Should I partner with my college student on a real estate investment?

Taking a risk on our kids can be scary and unpredictable. However, do the potential benefits outweigh the risks and anxiety? It’s been a year since I started this blog. I wanted to see the results of my own Investment experiment with my daughters before sharing it with you. It’s been quite a year.

Reality has a way of catching up and beating down the novelty of purchasing a property. Choices are made; feelings can get hurt, and then, with time, we learn and move on. My goal in all of this is to be an advisor and consultant to my daughters. I presented them with an opportunity that If embraced with diligence and responsibility, could provide a financial cushion for the future, but more importantly, teach them life lessons, financial investing, and provide stable housing.

I wanted my daughters to learn what “adulting” is all about with bills, stress, relationships, work, and even investments and planning for the future. I feel fortunate and delighted that they have experienced and overcome quite a few struggles this year. It wasn’t easy; nothing is easy. I do not always agree with their choices, but do not interfere. I am there to give advice and my opinion, if asked and hope thoughtful decisions follow.  Of course, I have precautionary language in our partnership agreement, but we will get to that later.

Dealing with each other’s evolving lives and communication has been the biggest challenge. Of course, there are the crazy roommates, the maintenance issues, neighbors, money stress, compromises and the joy of accomplishment, recognition, complete and quality repairs, and neighbors who appreciate your efforts. 

I wanted to share our home-buying experience with you.  I have included some tips, links, recommendations and observation that may be helpful for you when making your own decisions about investing in property and, possibly, including your student(s) as a partner. 

Buying property and including my collegiate daughters as partners is an experiment in trust, responsibility, finance, humanity, and patience. As partners, our goal is to invest and improve a property that will provide stable housing in the shortterm with a potential for future appreciation.

For me, this is primarily a financial investment. I will be charging interest on my initial investment in addition to a percentage of appreciation on the back end. It’s a risk, but having confidence in my girls gives them confidence in themselves.

For my girls, it’s an investment of time, patience, money, and the business of relationships.
Both investments have value and are deserving of appreciation.

Owning the property that your students live in can be beneficial in many ways.

Stability. Your student won’t have to look for different apartments each year.  As partners, you can choose the location and condition that best fits their needs and finances.
Fixed Housing Expenses. With a fixed mortgage, monthly costs will stay relatively consistent, no additional deposits or sketchy landlords.
Life Lessons. Including your student as a partner is an excellent learning opportunity. During the process, he/she will become more educated on credit, investment of real estate, property management, and bill paying. Also, the process of looking for a home requires tenacity. It’s not easy, especially in a hot market like San Diego.
Financial Benefits. Financial benefits include the potential for appreciation, debt reduction, which increases equity and the potential for rental income, which could offset the mortgage payment.

Of course, there are also risks involved when partnering with your student.

Unpredictability. College students tend to change their minds, move around, and make rash decisions. Creating and executing a partnership agreement together and then drilling down on the requirements, potential benefits, and consequences of the deal will clarify expectations.
It’s Business. Be sure this is very clear to all parties. The partnership agreement is legitimate. Be sure to include a formal closing table ceremony, review of the final documents, and notarized signatures.
Responsibility. If your student plans to rent out extra rooms, he or she will be acting as a landlord.  Your student will be collecting rents, pay bills, and dealing with the irresponsible and unpredictable tenants which can be stressful for anyone, but especially a student.
Insufficient Appreciation. If you plan to the sell the property when your student graduates in four or five years, there is a chance that the value may not appreciate enough to make up for the costs of buying and selling the property. Be aware and do your homework.
Additional Costs. Parents and students typically spend $5,000 to $10,000 in room and board or rent during a school year. A mortgage payment is often about the same or more; however, you must consider other additional costs of homeownership besides the mortgage, like maintenance expenses, furnishings, homeowner association fees, taxes, and insurance. Be sure your cost analysis includes these additional expenses.

