Second-home purchase beats cost of college dorm living

Investment shelters kids, offers profit potential
By: Tom Kelly: Inman News
My bank account is not any larger, nor does my debt load seem any smaller. However, for the first time in five long years, we have only one child headed back to college.

I would like to see Andy finish his next two years as fast as possible (the academic equivalent of prepaying your mortgage) and save the cost of another term, but there are rumblings of his taking a semester off to work in the film industry. (Ah, a semester off. Had I taken a semester off in 1970, I would have lost my student deferment from the military and been given an express ticket to an oceanfront in Southeast Asia.)

Andy, like many college students today, has no obligation to live on campus. In fact, college dormitories are so jammed at many schools that individuals are encouraged to seek off-campus housing.

If you are preparing to drop your son or daughter in a college environment, payment shock is probably alive and well in your household. And, you have probably asked yourself – especially if you have been through the drill with an older child – if this is a good time to consider buying a home near campus as an alternative to dormitory living.

But before you start visiting homes for sale near a college or university, take a look down the road. How many years do you expect your child to live there and, if he transferred or "stopped out" for a term, would you want to rent to his friends or students you have never met?

Many accountants advise parents with college kids to estimate what home prices will be when the child's course work is done. Will that market appreciate 5 percent to 7 percent a year, or perhaps 30 percent in five years?

If your child is headed to an established college or university, the chances are very good your investment will show at least modest appreciation. Even historically slow housing areas are experiencing a comeback, and homes in college towns typically have appreciated at a greater pace than the national average.

But just how much appreciation is necessary to make the numbers work? I've been given a rule of thumb that 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 25 percent and feel the investment will appreciate 25 percent in the time you hold it, it could be a nice option for everybody involved.

Typically, the student manages the building while mom and dad reap the tax benefits and appreciation that come from owning a rental home. Often the venture won't work because some buildings near schools are too expensive for the numbers to properly crunch. Also, there is the initial problem of handling the down payment and monthly expenses – in addition to skyrocketing tuition fees.

Let's say you found a home in a college town that costs $200,000. You would probably make a down payment of at least $20,000, perhaps coming from the equity in your primary residence. If you finance the remaining $180,000 at an interest rate of 6 percent over 30 years, your principal and interest payment will be about $1,080 a month. Toss in taxes, fire insurance and a few new keys, and you will be looking at $1,400 a month, maybe a bit more if the low down payment requires mortgage insurance.

That's not too bad, if you can get four mature kids to pay $350 a month rent, not including food and other essentials. Students could probably eat and live in a dorm for less, (young women rarely eat dormitory food anyway) but this way they have an alternative to noisy halls, and the parents have a fairly secure, four- to six-year venture.

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. If it's definitely going to be a rental, you can't rent to your children and their friends for a song. The IRS will not allow you to show a taxable loss on the property if you personally use it for more than 14 days or 10 percent of the total rental period. "Personal use" includes renting to any relative unless you charge a "fair market rent."

If the student-partner does not pay rent, depreciation cannot result in a taxable loss. Expenses may be deducted, but not to the point where an actual loss is shown. In order for the parent-student partnership to work, students must be responsible landlords. So, if your student is not, perhaps you can choose one of his or her friends who are more organized and maintenance-oriented.

Next year, we go back to having two youngsters in college at the same time. Could they possibly be at the same school? Would I dare to suggest under the same roof?

Tom Kelly's book "How a Second Home Can Be Your Best Investment" (McGraw-Hill) was written with John Tuccillo, former chief economist for the National Association of Realtors, and is available in local libraries and bookstores. Tom can be reached at news@tomkelly.com.