Using Real Estate To Build That College Fund

SAVING FOR COLLEGE WITH REAL ESTATE

Two months ago, my wife and I welcomed twin boys into the world. In the next few months, we’ll have their entire college education effectively paid for using proportionally very little of our own money. How? Through long term real estate investing.

Our goal is a lofty one: be able to pay for 100% of our children’s total college expenses. This amounts to roughly $215,000 per child for four years at a public, in-state school by 2037, when the twins will begin their final year of college. So, we’re anticipating needing roughly $430,000. That’s in addition to meeting our own retirement, investing, giving, and lifestyle goals. Daunting!

However, we have a plan—and a rather simple one at that:

1. Buy a single family home and rent it out.

2. Let our tenants pay down the mortgage over the next 18 years.

3. Sell or refinance the property.

4. Use the proceeds to pay for our twins’ college expenses (or whatever else).

But there’s much more to it.

First, we have to define the right property. How much house should we buy? The initial constraint is that we need to net at least $430,000 from the sale or refinance of the property by the time college rolls around. We know we’re unlikely to hit this number exactly, and coming in too low would be much worse than ending up better than we planned. So, we’re choosing to err by overshooting our target.

Suppose that the property we buy will appreciate on average 5% each year for the next 18 years—a figure I believe to be slightly on the conservative side for central Texas, the Austin area especially. With 20% down and 4.625% fixed for 30 years—typical for non-owner occupied mortgages from retail lenders—we’re looking for a home worth around $240,000.

With $468,656 in projected equity after 18 years using conservative mortgage terms, we will have room to choose between selling the property and refinancing when 18 years is up. Either way, we should come out at or above the $430,000 target. Note, also, that the numbers above do not take into account reinvesting future rental cash flow into improving the property making additional mortgage payments. Once we take that into account, things look even better.

Beyond the numbers, we want at least a 3/2 home in a good school district and strongly prefer a single-story with at least three-sides masonry. We’re also not particularly concerned with the investment generating meaningful cash flow in the near term. In fact, we’d be happy if we can come close to breaking even over the next few years. We don’t expect rental rates to fall on single family in the Austin area over the next 18 years. In fact, we expect meaningful cash flow over the longer term as rental rates continue to rise. This will help us accelerate mortgage pay down and build equity faster.

Second, there’s the matter of actually finding the property. Our time horizon is long on this particular investment. So, we’re not against purchasing a rental-ready home straight off of the MLS. However, who’s not up for a deal? In a future blog post, I will detail some strategies I (and other investors) use to source deals in this hot central Texas seller’s market. However, in the Austin area market, for the type of property we’re looking for (described above), we’re most likely going to have to buy it retail on the MLS or from builder inventory.

Third, we need to determine the best way to buy the property. In one way or another, we’ll need to get a mortgage. Mortgage loans can come from many sources: private individuals, banks, mortgage brokers, mortgage bankers, credit unions, etc. It makes sense to shop around heavily. However, for a 30-year non-owner occupied fixed rate mortgage from a retail lender, we’re looking at around 4.625%. Mortgage insurance doesn’t cover investment properties. So, we’ll need to put at least 20% down, which comes out $48,000.

I realize that $48,000 is a significant amount to most of us. Indeed, the down payment will most likely be the largest hurdle for most of you reading this. In a future post, I’ll outline sources of long term investment property financing that can require less than the usual 20-25% down for well-qualified borrowers. It’s also possible to tap equity in your primary residence via a HELOC to make a down payment. However, realize that, if you’re going to be saving for your child’s college anyway, you can put off the strategy I’m describing here in order to raise the funds needed for a down payment. Just be sure the money you’re putting aside is invested in a vehicle that will keep pace with inflation and provide some growth, such as a short-term bond mutual fund.

The upside is that, once we commit that down payment, we’re effectively done paying for our kids’ college. For the next 18 years, we’ll have other people (our tenants) paying toward our kids’ future education while the property appreciates in value.

