These days, parents are more involved in their kids’ lives than I am in my own life. Parents do things like insist on sitting in during a 4th grade class to make sure the teacher is doing stuff right, a request that would probably be met with the middle finger if I was said teacher. That is an actual true story. Well, not the middle finger part.
This doesn’t end once the kid hits puberty either. We’ve all heard the horror stories of parents writing letters or making phone calls to employers or professors that SCREW OVER little Johnny. Parents are very active in helping their kids with everything from picking out the right university to getting them laid. You don’t believe that last part, but I’ve seen many parents try to fix up their kid with some “nice boy” they’ve met.
Frankly, I don’t get any of this. Take it from the person who knows best, a non-parent. The best part about being a parent is when the kid is out on their own, and you don’t have to worry anymore. If the kid screws up, it’s their problem. You get to observe from a distance. It’s the same reason why grandchildren are better than regular children. You get to ship them back to mom and dad once they turn into the spawn of satan.
Even so, some parents work really hard at helping their adult children, especially when these kids first go off to university. Since I guess giving them money, doing laundry, answering a million questions about how to operate a stove, and so on isn’t enough, some of these parents decide to buy a house for their kids while they’re away at college.
Here’s how it goes. The parent buys a four or five bedroom place, preferably near the school. Junior occupies one of the bedrooms and rents out the others. He (or she, but it’s most likely a he) is in charge of collecting rent, making sure his buddies don’t destroy the place, and so on.
People who support the strategy (like Kyle from Young and Thrifty) say it has a few big advantages. You’re teaching junior about things like dealing with people who owe money. Rental property near universities will always be in demand. And if your kid stays in the city, you can just let him take over the mortgage payments, gifting him the equity.
(Aside: I did a deal like this [gifted equity] while I was a mortgage broker. Lenders hated it. I got it done, but it was frustrating. Something to keep in mind. Also keep in mind I wasn’t a great mortgage broker.)
Fine, I’ll admit those are some potential benefits to the plan. But it’s pretty easy to counter them with some disadvantages as well.
Renting to college kids is terrible, as anyone who has ever met a college student can attest. You’d think a guy who used to use the pen name ‘TeacherMan’ would be aware of this.
Your kid might also be a terrible landlord. 18-year old Nelson sure would have been. Hell, 32-year old Nelson still gets butterflies calling up people that owe him money. And he’s an uncaring asshole who refers to himself in the third person for some reason.
If your kid doesn’t decide to stay in the city, you’ve got a decision to make. You can either keep renting the place out, whether it’s to college kids or a family, or you can sell it. If you keep renting, you’ll have to find a good property manager in a city where you don’t live, a task I can attest is easier said than done. Or you’ll have to find a college kid you trust to run the place for you.
These aren’t insurmountable odds by any sense. But they are very legitimate drawbacks.
There’s one more big reason why buying a house for your kids in college isn’t a good idea. You’re not only making a giant levered bet on real estate, but you’re making a giant levered short-term bet on real estate, an asset that will cost you at least 5% to sell.
In Kyle’s piece, he says that even if you break even on rent, you’ll be fine because you’re “building equity.” Which is all fine and good — assuming the market keeps going up.
Say mom and dad buy a place worth $400,000, which is about the average price for a house in Canada. It’s a four bedroom place, and junior’s three friends drop $600 per month to live there. Cash flow is $1800 per month.
If mom and dad put down 5% and have to end up paying CMHC mortgage insurance fees of $13,680, they’re on the hook paying back $1821 per month. If that was their only payment, they’d be okay.
Are utilities included in rent? Just about every roommate situation I’ve ever come across they are, but let’s assume they’re all chipping in for utilities, just to help out their friend.
The parents still have to pay house insurance ($100 per month), property taxes ($250 per month), and maintenance (we’ll assume $200 per month). Add all that up, and mom and dad are subsidizing the place to the tune of just about $600 per month. Over the first four years of a 25-year mortgage, mom and dad are out $28,800 out of pocket.
But, as Kyle says, mom and dad have built up some equity. Over the first four years of the mortgage (fixed rate, 2.79%), they’ve paid down $46,184 in debt. Subtract the $28,800 they paid to subsidize the place, and they’re at $376,296 owing. Not bad for a place that originally cost them $393,680. That’s a profit of more than $17,000 on a $20,000 out of pocket investment.
Ah, but what happens if junior wants the hell out of dodge when university is over? If mom and dad sell the place (assuming the value stays constant), they’re looking at more than $20,000 in real estate fees. There goes the $17,000 profit.
What happens if the place falls in value just 5%? A house that costs $380,000 would cost $19,000 to sell. The total value would be $361,000 after closing costs. We have to then subtract the $28,800 the parents paid to subsidize the place and the $13,680 in CMHC costs, getting our total value down to $318,520. Add back the $46,184 in principal paid back, and mom and dad lost more than $36,000 on the deal, which is 180% of the original investment.
Let’s look at the alternative. If mom and dad just gave junior $600 per month over an eight month school year times four years, it would cost them $19,200. That’s it. That’s the whole cost, right there.
Thus, mom and dad are making a massive, leveraged bet on a strange real estate market during a national housing bubble that the value of the house won’t decline even marginally while they own it. If it goes down 5%, they’ve lost their entire investment plus another $16,000, and that’s even after building equity. If it goes down 10%, look out below.
It comes down to risk and reward. If you’re shelling out $600 per month for your kid to rent a room somewhere, you know your cost going into it. If you buy a whole house, the value could go down, and you could not only lose your down payment, but also your down payment plus much more.
(If you want to be really depressed, run the numbers again if the house declines 10%, 15%, or even 20%. At 20%, it’s the kind of loss that could wipe someone out.)
It comes down to helicopter parenting. Parents want to help, so they buy a house for their kids. Maybe it’s better for the kid if mom and dad gives them money with the expectation that they’ll find their own way and their own place to live. Parents often forget that adult kids are capable of making decisions on their own. College is the perfect time for them to start working on that.