place but you could minimize that through somewhat higher security deposit or parental cosignature. Many different ways to make this very profitable. You could even increase earnings and oversight if your daughter lived there…saves the dorm payment and has related eyes there at all times.
The numbers do not look that good because:
1. 9 month lease, have to get to 12.
2. Price to rent ratio is only so-so. Not terrible but not great.
3. All cash purchase. This is the biggest problem with your returns. You need to find a property that will give you decent cash flow on a 75% LTV mortgage. This will juice your returns. If it doesn’t make sense financed, it doesn’t make sense period.
I don’t know what the housing stock is like around the college but if it is available my advice is to try to find a 4-5 bedroom existing house and then rent out to 5 college students instead of 3. This will greatly improve your ROI. Finance the deal and if it works well after a year, do it again, and again. You should be looking for ROI of at least 15% annually when financed. If you can’t get that, it’s not worth the hassle in my opinion.
In the example you gave, 140K profit on 250K invested over 10 years would make me ill thinking about that from an investment standpoint given the risk and the hassle factors one is taking on to get an annualized return of 4.5%. You mentioned not counting depreciation or tax benefits but those are negligible because while you would get some benefit while you own it, when you go to sell it you would pay them all back with recapture taxes on the depreciation you claimed. So even though you would only have 50K of capital gains you would pay tax on that plus recapture tax on about another 75K. So you would have a hefty tax bill in the selling year unless you 1031 exchange the property into another property, but if you are getting out then you may not be looking to stay in another property. So the only benefit you would get is some time value of money for taking the deductions in the early years. But if you didn’t set that money aside and reinvest it but rather let it get spent because it was just an extra grand here or there off your taxes, then come selling time you would have a huge tax bill without the extra money set aside to pay it and you would feel like you got robbed. It happens all the time to people who do not understand that depreciation is not a tax avoidance system, its a tax deferral system, and if you spent the money you saved, then when the bill comes due it eats a large portion of your remaining profit.
I truly cannot emphasize this enough. Whether you are going to put financing on it or not, always make sure it will perform well with financing. If it won’t, it’s not a good real estate investment. (HINT: Your scenario above won’t perform well because with a 4.5% annualized return after appreciation, interest alone on the property would eat all your return and in fact would be cash flow negative all 10 years until you got the capital gains at the end. You have to find a property that will return better numbers than this) (Caveat: I can only speak to this financing rule based on today’s interest rate environment. In the world of 1981 when interest rates were 15% that rule might not hold. I haven’t tried to invest in that world since I was in grade school at the time, but in today’s world of 4-5% interest, that rule is iron clad.)
All great points to consider. Thank you!
If it doesn鈥檛 make sense financed, it doesn鈥檛 make sense period. – Very True!
I spent my college years in a house we rented from my best friends parents. It was one of my favorite parts of college. I think there is some intangible value in having your daughter in a place you own during her college years. That being said, if you intend to keep as a long term rental, I’d make sure it makes sense up front (great responses already above).
Two things: the last time I looked into this, an experienced landlord explained that his rent was paid up front for the entire semester-the college does it, so he does it too.
Although I do not rent college units, I have owned other rental homes for 30 plus years. My other comment is that your scenario is filled with “I think I can get”, “assume I can”, etc., but very few solid numbers. More research is needed to project this out.
I personally rented places “summer only” when I stayed in my college town over the summers (40 years ago). I lived on campus during the year. So, there is a market if you place is vacant.
I agree with your comments. I’m on campus this weekend for parents weekend and will be doing more research so I have less assumptions going forward. I appreciate your feedback.
I would find out if the condo allows rentals, or if there is a cap on rentals. Keep in mind, there may not be a cap on rentals now, but the HOA could vote it in at a future time. A better option, in my opinion, is a single family dwelling. This is coming from someone who owns a newer condo, and is going to pay a huge assessment for new siding (construction defect). So, you can get burnt on a condo.