The Experiment – Fall 2017

I jumped on the real estate roller coaster this morning. It isn’t the first time, but always a ride and this time I am including my daughters. I have been in this business for nearly 30 years. As a Broker, I have seen the good, the bad, and the super ugly. I have witnessed, lived and worked through a terrorist attack, a couple of market crashes and the Great Recession.  With all that working knowledge, I still wholeheartedly believe that owning property is better than renting if you can make the numbers work.

I believe that if you can break into a market and feel comfortable with the numbers It’s better to pay yourself than to pay rent to someone else. At the very least, it’s a forced savings account if you do it right.

I try to pass this knowledge along to my daughters (18 and 23). My oldest daughter lives, works and attends college in San Diego, California, and my youngest plans to join her there. Have you looked at the market in San Diego, California? It’s (ridiculous) one of the most expensive places to live in the country and the cost and prices keep going up.

As a Mother and an Investor, there are goals for this experiment:

LOCATION – Have a safe and stable place for my daughters to live while in California.
PAY OURSELVES – If they must pay rent, then pay it to themselves instead of a landlord.
EXPERIENCE – Learn and appreciate the process of buying a home.
RENT – Produce additional rental income that would offset the monthly mortgage.
APPRECIATION – It must be an investment with a potential for appreciation in the future.

Our initial condo search looked like this:
Price Range: $300,000 to $320,000
Condo – 2 to 3 bedroom / 1-2 Bath
Low HOA dues $100 to $300 a month
Small complex
Garage or dedicated parking
Clean, updated
10 to 15 minutes from the beach
Quiet neighborhood

Let me set the stage. I live in Colorado and my daughter, Kenady, lives in San Diego.  Kenady will be searching, viewing and touring properties with our Broker, Melanie Fitzgerald.  I will be consulting and advising from Colorado until we have a deal and then I will fly in for closing.  Our search started in areas that are on the fringe of some very hot neighborhoods; North Park, Normal Heights, and University Heights. This search brought us to properties that were “on the other side of the highway” or “a few streets away from…” Which means, pretty much just on the right-side of the ghetto.

It took months before we found the first property that had good numbers and was in an acceptable location. It was on a decent “up and coming” street and walkable to a popular section of North Park. Our Broker, Melanie Fitzgerald, was very patient and worked very hard on this one.  

Good Numbers.  So I am a spreadsheet girl.  I like to run the cost vs. expense analysis on all my real estate deals. Smartsheet has some great templates.  Good numbers simply mean that the final monthly mortgage payment, HOA Dues plus bills are LESS than the amount of monthly income received.  Which enable us to bank a surplus for repairs and maintenance.

What we found, at this price point, is that there are usually “challenges” with a property. Our particular challenges with this property were that the HOA had not kept up on the exterior of the building and the owner was an older woman who lived with her grown nephew who was, well, a bit sketchy. The Owner and tenants were on the verge of being hoarders and dirty, which was a shame because the property had been in great shape when it was purchased a few months earlier.

Yes, I said months.  The best part, we were not allowed to view the property until an offer was accepted.  Yep, where I come from, that is an outrageous request. How could a buyer possibly make an offer without seeing the property?

Our Broker explained that it was a unique situation and they didn’t want a bunch of buyer traffic. It still seemed fishy to me.  Our Broker wrote up a very “buyer protected” offer, which was accepted, and we scheduled an inspection.

Reality hit us in the face at the inspection.

The photo above is what was in the MLS at the time we set up the first showing. We found out later that the photograph was from the previous owner’s MLS listing months earlier.

This is what the condo actually looked like.  I’ve been in this business long enough to know you have to look past the dirt and clutter. The inspection proved that the bones of the condo were good, but the exterior needed some attention and these people had a lot of stuff to move. That was concerning.

During the inspection, the inspector pointed out a list of items from electrical and plumbing to cosmetic repairs that were needed on the interior as well as some drainage and stucco repairs on the exterior. The interior smelled like smoke; however, the owner’s claim they did not smoke inside the house.  A few of the repair items were code issues such as smoke detectors, missing electrical outlet covers, leaking pipes, etc. I wanted those items to be repaired or replaced.