Fourth, we’ll have to get the property leased and managed. For those with less experience or time, but especially if it’s the first time, it almost always pays to work with a REALTOR®. He or she will help prepare, price, and market the property, ensure compliance with the relevant local, state, and federal regulations, provide leasing and other paperwork, screen potential tenants, and negotiate on your behalf.  For these services, a REALTOR® typically requests compensation equal to one month’s rent. Fortunately, as an experienced REALTOR® and investor, I’m comfortable with all that goes into getting a property leased to a great tenant for top market rent in central Texas.

What about management? It is perfectly possible to manage one or a few single-family rental properties while maintaining a full-time job, as long as you have the temperament for it and the properties are within your immediate area. In fact, unless a property is a significant distance away, I don’t see any reason to have a single-family investment property professionally managed, unless you really are just too busy, uncomfortable being a landlord, or simply have too many properties to manage alone. Though nobody enjoys getting a call about a leaking water heater or a broken A/C in the middle of dinner, my wife and I enjoy even less someone else taking a cut of our rental income.

Finally, I’d like briefly to mention one unique benefit to this method of saving and paying for a child’s education on which it’s difficult to place a dollar value. As soon as my twins are old enough, which is sooner than you’d think, they will help me run every aspect of the property. I want them to really feel like it is their house, their tenant, their investment, and ultimately, their responsibility. They will need to learn to make and follow through with plans, interact with others, and work together to solve problems. This will provide me years of opportunities to teach financial and personal lessons and bond with my sons.

Though there are plenty of great ways to save for a child’s college (e.g., a 529 Savings Plan), my wife and I believe the real estate based strategy outlined above makes good financial sense. However, we are aware of the risks involved when compared to other options. I could give a list of pros and cons, but my goal here has been to describe what my wife and I plan to do, not argue that everyone should follow in our footsteps. However, I do think it’s something anyone facing the uphill battle to save for a child’s college expenses should consider seriously.  

If you’d like to discuss real estate as a way to save for college (or even retirement), reach out to me below or give me a call at (512) 991-4801x3.

RELEVANT RESOURCES:

College Savings Calculator // Home Equity Calculator

Is It Time To Sell Your Austin Investment Property?

6 Reasons Why It Might Be Time To Sell That Investment Property

Predicting the real estate market is like the predicting the weather… you have a lot of facts, historical data and experts giving advice, but sometimes it just rains without any warning. So take my perspective with a grain of salt.

I am voracious consumer of all information real estate. I love the facts, figures and data behind all of it. I like taking into consideration the most minor neighborhood intricacies--like why a house two blocks north sold for $50,000 more than the same house a few blocks south. I also like to look at world events, like #Brexit to understand how that can potentially affect housing values in Austin.

The Austin Housing Market

Austin’s housing market is stronger than ever, demand still consistently outpaces supply. However, if you were around in 2007, you know as well as I, that it can come to a screeching halt within a few days, and there are more factors that contribute to that than just the state of the national economy! 

For example, let's take a look at the property around Lake Travis. We were in a 5 year drought and there were experts predicting that the lake might run out of water completely. Activist groups sprung up, water was shipped in to some neighborhoods. The lake levels were the lowest in history and housing prices were bottoming out. Houses were selling for an average of 5% below asking price when the rest of Austin was averaging less than 1% below asking.  And then, just a few rainstorms later, the lake was 120% of capacity and we had the complete opposite problem. Coincidentally, homes sales are up 44% and median prices are up almost 25% year-over-year for Lake Travis waterfront homes.  

I am singling out real estate investors specifically with this information only because most people need to either buy or sell a home no matter what market we are in. If they get relocated for their job, get a promotion, need to downsize or finally have saved enough to purchase a home--most people just move and deal with the hand they are dealt.

Real estate investors, like myself, depending on their investment strategy, are taking in factors like rental rates, cashflow, ROI, taxes implications etc. And if you are a real estate investor who purchased in 2012 or before, it might be time to sell to get the highest return out of the property.

Why Sell Now?

1. Home prices are still on the rise, but they are not going up as fast as in the past.

• This is the lowest May (2015) over May (2016) growth in median home prices in 6 years, only going up 1.39%.
• The trend so far this year is showing that prices are only going up about 5% overall this year, when they went up double digits the previous 3 years. See chart below. 