I appreciate your comments. These are definitely things I need to consider!
My recommendations:
– As others have mentioned, you rent for 12 or 24 months, with good clauses in the contract in case they want to leave early. The good news is that if you have a good property, you will typically get new tenants quickly from word of mouth. As people graduate, they let others know they are vacating.
– make sure you have good language regarding sub-letting. you might get a tenant that then turns around and tries to fill up the apartment with additional people to lower their cost.
-Make them get renters insurance.
-due diligence on their finances ahead of time is a must. in my case, target market is foreign students who typically have lots of resources.
-inspect property at least once a year.
-you need to work out finances to see if its worth to you, but the roi you are looking at seems low. there might be other properties that cost half as much that would be better income generators.
-make sure you are adequately insured and consider buying under llc
-set up po box for rent checks, not your home address
– accept that toilets will be clogged, refrigerators will stop working, furnaces will need maintenance, light bulbs will need replacement, walls will suffer punctures, carpets will be stained, etc. its part of the business but dealing with these issues is not as hard as it sounds. account for this in your budget under expected maintenance costs. if you dont spend, then its upside to you.
good luck
Thanks M15 for your thorough analysis. BTW, loved your MI story!
ProTip as mentioned earlier by M15:
Rent to Foreign Students who are doing engineering or masters, they don’t party, most are focused on studies, have ample resources to pay rent and most importantly have a great network & tight knit community with other incoming students. As a result, all you have to do is find one group who will in turn pass on your apartment for rent to other incoming students on their own. Hence you don’t need a property manager!!! The apartment I rented for first time 10 years back is still being passed on to incoming students!
2) A lot of them stay back during the summer to finish up extra credits, hence your apartment will easily rent 12 months a year!
Let me know where I can send you an invoice 馃檪
That really does make a lot of sense and thank you for pointing it out!
Interesting read on the whole college lodging. This is something the Mrs. and I have been speculating about when our kids do go to college. Should we buy our own housing for our student(s) and rent out the other rooms?
I agree with previous posts about the numbers not making sense even if the deal is financed.
A couple of adjustments and suggestions to make:
– Assume you will increase the rent every year since maintenance, taxes, insurance, and other expenses go up every year. (in my experience this is true)
– Look for Single family homes with more rooms so potentially more students paying rent, higher cash flow to improve the numbers.
– Consider financing the deal with as little as possible. (20% if you can to improve the numbers. You can also keep the difference invested @ 7%)
– If you find a SFH you could slate what would be the HOA payment on the condo, to the ‘maintenance’ category on the home.
Good luck, and great points made.
I appreciate your suggestions and tweaks to some of the comments. Awesome!
I have not done this, but thought about it (with 4 kids going to college). Definitely would recommend 12 mo leases (all our kids always had to do that in their housing beyond the dorms, always ran from August to July). Definitely require parents to co-sign or guarantee the lease (unless renting to grad students with good credit scores, as suggested). Require 1 month’s security deposit, forfeited for damages, and mandatory (~$200) cleaning fee (usually standard part of lease contracts), that may reduce expense and risk of renting to college students. And be cautious about counting on each of your kids to be renters for 4 or more years, if you have several kids and expect that they will all attend the same college. One of mine did not want to go to the large state university in town, and was much better off going where he ended up, another quit school after 1 year.
Thanks ROG, lots of moving parts for sure and a lot to consider from positives and negatives. I appreciate your input.
My experience in this area has been negative. Points to consider:
– Rents in college towns rarely go up
– There are always new condos and rentals coming on the market to give you competition
– Wear and tear, as well as emergencies will happen – even with foreign students
– Do not expect your child to act as a responsible property manager – no matter how mature they may seem
– Remember non-discrimination housing laws also apply to students – be careful who you turn down and why
– It may not be possible to legally require tenants to have renter’s insurance
– If you include utilities, as many landlords must in order to compete with college housing, expect higher than average expenses
– Do not expect your property to appreciate much in a college town
– Expect higher mortgage and insurance rates for student rental properties
@J-P
3 things you point out that seem counter intuitive to me. I would be interested to hear your experiences that explain why. For starters I am going to assume we are not talking about third rate community colleges, for profit colleges like the kind in the news the last few years that have been shut down by govt agencies, or state universities in small towns that may be specialized and facing declining enrollment, etc. Basic good state 4 year universities in a stable or growing demand city for example.
