Here’s a fun (?) idea for all you real estate investors out there ;)
From a friend of the blog after hearing about my 15 vs 30 mortgage conundrum, which I’ll be updating y’all on shortly…
Hey J.,
Have you heard of the concept of using rental properties to pay for your kid’s college? Brandon Turner on BiggerPockets talks about it quite a bit. It’s a neat concept and something I’ve implemented for my three kids’ colleges.
I originally opened up a 529 and started the traditional dollar-cost averaging index funds for my first kid 6 years ago, but after getting into real estate I haven’t put a dime towards any college funds or savings programs since.
The general concept might sound extreme, but the numbers can be fairly straightforward (depending on the market you are buying into). The idea is you purchase a rental property for each child when they are born, and then set the payment schedule to a ~15-year amortization payoff plan, thereby giving you a paid off place to sell or refi later to cover tuition.
As an example:
– Purchase a $150K rental that should at least break-even after rents vs. expenses. (I use $150k as a benchmark because that’s what I feel a decent 4-year education at a regular state school costs today)
– Assuming 20% down payment, this is a $30k upfront investment
– Assuming a 5% annual appreciation; after ~14.4 years the home may double in value (rule of 72; 72 / 5 = 14.4 years to double in value)
– You now have a paid off home with multiple options!
I personally like the idea of doing a cash-out refi of your now $300k home and getting ~80% back, or $240K which is tax-free (cash out refi’s are a non-taxable event).
Other than the initial ~$30k you put into the investment 15 years earlier, your tenants have essentially paid for your child’s college education :) Best part – you still own the property and can now take the tax deductions on the new mortgage again!
Here is a good article on it by Brandon: How I Used Real Estate to Pay for My Newborn Daughter’s College Education
Cheers,
– Brad
PS: I also really like the idea and plan on purchasing a small multi-family property (duplex or triplex) wherever my kids will be going to school. The idea being of having them live in one of the units and serving as the property/asset manager of the other units responsible for screening tenants, collecting rent, managing contractors for repairs, etc. If you are old enough to smoke, drink, and get drafted into the Army, my feeling is you are adult enough to learn about the trials & tribulations of investing/rental properties, haha.
That’s a good point on the last part there ;)
And honestly, not a terrible idea on the first one either, so long as you have the propensity for real estate strategery and actually enjoy it?!
I can barely wrap my head around owning a personal property again, no less taking on a fleet of rentals to manage!, so it’s not for me, but I know there’s a lot of real estate lovers up in here so wanted to at least pass it by in case you find it worth exploring more…
Anyone ever try this idea before? Or currently trying it? Anyone hacking it even further to get to that end goal faster?
I can’t say I’ve ever heard of this one until now, but I do love the whole “gigs for goals” concept here – something we’ve covered ourselves over the years, just on a much lower, less-passive scale ;)
There really is something gratifying of attaching an end goal to a specific income-generating source though. Whether it be from a simple little side hustle, or something much more grandiose like a rental property (or 10!).
As for me, I’ll be sticking to the boring ol’ 529s for my kids’ future, but I got nothing but respect and admiration for all y’all pushing those envelopes even further.
Lots of ways to cross that finish line, but you gotta be in it to win it! So be sure to GET GOING no matter what your poison of choice! Even setting aside $20 right now can get the snowball rolling!
XOXO
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While this all sounds easy, be prepared to deal with tenants that cause damage plus paying attorney fees to evict the deadbeats who quit paying their rent. My mother has owned apt. buildings since the 1980’s. She & her husband poured thousands into lawyer fees (some tenants even stole the appliances), maintenance, remodeling & repairs caused by tenants on top of snow removal costs (per town requirements). They recently sold one building for $298,000 which resulted in them having to pay $69,000 capital gains tax (even though they re-invested some of the $$ into buying another rental property). On the up side, one building they paid $58,000 cash for in the 80’s is now worth $1million. They gain $12,000 a month in rents on one building & $1500 a month on a 2 family home & their properties are seldom vacant. They’re allowed to raise rents 5% each year which helps keep up with inflation. I hope it all works out for people who try doing this to help pay for college expenses. Personally, I dealt only once with a rental property. The tenants did $10,000 worth of damage & disappeared. Never again for me!!
