This article initially appeared in Canadian MoneySaver Magazine.
Your firstborn is approaching one of their major rites of passage – their high school graduation – and you’ve got a couple more that are growing like weeds. Wasn’t it just yesterday you were driving them to swimming lessons and squirt soccer practices? On top of those three full-time jobs, your parents need more and more help as they enter their Golden Years, that promotion at work isn’t going to take care of itself, and every time you get 10 minutes to take a look at how your finances are doing it looks like things are ok… you hope.
If someone told you that now was the perfect time to jump headfirst into becoming a landlord and learning about real estate, you’d likely stare incredulously at them through sleep-deprived eyes and question their sanity. If that same crazed individual then told you that you should make your 18-year-old son or daughter the property manager for this large proposed investment, you’d probably have to laugh at the sheer audacity of the individual before quickly kicking them out of your house.
I’m that crazy someone.
Ready to Be a Landlord?
Several parents across Canada are looking at the increased expenses that come along with their children’s post-secondary adventures as an opportunity to make the successful leap into purchasing their first investment property. After all, most parents are going to be helping their precious little angels pay rent to somebody – why not keep that equity in the family?
This entrepreneurial niche of parents often choose to purchase a house relatively close to campus for their children to live in while going to school and then rent out extra space to other students in order to generate the cash flow that any successful rental property needs to thrive. This might initially seem like a risky venture, but when you crunch the numbers, could it really be that much more risky that simply handing over thousands of dollars in residence fees every semester for each one of your children?
$30,000 Can Buy Some Decent Home Equity
The average student that lives away from home for four years as they complete their undergraduate degree will likely pay somewhere in the neighbourhood of $30,000 in rent during that time, with that number being a low estimate with a high degree of variance depending on what part of the country you choose to go to school in. Rather than part with a rent cheque for each of your children every month to fill the pockets of other landlords, filling your own pockets and building equity can make a lot of sense in the right situation. In the majority of instances where I have seen this strategy work well, the landlord’s children usually recruit one or two of their friends (in a perfect world they are family friends that everyone knows and are comfortable with) to rent with them as they all go through university or college together. Depending on the family make up, this could potentially mean 10+ years of relatively easy clients as each of your children attends school at a different time and brings some well-behaved friends along for the ride. Because there are considerable rent premiums close to campus, parent-landlords can often offer their child’s friends a slight discount on the market rate and still make healthy return on their investment.
Related: Advantages of Owning Versus Renting
Obviously this sort of arrangement doesn’t work as well if your children attend different post-secondary institutions; however, in many cases across Canada central locations are relatively easy to compromise on. With more and more young people finding they need a variety of credentials in our ever-evolving workforce, finding a spot close to public transit that serves both a major university and a skilled-labour-based institution is likely to be a good bet.
Will Your Child Turn the Home Into Their Frat House?
As in any rental adventure, the key is to find renters that won’t be too much of a hassle and cause a bunch of problems. Many people probably wouldn’t recommend the student crowd as the ideal renter demographic. This is where knowing your child and their friends comes into play a little bit. I’ve seen this setup work for several different groups of students, and it’s amazing how much more respectful young adults can be compared to the stereotype when they personally know the owner of the house, and have to answer to their friend if anything gets broken. On the odd chance that something does get broken (let’s be honest, beer pong can get a little hectic at times) it can actually be a positive thing over the long-term if the parent-landlords simply force their child and their friends to learn to fix whatever got broke. My buddies learned how to re-plaster, do a little dry-walling, replace some hardwood flooring, and a dozen other little maintenance experiences that will be quite valuable when they move into their own place.
Let’s check out the math behind a theoretical situation where a family with three children attend the same school. If parents-landlords were to buy a 4-bedroom house for $350,000, and amortize the mortgage payments over 25 years (with a standard 20% down payment of $70,000), and we assume a 3.9% interest rate on a 10-year mortgage (I make the assumption not because I endorse the 10-year rate option, merely to keep the math simple over a stable medium term), the monthly mortgage bill would come to about $1460. Most students will pay $400-$600 per month to live relatively close to campus, so at minimum you have the equivalent of $1600 of cash-flow (or cash-flow equivalency if you don’t charge your children rent) coming in to offset the mortgage if the siblings could find a fourth person. Once you calculate in repairs, property tax, and all of that other fun stuff, parents might not make a whole lot of money from month to month, but they are building some pretty substantial equity instead of paying other landlords over their children’s post-secondary careers.
It’s Pretty Tough to Move a University
In terms of making a pure real estate purchase, buying a multi-room detached house in a neighborhood that is close to a post-secondary campus is quite safe from what I can tell. Since there is always such a high demand to rent in these areas, housing prices rarely take a beating, and often appreciate at quite a nice rate. Because of the extremely low vacancy rates, having rental rates drop for housing close to campus is almost unheard of in Canada. My reasoning in calling a property like this a pretty safe investment is that if you consider that most educational institutions have been around for decades, and are heavily invested in certain areas, it is a virtual certainty that they aren’t likely to move anytime soon. This proximity to a renewable student population is the key to your property’s value as a rental unit.
Related: The Rent vs Buy Debate
If parents were encouraged by their initial landlord experience, renting out the house after their child is done with school is certainly an option since there will always be a demand there. I’ve also seen students choose to take over the mortgage from their parents (basically as a graduation gift from the parents to their child) after they are done schooling. What a great way to give your kid a leg up, right?
While buying a rental property isn’t historically the perfect investment, it still has a pretty good overall rate of return and represents a hard asset that can diversify your investment portfolio. Some people will quickly point out that you have to claim the rental money as income. While this is true, don’t forget to also factor in tax deductions for mortgage interest, property taxes, insurance, and upkeep on a rental property. The coup de grace as far as taxes go is that parents can actually pay their child a salary to be the “property manager” and that is also tax-deductible. If parents choose to sell the rental property when their children are no longer attending school, they will be on the tax hook for any capital gains that were made (unlike any capital gains on the sale of your principal residence). The silver lining if the local real estate market takes a dip and you choose sell at a loss is that you can use that loss to offset other investment income when tax time rudely arrives. There is a bit of a formula to figuring out what your capital gains would be when selling the rental property. It takes into account the cost of any upgrades you put into the house (although not general maintenance) amongst other things. Capital gains tax is also taxed at only half of the rate as other income, so it’s usually pretty manageable.
Finally, if you purchase a rental property for your children to live in as they attend school they will never have to worry about moving or where they will live the next year. They will also never have to deal with a residence advisor they don’t like, or a jerk of a landlord (well… hopefully they won’t consider their landlord a jerk anyway). That stability is worth something. There is likely some sort of direct correlation between stability and academic achievement. Your real estate investment could translate into less dropped courses, more scholarships, and several other positive spin-offs for your child, as well as a nice chunk of equity and some valuable real estate experience for yourself.