Buy your college kid a condo?

By Liz Pulliam Weston

So far, parents Cindy and Jay Kasin say the Seattle townhouse they bought for their law school student son seems like a good deal. The Kasin scion gets to live in a nice place, and the property has been appreciating in value.

"We think it's one of the few investments in our portfolio that has actually gone up in the last couple of years," Cindy Kasin says.

Former student Shawn Vita also has good things to say about the house his mother bought for him while he attended Purdue University in the late 1980s and early 1990s. He eventually purchased the home from his mother and later sold it at a tidy profit

"It transcends just helping you with school," said Vita, who's now a software design engineer for Microsoft. "I got to learn to be a responsible homeowner. I learned about paying bills and taxes and about credit. . . . I learned to be pretty handy, and (when the house sold), it was the basis for a down payment on a really sweet place." (Microsoft is the publisher of MSN Money.)

But San Francisco financial planner Tim Kochis typically tries to talk his clients out of buying real estate to house their college students. He finds parents often:

• Overestimate the possible savings.

• Overestimate the potential appreciation.

• Overestimate their children's ability to serve as landlords.

"We don't think it's a really good idea," Kochis said. "It's often not clear (home ownership) is going to be better than renting, and it's likely that it could be worse."

Many parents are tempted by the idea of buying their college students a place to live rather than paying for dorms or apartment rents. Whether it makes financial sense depends on a number of factors, from living costs in a particular college town to the emotional makeup of the kid.

If you're thinking about making such a real estate buy, here's how to make sure your investment gets a passing grade:

Understand the risks

The last few years have lulled many investors into thinking that real estate prices only go up. But sometimes home prices plateau -- or even drop. If you own the home for just a few years, it's possible you may not get enough appreciation to offset the considerable expenses of buying and selling the property. You'll face fees for getting a loan and potential broker commissions of 6% or so when you sell.

"With a home, it can take six to seven years to recoup the costs," said financial planner Deena Katz of Coral Gables, Fla. "Presumably you're only going to own a kiddie condo for four years."

What's more, neighborhoods and towns that cater to college students often experience less-than-average appreciation. The transient nature of students -- and their casual treatment of homes or apartments -- frequently make those areas less appealing than more stable neighborhoods.

"Remember when we were in school?" Kochis says, "How much care did we take of the places we were living?"

Here's what's happened in college towns where student enrollment is equal to at least 25% of the local population:

Housing appreciation in 5 big college towns*
City	University	1-Year	5-Year
Ann Arbor, Mich.	University of Michigan	4.77%	31.36%
Athens, Ga.	University of Georgia	5.72%	30.27%
Champaign-Urbana, Ill.	University of Illinois	6.44%	32.03%
Columbia, S.C.	University of South Carolina	4.87%	24.99%
Provo, Utah	Brigham Young University	3.10%	13.34%
National Average		11.17%	49.67%

*For periods ending Dec. 30, 2004

Source: Office of Federal Housing Enterprise Oversight

You can offset the college-town effect somewhat by choosing properties that aren't right on the campus border. Vita's home, which cost $44,000 when his mother bought it in 1989, was about a half-hour bus ride from Purdue University, where he was studying computer science. He sold the house in 1995 for $65,000.

Think about cash flow first

Kochis likes to see deals that make sense from a cash-flow perspective. In other words, all the costs of owning the home, minus any rent paid by roommates -- are less than what the parent would pay for a dorm or apartment. Some costs to consider:

• Mortgage

• Property taxes

• Homeowners insurance

• Additional liability coverage (see below)

• Homeowners or condo association dues

• Maintenance and repair costs

In low-cost South Lafayette, Ind., the $200 rent Vita charged each of his two roommates covered his monthly mortgage. He shouldered the property taxes, insurance, maintenance costs and upgrades, which he believes still worked out to less than the $255 a month he previously paid for a rental.

Many parents, however, may find a property doesn't make financial sense once they factor in all the costs, Katz said. They may still opt to go ahead, of course, just to provide their progeny a nicer place to live.