PS the property they sold for $298,000 they had paid $100,000 cash for it 25 years ago. So the $198,000 “profit” from selling it is reduced to $129,000 after paying the $69,000 capital gains tax (they just paid this 4/15/19 so these figures are quite recent). Of course they did a lot of repairs/remodeling/maintenance over the years & unfortunately this building was empty for several years during the recession so this investment probably was not very profitable.
ALL GOOD POINTS!!
And stuff most of us don’t think about as we get caught up in the excitement of it all, haha…
Always more to it than meets the eye.
They probably could have done a 1031 exchange (at least for the part they reinvested in RE)… the expenses of that can be a little steep but not 35% cap gains tax steep. Plus 1031 fees can get written off as expenses.
Dealing with useless sh^&tstain human renters is a completely different problem though.
$60K to a million in 34 years (assume they bought in 1985) is 8.74% annually. Assuming it was leveraged and they spend 5 hours a week of stress and elbow grease to make it work they made about $56 bucks an hour (if my math is right) – and this was tax deductible instead of taxed. Seems pretty good.
Love the idea. That’s what I’m planning to do. Plus, I want my kids to get their basic courses through community college to score some great savings. I brought this up to Paula Pant in one of her shows. When i hear co-workers talking 30-50k a year for their kids tuition I just can’t believe they let all that money go. I have 4 kids. I would need almost a million to get them through school. There is no way. I don’t worry anymore. We have had our first rental fur almost 4 years and I have been there to do repairs about 4 times. I have a great relationship with my section 8 tenant. I give then gift cards here and there because I appreciae their business. I tend to things in the house right away and in return they have never been late one day with my rent.
I have learned to be handy because I’m money driven, and that’s helped.
Thanks for sharing. Great article.
Sounds like it’s a great fit for you :)
Excellent idea on the community classes route first too – I’ve heard that a number of times and seems to be getting more popular over the years (probably because of how crazy the costs keep getting!).
There is a big assumption here, real estate is already too expensive and will not appreciate 5% per year. I’m expecting a real appreciation rate of somewhere between 0 and 2%. I would love to dip my toes in real estate rentals believe me I would but there is literally nothing around me that would cash flow. Even the cheapest condos are $230k for a 2 bedroom and those will only rent at around $1500-$1700/mo. I suppose I could expand my geographical search but I literally am the Jon Snow of real estate (I know nothing).
I really do think that the people who FI through real estate figured out how to short cut the system through leveraging debt. I wish I could join them.
Me too – I just don’t have it in me ;)
I don’t know why anybody would mess with tenants when they can just put their money in a REIT like CIM or MRRL and rake in dividend checks!!! Literally no effort at all except cashing the checks!
More control over it maybe? Since you pick the properties/tenants/game plan?
Good article. The key sentence in the article is:
“And honestly, not a terrible idea on the first one either, so long as you have the propensity for real estate strategery and actually enjoy it?!”
You are embarking on a 15 year “side hussle’ here. It is not for the faint of heart and you need to be able to stick to it. I call the residential rental business a “blood sport”, especially in my jurisdiction where Landlord and Tenant laws are definitely not in a Landlord’s favour.
I have 105 units and have been in the rental game for over 30 years. It’s been a good run, There was a long period of ugliness though, including nearly 10 lost years at one point. That was tough to get through.
I agree with Paul’s statement that real estate is not likely to appreciate by 5% per year. It really depends on where you live. If there is no population pressure then I wouldn’t buy anything. As long as there is some population pressure you will likely do o.k. If you’ve paid off the property it really doesn’t matter if the home has doubled in value. I would also strongly advise you to only buy real estate that you can manage yourself. Buying in a distant city is a recipe for disaster.
Finally, join a local Landlord group and learn something before going down this road. Forms, policies and procedures are crucial. And do not be afraid to spend money on quality legal and accounting advice.
105 units!!!
If you ever want to do a guest post here and share all your knowledge (and tribulations!) with us, we sure would enjoy it! That’s an insane amount of properties – wow! (and congrats!! You’ve got the game figured out!)
I’ve seen too many Judge Judy’s/People’s Court episodes to think of this as a safe investment. The profits from ten years of good tenants can be wiped out by ten months of horrible tenants.