As Kenady & our Broker were leaving the inspection. The nephew was picked up by the police. It was quite the scene.

OK, so how are we doing on those goals?

LOCATION – Decent location, some concern about safety, but we’ve seen worse.
EXPERIENCE – Is Kenady having a good buying experience? Yes, and an education on humanity.
PAY OURSELVES – We are still working through all the options.
RENT – The numbers are not great w/ 2 bedrooms, but Kenady believes it can work.
APPRECIATION – The location is excellent, restrictions are a bummer, and the exterior is risky. We are betting on the location.

Pay Attention to the Homeowner Association Declarations and Bylaws.
Be sure to read the Homeowner Association Declarations and Bylaws. We found that on this property, there was a restriction that did not allow short term rentals. The market for short term rentals through VRBO or Airbnb is active in this area, so this restriction was unfortunate for long term plans. However, because the girls plan to live there full time for the next five years, the limitation worked for us in the short term.

Second Home vs. Investment Property

Lenders perceive a “second home” as less risky. 10% down payment is required. As opposed to an “investment property,” which is more  risky and requires a 25% down payment.  However, with an investment property the rents count when determining the ratios of the loan. A future 1031 Exchange is more straightforward with an investment property and can be problematic with a second home.

The deciding factor was the down payment. Because I didn’t have 25% to put down on a $320,000 (or $80K, ouch), we decided to designate the future property as a second home.

The numbers look like this:
$320,000 Purchase Price
$5000 Paid to the Seller when nephew moves out on Nov. 4th (crazy terms)
$325,000 Total Purchase Price
$32,000 10% down on the Purchase Price

$8000 Closing costs, pre-paids and escrows (out of pocket)
$5000 plus the fee to get the nephew to move out noted above.
$45,000 Total Out-of-Pocket

$288,000 Loan Amount
$1563 Principle & Interest monthly payment at 5.1% (higher rate to include daughter on loan)
$267 Taxes monthly – Taxes are estimated at 1% of the purchase price or $3200 annually.
$53 Hazard Insurance
$180 HOA Dues
$100 Maintenance
$2163 Subtotal
$200 plus estimated Utilities
$2363 Total Monthly Nut (round up to $2400)

Kenady and her boyfriend would take the largest master bedroom #1 with its own bath and the Carly and roommate would take bedroom #2 and use the common area bathroom.

$1200 Bedroom #1 (split between 2 – so $600 each), $1200 Bedroom #2 = $2400
With 4 people living in the home, each person was looking at roughly $600 a month. In San Diego, that’s not bad.

The Partnership:  Kenady, Carly and I have a contract between us that outlines explicitly how this partnership will work.  We call the contract the Partnership Agreement.  There are a ton of online website that offer free Partnership Agreements, but I have had good luck with RocketLawyer on other standard contracts and documents.  For this transaction, I had the Agreement drawn up by a local attorney and reviewed by our accountant.  So this is the Deal:  I get the loan,  pay the downpayment and any other closing fees. Kenady and I set up and control the “house” account which all income and expense flow through.  The girls are responsible for setting up all of the household bills, HOA and paying them on time.  They are also the acting landlord to the other two renters who are required to pay a deposit and sign a lease.  The deposits are held in a separate “deposits” account.  Any maintenance issues or repairs and replacements are their responsibility. Any items over $500 require all partner approvals. The partner responsibilities, expectations, and consequences are well defined.  If the girls miss or are late on more than two mortgage payments (for any reasons), I, as the principal partner, will ask them to vacate the property and all agreements are terminated. No hard feelings, it’s just business.  On the flip side, the agreement also includes a conservative forecast of the future equity split in 5 years. The equity split is VERY rough because who knows what is going to happen with the markets in the next 5 years. And also where my daughters will be in their lives.  However, it does give them some incentive. I discussed with our accountant how we are structuring the loan, tax consequences for the future, and had her review the partnership agreement.  When we close on a condo, the Partnership Agreement will be included in the closing documents and require notarized signatures. 

