Preparing For The College Years
A new trend in real estate investment is emerging: parents investing in real estate to fund their children’s college education.
With the decline of the stock market in the past decade, more parents are seeking to invest for their children’s future through other assets, including real estate. These parents believe that the time is right to purchase real estate because of low prices and mortgage rates, and a strong belief that real estate prices will show considerable appreciation by the time their children are in college.
The idea is to purchase a house as an investment property when a child is born or very young. Ideally, a 15-year fixed rate mortgage is used for a property that cash flows in the first year. By the time the child has reached college age the property is paid for and the parents can sell the asset and use the gain to fund college. Not only has the equity in the property grown over 18 years, they’ve benefitted from the yearly cash flow as well.
Here’s how the scenario might play out:
Let’s say our fictional parents purchase a $100,000 house with $20,000 as a down payment. They take out a 15-year mortgage for the balance at 6.75 percent interest. Their mortgage payments are roughly $8,945 for the year (or $708 per month).
If they rent the house out for $1,200 a month and have around $325 per month in expenses (taxes, insurance, repairs), they should see about $2,005 in cash per year from rental income for the first 15 years. From years 16-18, the expense of the mortgage is eliminated, yielding them $10,500 in cash flow annually. Over 18 years the total cash flow equates to $61,575. Note that this conservative estimate does not include potential rent increases that will increase cash flow and will help offset additional property taxes. Nor does it include interest earned if the parents decide to reinvest cash flow.
In 18 years the property will have appreciated, too. The standard rate of appreciation for real estate nationally over the past 40 years has been 3 percent. At that rate the $100,000 property they bought would be worth $170,243 at the time of sale.
The initial $20,000 investment would have earned $150,243 over 18 years - a return of over 13%. Including cash flow, the return is 15%!
While it is difficult to determine what future tuition will be—increases in tuition have spiked dramatically in recent years—a $230,000 ($170,000 sales price + $60,000 in cash flow) cushion should be enough to soften the tuition blow.
Investors aren’t limited to purchasing real estate to fund college; many choose to purchase property during the college years to provide their children with a home and save on room and board.
In a survey of Coldwell Banker agents, 64 percent saw significant number of parents investing in college-town real estate for their children. With increased room and board and the high demand for rental property in college towns, the strategy makes sense.
San Francisco-based parents Katie and Dale have purchased a house with multiple bedrooms for their children, leasing the other bedrooms to other students. Because of the high demand, the rent helps pay the mortgage on the property and the parents plan to sell when their children no longer need the house.
In the long run, these savvy parents are saving money and helping to provide their children with a stable place to live during their college careers.