Hahahahhaha…
Heya, since you probably looked into it, what happens to the 529 if they don’t go to college or get full scholarships? That’s what has kept me to a CD ladder for our daughter…
You can transfer it in other kids/peoples names or use it yourself or just cash out of it and take a penalty/tax hit worst case scenario (which is a pretty ugly one, but it’s not like all your money just disappears! Haha.. It’s just finally taxed after all those years of tax-free growth :))
UPDATE: Should have clarified more – the taxes/fees are for *earnings*, not the contributions you’ve made to your 529 over time:
“The most important thing to know about penalties and your 529 plan is that your principal can always be withdrawn without penalty. The money that grows over time is subject to penalties, though. Unlike normal investment accounts, the growth of your college accounts is treated and taxed as income and not capital gains.
If you remove funds for non-qualified expenses, then you’ll pay a 10 percent penalty on your gains. You’ll also be subject to income taxes on the gains and may even have to pay back any state income tax deductions you previously claimed.”
(Per that same article Shak mentioned below)
You can withdraw the amount of the scholarship without any penalty. In addition it can be tax free if you can use it to get computer and internet access too! Here is more about it.
https://www.thebalance.com/how-529s-affect-scholarships-and-vice-versa-4153510
Woww that’s pretty interesting, I never knew that about scholarships!!
It wasn’t intentional but we’re currently set up to do something like this if I don’t get too sick of managing the property in the next 15 years. I bought our first rental property just after we got pregnant and had intended to expand the empire by one property every year or two but it was exactly what we could handle between the main jobs, one rental, keeping kid and dogs alive with only some childcare, and keeping our marriage healthy. My instinct said we were not ready to add another rental after two years and that was exactly right because we ended up sinking that capital into a new home for us three years later.
Four (half smooth and half rocky) years later and our property has supposedly (per our broker’s estimate) appreciated about $70,000, recouping our down payment if we sold now, but while I’m ready to stop owning a rental with a terrible HOA, I’m not ready to only break even after tax and expenses so we’ll hold on longer but I know it’s a real risk and not a guaranteed clean transaction like Brad describes. There’s some amount of good luck involved for that to happen: getting really good long term tenants for one!
I keep telling myself it’s good to have a backup house even for our own use later in case the Big One demolishes our current home, and also that we should at least make back the equivalent of what we would have gained in the market if we had just invested that cash 4 years ago. We’ll see!
I think you’ll come out okay in the end :) Super smart to stop yourself though when you did before going overboard…That’s hard to do – especially in this community where everyone seems to be maxing out every last dollar!
Definitely an interesting strategy but not for me. I’d love to get into real estate down the line as a way to diversify our investments, but I think it’s a risky plan for college funding. I, too, will stick to boring 529s.
Another idea would be to buy a house in the city the child wanted to go to school and let the child live in it and have roommates and friends and collect rent from the roomies. I would buy a house that would be hard to destroy and lots of rooms/parking. Block and older?
I like it!!
But *only* if it’s a hard one to destroy as we sure were rough with ours and our weekly parties, haha… (damn those were good times, though…)
Having real estate appreciate 5% a year seems like a huge leap of faith. Talk about a financial bubble ready to burst!
I wondered if it were like that in the US, but it looks like I’m not the only skeptical one. It has happened here in very unpopular sectors being rehabilitated, but other than this…
My mom and aunt did it. Sorta. By accident. They kept an inheritance in Paris and rented it, in case one of their kids would study here (we didn’t). They sold last year. The profit was there, but clearly not THAT much.
(Context: compared to the rest of France, Paris is REALLY stupidly expensive for both renters and buyers, and the demand is so high you have 10 candidates for 1 place.)
I do intend to try it out at some point, when I’ve trimmed down the mortgage a bit. Not for kids, but toward my own FI.
Interesting (and believable!) about Paris! It’s only one of the top places to visit for pretty much everyone in the world!! :)
For visiting, admittedly. For living, I guarantee this is not a good PF decision.
Simple reason: people find they make more money on AirBnB than with classic renting, which mechanically rarefies the offer for permanent residents. The phenomenon exists everywhere, but is extremely acute in Paris, which means, if you try to live here, you’ll pay a fortune for something cr*p. Meh.
Seriously, when I was a state-employed teacher and got my assignment in the immediate vicinity of Paris, with teacher wages… Ugh. Glad I never went.
(That was the French culture minute ;) )
Oh dang!! Well then only for visiting indeed! :)
Kinda sorta related to the idea of buying a property where you plan to retire, and rent it out until then. Lots of obvious pitfalls but if your retirement plan is that solid and you love the area it can have some nice benefits.
Totally!