After the inspection, we reviewed the inspection report. Our Initial request for repairs covered most of the defects noted in the inspection. The approximate cost of repairs was $3000.  We gave the seller the option to make the repairs or credit us at closing and we could completed the repairs after closing.  They did not counter.

Then we countered with just the primary items of concern that needed repairing.  Silence.

The silence continued for a couple of weeks.  Around the end of October 2017, a few days before the Inspection deadline, our Broker pressed the selling Broker on why there had been no response on the Inspections items, but also pressed on the creepy nephew move-out deadline which was in a couple of days.

Finally, with one day remaining before the inspection deadline, the Seller’s Broker responded that the nephew was not going to move out by November 4 and they wanted an extension.  The news was regrettable but gave us insight into the situation. We did not want to extend the deadline. Our Broker strongly recommended that we terminate.  

I had already invested over $1000 in inspections and appraisal fees. I would never get that money back.

We terminated the contract the next day. It was bittersweet because we had had faith this could work out.  There were tears of frustration and motivation broke down. We were deeply disappointed.

The next few months, we took a break from our San Diego real estate search. Kenady wasn’t ready and had a lot going on with life, work, and school.

February 2018. “Here we go!”

The Real Estate prices in the San Diego neighborhoods such as North Park, Normal Heights, and University Heights keep going up. When we started our initial search in the Fall of 2017, you could find 2bedroom / 2bath condos for around $320,000 to $340,000 + HOA Dues. When we started up again in February 2018, the prices were now $350,000 to $400,000 + HOA Dues. The high HOA dues are what kill our numbers.

So we discussed looking in other, not so hot, neighborhoods. I wasn’t super thrilled with that idea, but willing to look at it if the girls found something interesting.

On a whim, I searched Zillow for neighborhoods around San Diego State University.  

At the time, Kenady had applied to SDSU but was not been accepted yet. I was hoping she would be accepted and the location would turn out to be ideal for her and for finding renters with it’s proximity to the college. 

Condo #2 was located 2 miles more inland than the North Park or Normal Heights neighborhoods, so I thought the prices might be more reasonable, but at first glance, they were not.  

But then, ta-da, a “Coming Soon” listing popped up!  

$400,000 Purchase Price
Three bedrooms (2 suites and one tiny bedroom)
2.5 bath
$287 HOA Dues (not bad)
1.5 miles from SDSU
Good Condition

The price was far more than I had intended to spend when we started this process, but with three bedrooms, it could work. Our Broker found out it was not going to be on the market for a week, and there would be only one open house and contracts accepted after the open house.  

Again, the photos in the listing were from the previous sale in 2014 for $300,000. The listing photo for the kitchen is below.

What it actually looked like at the Open House is the photo below.

If you can look past the clutter, it seems to be in relatively good shape. 

There are not a lot of 3 bedroom condos on the market. For some reason, San Diego has a lot of 2 bedroom /1 bath units, but very few three-bedroom / 2.5 bath units. When our Broker pulled up comparables, she found a couple of condos that were a bit further from SDSU.  However, they were either lower in price with much higher HOA Dues or much higher in price.

We decided to make an over-asking offer of $405,000 with hopes we would not get into a bidding war with other buyers. Another new twist is that Carly, my youngest daughter, officially, decided she is attending college in San Diego. The plan is coming together, and they agree to live together until each graduate to be fully vested. They would both have to act as property managers.  

The preliminary numbers look like this:
$405,000 Purchase Price

$40,500 10% down on the Purchase Price
$9296 Closing costs, pre-paids and escrows (out of pocket)
(-2531) 25% referral from our Broker
$47,265 Total Out-of-Pocket

$364,500 Loan Amount
$1954 Principle & Interest at 4.99% (Interest rates have gone up since last fall)
$422 Taxes annually are estimated at 1.25% of the purchase price or $5064 annually!
$28 Hazard Insurance
$287.50 HOA Dues
$100 Maintenance
$2791.50 Total Monthly Nut + Utilities

To make things easy and to build up a little bit of savings, we will call it $3000 a month. Ultimately, we would like to pay a bit extra principal each month to pay down the mortgage.