#1. Rents in college towns rarely go up.
Why would that be? On campus housing costs seem to keep going up. Pardon the university analogy here but this would seem to violate Econ 101. If off campus prices stayed flat while on campus went up then demand for off campus should increase which in turn would lead to increases in price. My nephew was just complaining to me last week about off campus rent increasing for him next year by 8% in one year. Off campus housing supply is limited, demand is strong, the market is captive, & the consumers have little choice. It’s almost like a natural monopoly. I was explaining to him that this was basic Econ 101 and price in-elasticity due to a captive market. He is taking micro economics this semester, but was less than enthusiastic about being part of a living example of what he was learning.
What in your experience has kept this from happening?
#2 Do not expect your property to appreciate much in a college town.
This would seem to be related to #1. If #1 is true then this would make sense, but if rents do increase then property values should too.
#3 There are always condos and rentals coming on to the market to give you competition.
What is unique about a college town that makes new supply more likely than other places? This seems like it could be a location problem. if you are close enough to campus you have a captive market. The supply is limited by land and zoning requirements. If you get too far away from campus then supply could come from anywhere but at that point it might be hard to suggest you are predominately student housing anymore.
What has been your experience with new supply coming on to compete, and why would people be bringing new supply if rents and appreciation were stagnant?
The one thing that does seem like a potential risk to me is the notion of a potential college bubble. With student debt going through the roof, more college students struggling to get jobs after getting degrees with limited career application, the continual improvement and availability of online courses and degrees, etc, one wonders if there will eventually be a peak in demand for and decline in enrollment at physical on campus universities. I am certainly not predicting that outcome, but if that were ever to happen then student housing properties would become an investment pariah. Rents would fall and properties would depreciate. But I believe that is a different case than the one you are making so I would be interested in the experiences you have had which led you to these three points.
@Apex
All of my points are based on my particular personal experience investing in two student rentals in two college cities (Harrisonburg and Richmond VA).
#1 Rents have not gone up for the units I purchased 7 and 10 years ago (I had to go below market to attract tenants a few years)
#2 No appreciation and several years of declining values over the past 10 years. Values have not reverted back to purchase prices.
#3 Harrisonburg in particular has seen a large influx of new student condos and the universities have built their own new housing. Richmond has many refurbished small apartments competing with established owners.
Yes, I agree that in both cases I have a location problem. Perhaps Penn State will be different, but what happened to me can happen anywhere.
Thanks for the reply J-P. I don’t do student housing so I appreciate your first hand experience. I was trying to find out if it was student housing related or town/location related. Hard to know for sure I guess.
Thanks again for the reply.
Thanks J-P, everything you say makes a lot of sense!
No.
1. Doesn’t meet the ballpark “1%” rule. Do your homework on this.
2. It’s a condo so you’re going to be paying more for management and have less control over expenses.
3. It’s your daughter’s college town, not yours. If you really want to be a real estate investor, find a different town. When family goes to visit her, the conversation needs to be about her college experience, not your rental experiment.
Thanks Bill, and thanks to all who commented on my post. I just came back from a visit with my daughter and decided not to invest in a place for her to live and rent. All of the comments here were extremely helpful and compelling.
I am very comfortable with our decision and again, very much appreciate the time all of you took to weigh in on this!
Rental Rookie
The one thing I noticed is that you and all comments never mentioned the fact that you HAVE TO pay for your student to live somewhere. The finances are somewhat skewed for the years they are there as a student. I’m currently paying around $13k to a college for room and board, so that’s lost money either way.