I’m glad you highlighted the persons question because I’ve always thought I would go the 529 route just because tax sheltered seemed the way to go, but I also read BiggerPockets and I’m a huge fan of Brandon’s way of having rental properties as a way to pay for his kids school. Another thing I don’t like is 529 has restrictions on how that can be spent for education whereas rental income you can spend how ever you see fit. I also just realized I’ve spent entirely way too much time debating this internally and I don’t even have kids yet!
Haha… there could be worse things to deliberate on! :) And now you have extra fodder for your own blog too!
I’m all for being prepared but in this situation I’d be putting the cart before the horse 100%. I have at least 20 years before my hypothetical child would even go to college. It’s booked marked as an idea to visit if I do have kids!
We didn’t use rental properties–we just used our regular family home. Sat on it for 20+ years, so when it was time to sell, made a good profit, bought a smaller place (1/2 cost and size) and the rest is going to college education for our two girls. Perhaps not workable in every market, but in suburban Chicago, it worked perfectly.
Plus such a great way to start your next life! :) Less to maintain and more for freedom! Haha…
Yep, I adore rentals for college, if you’re the right investor. We did this a number of years ago (5 actually at this point) and it’s working out perfectly. Here’s the short version;
We set up an LLC with our kids 80/20, we are 10% each but we are also the managing members (no running off to Europe or rollin in a Range Rover at 18!) so we are in charge. We used some cash and some home equity to gift the down payment to each girl (double gift, single tax year) then we used the equity to loan them the balance and funds for rehabbing the units. So yeah, there was an outlay on our part but it could have been through a bank.
We did the rehab (because we have the skill set) which saved us some, but if you factored in labor it really didn’t. We worked hard, had fun and did it the way we expect so that’s the win I guess! The key was we were buying under value in an area where rents were rising at turnover. A regular unit would increase maybe 5-7% but a rehabbed unit would rent for a good 20-30% more (they REALLY needed updating!) so that made it a no brainer.
We set up rents to cover existing and anticipated costs and we’d done the updates to mitigate emergencies and repairs in the 10 year window. We incentivized multi year rents and landed a long term renter (3 year with 3 yer renewal terms) out of the gate. She just finished year 5 and our second renter is finishing year 4 with no intent to leave!
But the math right? Like I said, rent covers all existing costs (insurance, taxes, HOA, minor repairs) which are minimal with the updates. So the rent actually becomes loan repayment to us, so the rentals are paying our HELOC as an expense to them. They will pay off as my oldest enters college. Both have 529’s to cover the first 2 +/- years depending on what school and what scholarship funds (they’ll never qualify for loans) are gained. The cash flow (taxed at their rate primarily) will cover funding the last couple of years (systematically saved into a NQ account) and bridge the overlap for 2 years when they are both in college. At the end of it they own property that can be 1031’d to a new rental (think duplex you’d live in just post college) or a really nice downpayment on a house when they’re ready. Our equity can be bought out or gifted, the units maintained or sold.
It’s complicated but simple in reality. We did the work up front to make management simple and we screened renters to reduce that risk as well. It’s not for everybody but it’s certainly not hurting my feelings!
Love it!!!
You guys have figured it out!!!! :)
What an interesting read. Definitely a different spin and point of view on college savings. I love the idea of real estate and rentals but the thought of dealing with tenants and burst pipes is enough to scare me away! Concept is spot on tho!
I like the concept, but don’t think I would want to force my kid to be a property manager. I used to own multiple duplexes, triplexes, and quads, but I stay away from them now. Heres why:
1.) Higher turnover
2.) Disputes between tenants and I have to get involved in the drama
3.) I have to cut or pay to cut the grass and do the landscaping
4.) I have to pay water and/or common area electric or gas
5.) I like the ability to move into the property for two years before I sell, in this case, the kid(s), could move into if you deed it over to them, and avoid capital gains tax, which would be pro-rated for a multi-unit property.
That’s five cents! Have a great day!
Haha..
5 cents that can be worth a helluva lot more down the road for some if they don’t take everything into consideration!
Thanks for dropping this!
So I am super into rental properties…and I bought a house for my first kid.
I stopped for two reasons.
1 – Its more work and paperwork complex than just dumping money into an index fund in an education account.
2 – You miss out on tax benefits of 529 accounts!
Houses are the ideal way to invest money that can’t go into tax-sheltered accounts but if you don’t hide your money from the taxman using your kid’s investments you are really missing a once in a lifetime opportunity.
529s are great :) One of the first things I set up as soon as a baby is born!