• We will most likely continue to see modest gains in home prices over the next few years, but the huge upswing has happened already with our market going up 40% over the last 5 years.  

2. Housing inventory is still consistently low at 2.4 month’s supply of homes.

• There is literally nothing out there to buy. Multiple offers, record setting prices and favorable terms for the seller are still happening everyday. This is the “high”, when people utter the infamous phrase, “buy low, sell high”.
• The chart below details out how the housing inventory has shifted from a buyer’s market in 2010, to a seller’s market within a 12-14 month period. Seasonally, the housing supply tends to shrink into December and January. A 2 month supply in February this year represents the most extreme seller’s market we have experience in over 10 years.

Months of Inventory is the amount of time it would take to sell all current listings at the current sales pace if no new listings became available. It is generally determined that 0-4 months is a “Seller’s Market”, 5-7 months is a “Balanced Market”, and 8-12 or more is a “Buyer’s Market”

 

3. Interest rates are at a 5 year low--30 year is around 3.5%.

• Why are low interest rates great for investors? It means your average homebuyer can afford more home. Coincidentally, you can sell your property for more money. Once interest rates start creeping up again, it will start narrowing the potential buyer field. The rule of thumb we use is that for every point interest rates go up (i.e. from 3.5% to 4.5%), this reduces the buyer’s price range by $25,000.

4. First-time homebuyers, who represent 32% of the homebuying population, are getting squeezed out of the market.

• The average age of first time homebuyers is 41 years old. I could not find any specific data to back up my next opinion, but 41 sounds really old to being buying a first home. Maybe I’m the exception to the rule, but I bought my first home at 25. This says to me that younger people with lower incomes cannot afford to get into our market. They are delaying their entry into our market and thus, narrowing the potential buyer pool. If we continue this way and incomes don’t go up in alignment with inflation at the very least, we will lose ⅓ of the buyers in the market.

5. There are many national and world issues that can have a ripple effect on our housing market.

• There is a very tumultuous election coming up in 4 months. Most economists are predicting that no matter who wins, the housing market will experience some sort of a change.
• We still haven’t seen how Brexit will affect America long term. Right now, it has only been positive. However, the official exit of United Kingdom from the EU has not actually happened yet. And Scotland is now even discussing leaving the UK.
• China, who played a large part in bailing America out when the last housing bubble burst, is now having their own housing bubble.  
• Something not being discussed AT ALL is how college student loan debt will affect the housing market. The average college student graduates with close to $38k in debt. With $1.3 trillion in student loan debt spread across 43 million Americans, this could have a major long term effect. There are several interesting articles arguing both sides of the issue here, here, here, here and here.

6. Appraisal reviews

• This is the latest in the Dodd-Frank laws designed to protect consumers in the market. This is something that most Realtors are NOT aware is happening. The short of it is this, if the home loan is being sold on the secondary market and complying with Fannie Mae’s guidelines--which 90% of loans are--then they are subject to review if there is any irregularity in the appraiser’s report. This extra layer of bureaucracy and oversight is slowing down the market AND in the majority of cases I’ve dealt with this, the values are coming back lower after the review.
• This single-handedly might explain why prices aren’t going up nearly as fast they were 12-24 months ago. This can be seen two ways. (1) Good-- to stabilize and pace the growth in the market. (2) Bad-- because it artificially regulates the free market capitalism of the real estate market.  Since this is relatively new, the longterm effects will remain to be seen. For further reading on the topic, see the best articles here and here.

In summary, my argument is that we know what market we are in right now. The cyclical and seasonal nature of real estate means we will be experiencing a slow down in the next 3-5 years, possibly sooner. There is no way around it. This market we are in is a great bird in the hand that has produced stellar returns for a lot of homeowners--both owner-occupants and investors. It might possibly be time to cash in on the returns and sell your Austin investment property.  Reach out to us below or give us a call at (512) 991-4801 and we'll be happy to help you navigate the waters of the Austin market.