"Maybe your child hates the dorm and wants to choose (his) own roommates," Katz said. "You should understand that's why you're doing this . . . not because it's a good investment."

Get the right financing

When buying your personal residence, it often makes sense to opt for the certainty of a fixed-rate loan and to make extra payments to try to build up as much equity as possible. That gives you a big cushion in case of financial emergency, and reduces the overall interest you pay.

When buying a place for a college student, though, you should think more like a professional investor and keep your monthly nut as low as possible. A couple of options:

• Adjustable-rate loans. These offer a low initial teaser rate that rises to the prevailing short-term rate after three to six months, and then typically adjusts annually. These loans can become expensive if rates rise suddenly, but they can be a good solution for short-term real estate ownership, if you expect rates to remain low. Your initial interest and principal payment on a $100,000 adjustable-rate mortgage could be as low as $395 a month, compared with $572 for a 30-year fixed-rate mortgage.

• Hybrid loans. These loans are fixed for a certain period -- typically three, five or seven years -- before going adjustable. If you plan to own the home just long enough to get your sophomore out of school, a five-year hybrid would lower your payment compared with a 30-year loan and give you some wiggle room in case graduation takes longer than expected. Your monthly payment on a five-year hybrid for $100,000 currently would be about $500.

• Interest-only loans. These typically offer monthly payments that are a fraction of what you would pay for a traditional principal-and-interest mortgage. The downside, of course, is that you're not building equity with your payments. If housing prices drop before you can sell the home, you might well find yourself owing more than the house is worth. You can opt for adjustable, fixed or hybrid rates, just as with a regular mortgage. A five-year interest-only loan might shave another $100 or so off the payment on the loan above, compared with a regular hybrid loan.

Make sure your kid is stable enough for this to work

Your student needs to be sufficiently responsible to collect rents, pay bills on time and take care of a property. But you also need to be reasonably sure she's going to stay put.

At some schools, as much as 30% of the freshman class doesn't return for the sophomore year. Students drop out, switch to other schools, run off with their boyfriends or girlfriends -- whatever.

That's why Cindy Kasin rejected the idea of buying homes for her three sons while they were undergraduates.

"It locked them into living in a single place for the rest of their college careers," said Kasin, "By the time they were really ready to do that, there wasn't enough time left before graduation to make it worthwhile financially."

Get enough insurance to cover your assets

If your student has roommates to help cover costs, you instantly become a landlord -- with all the liability issues that entails. If someone is hurt on the property, you can be sued.

You'll need to make sure you have sufficient liability coverage so you don't get wiped out in a lawsuit. Raising your homeowners insurance policies to the maximum liability limits and adding a so-called umbrella liability policy to boost your coverage to $1 million can set you back several hundred dollars annually. Factor in those increased premiums when you're penciling out how much this project will cost.

Understand the tax implications

You may be able to write off the mortgage interest and property taxes on a second property, just as you can on your home. But the high-income families who are most likely to be able to swing a second home are often the ones who get less of a tax break from their purchase.

That's because the tax law limits the amount of itemized deductions you can take if your adjusted gross income is over $214,050 (for married filers).

If you collect rents, however, you should be able to deduct part of the utilities and maintenance, as well as take some depreciation on the property. Your best bet is to chat with a tax pro to get specific numbers for your situation.Another potential downside is that any profit when you sell is subject to capital gains taxes. Second homes and rental property aren't eligible for the $250,000-per-person exclusion that's available when you sell your primary residence. If you rented rooms, some of the depreciation you took will have to be given back, as well. (Capital gains taxes aren't so onerous, now just 15%.)

There's a way to defer taxes if the property is a rental: You can exchange it for another rental property, perhaps one closer to home. But talk to a tax pro about the details, because these so-called 1031 exchanges have plenty of rules and require a third-party administrator to handle the swap. (For more on 1031 exchanges, see "Let Uncle Sam help fund your retirement home.")

If, instead, you've decided you've had enough of being a landlord when your kid is ready to graduate -- and you're lucky enough to have some gains -- you'll just have to give Uncle Sam his due.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.