So with three bedrooms, 2 suites and a small bedroom, we would be able to charge $1500 for each suite (x2) and an additional $600 for the small room. For a total income of $3600.  If my daughters each took a suite with a boyfriend or roommate, then they would be paying approximately $750 each for their own bedroom, bathroom and walkin closet.  The small room have the lower level common half-bath mostly to themselves, but have to shower in one of the other suite bathrooms. A little akward, but doable.  In theory, the additional income of $600 a month would allow us to pay extra principle and also build up the maintenace fund for any repairs or upgrades to the house.

We aren’t at the finish line yet. At the home and termite inspection, several items need attention. When you buy an older home, you can usually expect to have cosmetic repairs and possibly appliances replacement. What is not acceptable is when a property owner neglects to do regular maintenance and repairs. This home was not getting any love from the renters or owner. It has been a beautiful unit previously, but now we found a bunch of plumbing issues and even leaks that left three significant areas with wet spots. And with wet spots we all think of the dreaded result if not addressed, MOLD.  How long has the washer been leaking and now one noticed?

March 16, 2018, The initial inspection cost $414 and the additional plumbing inspection another $165. A total of $579 on inspections paid out.  Again, if this deal falls through, I will never get that money back. 

As we suspected, there was a bit of MOLD in the ceiling that needs remediation.  It’s not a massive amount of mold, but enough that we must bring in a licensed remediation company. The Sellers are working with us and agreed to pay for the remediation and repairs, but time is running out if we are going to make the March 27, 2018 closing.

The next seven days required patience and tenacity. The Seller’s Broker had little to no information about when the current tenants would be moving out and when the work would begin. The contract stated the tenants would be out five days before closing or March 21, but that day came and went, and the repairs were not starting. Technically, on March 27 with no closing, we were out of contract and could terminate. Kenady had to be out of her current rental on 31st and had no place to go. She started to get super anxious about the situation as we were all wondering if this deal was going to fall through.

On the 27th, our Broker negotiated a $500 credit, and the closing date moved to April 4. It was like pulling teeth to get this done and confirmed by the Seller’s Broker. He was having a tough time finding a licensed contractor to get the work and remediation completed. 

Work was still being done on the 5th when we moved in, but we moved in, and that was the critical part.  As expected, there are be repairs, and cosmetic updates to be completed after closing. Keep that in mind when budgeting.

The Repair List:
$50 Replace or repair upper bath shower door roller 
$120 Replace & Install laundry room bifold door 
$25 Repair laminate threshold between kitchen and living room 
$300 Replace Carpet 
$50 New exterior locks 
$400 Repaint living room (drywall patches painted wrong color) 
Total $585

The items above are honestly minor, and the condo is excellent for the kids and the dog. They all happily moved in, and we did the standard shop at Ikea and a celebratory beer with our Broker, Melanie Fitzgerald! Yay!

Carly graduated from high school and joined them a few months later. I am happy they have their space and that they found a renter for the small bedroom. It was well worth the effort and frustration. 

As I mentioned above, its been a year since closing. There has been drama with roommates and disagreements between partners. We have worked through them and learned a lot in the process.  Kenady, who is a full time student and working 30 hrs a week, has taken the lead on the property managment side of the home. She pays the bills, HOA and coordinates & executes maintenace items and contractors.  She also attends all of the HOA meetings and has become the driving force for the HOA to get repairs completed and keep costs down.  Carly is not taking such an active roll at this time and lets her big sister do most of the property management work, however, as a 19 year old, she is going to college and works two jobs to pay her portion of the mortgage and bills.  I am really proud of both of them and all of their hard work and persistance.