How to Use Real Estate to Pay for College
White Coat Investor explains how using real estate to pay for tuition can work well for the right person or family, either alone or in combination with the 529.
Today's classic is being republished by White Coat Investor. You can see the original Here.
As regular readers may or may not know, Utah's excellent 529 plan is my primary college savings vehicle. The funds in the plan are invested very aggressively (50% international and 50% low value). There are other, inferior, ways to save for college. Each has its own set of issues, including taxable accounts (high taxes), UGMAs (loss of control), Coverdell ESAs (low contribution limits and no state tax break), and even cash value life insurance (low returns).
One method that I think should be considered alone or in combination with a good 529 plan is to invest in real estate. There are a number of ways to do this, of course, but this post discusses a few ways I think real estate investments could have real value as a savings tool for colleges. I'll talk about the cons at the end, but first let's list …
# 1 The timeframe is right
Real estate is not a good short-term investment. But it can be a great investment in the 10-20 year range, roughly the time you should be saving for college. This is enough time to spread the transaction costs out over many years, get a reasonable appreciation, and go through at least one bull and bear market.
# 2 Returns are high
I am a fan of aggressive investing for college. Although the timeframe is shorter than retirement, the consequences of falling short are so much less that one can afford to be aggressive.
Real estate investments, like equity investments, have a long history of solid returns that can easily range between 8 and 15% per year depending on leverage. Even a not-that-hard-to-find, not-that-hard-to-find Cap Rate 6 property that is increasing in value at 3% per year should produce a total return of 9%.
# 3 Real estate becomes less risky over time
Leveraged real estate investing automatically becomes less risky the closer you get to your goal, simply by paying off the loan. You don't necessarily have to add bonds like many 529 automatic options to reduce risk. If you are using a 15 year mortgage on the property, it may even be fully repaid by the time the child enters college.
# 4 Major Tax Benefits
While I don't think the tax perks of real estate investments are as good as a 529 (you won't get a state tax deduction or credit for contributions, nor will rents and capital gains be completely tax-free forever when used for educational purposes) there are some tax benefits associated with real estate investments.
You can write off the property, and that depreciation over the first few years can make a lot of your cash flow somewhat deferred for tax purposes. The only way to get the depreciation tax free is to die before selling. However, you can still postpone the withdrawal of the depreciation by swapping the equity for a more valuable property after playing the Monopoly game. Of course, all your investment costs (mortgage interest, taxes, maintenance costs, travel to visit the property) are also deductible.
# 5 Three ways to access the money
There are three ways to get the money out so that you can spend it on college.
The first is just to sell it. This creates two problems: First, you have to pay capital gains taxes and transaction costs. Second, you will then need to figure out something else to invest the money in since not all of your college savings will be needed at any given time.
The second way to access your money is to borrow for a lifetime. You can get a home loan or a refinance. Aside from the obvious drawbacks of having to pay interest to use your own money, add credit-related fees, and increase the leverage and therefore the risk of the investment, there is some attraction to it; H. No tax consequences.
Use the stream of income
The third way to access your money is simply a source of income. If you bought a $ 100,000 property with a 6% cap and paid off in time for college, it might be worth $ 200,000.
That paid-off property should be paying a rent sufficient, at cost, to pay college expenses of $ 12,000 per year. Of course, you've invested a lot more in this investment than $ 12,000 * 4 years = $ 48,000, especially given the time value of money, but even by the end of your college years you still have an asset that is probably worth even more.
That asset can then be used for retirement, turned into a recreational property, used to pay for the next kids' college, and given as a graduation gift to the child (gift taxes would be levied on such a large gift unless you used a trust to spread the gift Gift over many years) or sold and used to buy something else you want.
# 6 Isolation from stock market returns
Although there is some correlation between the general economy, real estate returns, and stock market returns, real estate sources of income tend to have quite a low correlation with the overall stock market. Combining a stock invested 529 plan with a real estate investment can add real diversification. Obviously, bringing a large wad of money into a single property could be seen as the opposite of diversification, especially with a view to potential appreciation.
# 7 Opportunity to teach the child
One of the things I really like about using real estate as a savings investment for college is the ability to teach the child financial principles. I use my 529 to teach my kids about taxes, stocks, bonds, dividends, appreciation, and compound interest. But I think real estate investment would be even more useful.
I could teach the kids something
- Property Management
and perhaps most importantly, I could teach them about work.
If you manage the property yourself, every time the property needs something, you drag the child into the property to look after the tenants, collect the rent, fix the toilet, paint the fence, etc. " This is your college fund, kid. Better take care of it. “If you buy the property in college town, the kid could become the college property manager and give them the opportunity to work for their income and valuable skills. He could even live on the property and use his select roommates' rents to pay for his own college expenses and build valuable life and business experience.
# 8 Estate planning
Giving the child the property (especially in the beginning when it's not worth much) has the added bonus of making money out of your estate. Obviously, given the large amount of inheritance tax exemption, this isn't a big problem for most doctors in many states, but it is a potential way to lower inheritance taxes. You would obviously lose control of the asset (like you would with a UGMA account), but you could reduce that loss by creating a trust.
This also has a number of drawbacks, especially when compared to using a 529 account.
- Loss of the tax break on a 529. It's hard to beat an upfront government tax break plus tax-free growth.
- Loss of liquidity compared to a good 529 invested in stocks. It's relatively easy to get a few thousand out of a 529 every month, semester, or year. It is much more difficult to match your real estate cash flow to your college cash needs.
- Both home equity loans and selling the home come at significant costs that a 529 doesn't.
- Real estate investing also requires expertise and skills that buying and holding index funds in a 529 simply doesn't require. It is an inefficient market, and just as there are many people who use their skills, expertise, hard work, and luck to increase their returns, there are many people who because of lack of skills, feelings of happiness, and poor returns achieve hard work.
- Of course, there is also the problem that real estate investments are partial investments and partial second jobs. While a second job gives you the opportunity to teach your child to work, it also means you will be doing extra work that you wouldn't otherwise do. Maybe you just want to use your time for something else.
- Even if you're not a handyman, hiring a consultant to manage a 529 is much easier than finding a consultant to buy and manage real estate without your having to make any significant contribution.
- As mentioned earlier, buying a single investment property instead of thousands of stocks is the classic "put all your eggs in one basket and watch closely" and the "don't put all your eggs in one basket" puzzle. If this property is performing poorly or has significant unforeseen expenses, it may not work nearly as well as a more diversified approach.
These drawbacks are the same whether you are buying real estate directly or whether you are involved in syndicated real estate.
In the end, the most important thing about college savings is to start early, save enough, and choose investments that actually make your money grow significantly faster than inflation in the relatively short amount of time you have. Stock index funds in good 529 are a fantastic option. Selected real estate investments may also work well for the right person / family, either alone or in combination with the 529.
Do you think real estate would work well to pay for your child's college? Why or why not? Comment below!