Rent a Dorm Room or Buy a Condo?

NEW YORK (MainStreet) -- Better hurry: Time is running short if you want to buy a condo so Junior or Sis won’t have to pay room and board at college this fall. You’ll have to find a place, haggle a price and, if you need to borrow, get started on a mortgage-approval process that could easily take 90 days or more.

 But before you start, how about a reality check? Does buying a condo for a college kid really make sense?

A recent SmartMoney story touts the condo-instead-of-dorm strategy: “That way, you'll avoid paying through the nose for a dorm room or apartment with no hope of any profit. And if you buy a condo that has some extra space, you can rent it out to your kid's friends and offset some of the ownership cost.”

Imagine a dorm room would cost $7,000 a year. That’s enough for principal and interest payments on a $125,000 mortgage, assuming about 4% on a 30-year fixed-rate loan. Cram in some roommates and you might easily pull in enough rent for a $200,000 to $300,000 loan, even if you charged a bit less than the dorms. Then you could hope to sell the place at a profit after graduation. There are even some tasty tax benefits.

In much of the country, rents are high relative to sales prices, making a rental property investment appealing.

On the other hand, anyone who’s owned rental property will tell you that uncertainties can easily wreck the financial projections. So, what could go wrong?

Clearly, another dip in housing prices could turn your money-maker into a loser. The market seems to be bouncing along the bottom but is vulnerable to bad news.

For a rental to pay, you need enough appreciation to cover various expenses of buying and selling, like the realtor’s commission and, in some areas, transfer taxes. If these expenses equaled 10% of the purchase price, you’d need 2.5% annual appreciation to break even in four years. That’s close to the long-term average for real estate, and right now the market may be too shaky to count on making that much.

This risk grows if you child is required to stay in a dorm freshman year, shortening your breakeven period to three years. And in some college areas many rentals go vacant in the summer, potentially causing annual losses that would make the breakeven period even longer.

All landlords face issues like tenants who don’t pay or damage the place. With a responsible child on site, this would seem less likely. Then again, how much study time would your child give up to manage the property? What if he or she wants a junior year abroad, takes time off or transfers?

Start your analysis with the Rent vs. Buy Calculator, making allowances for income you’ll receive from any roommates. Keep in mind that although the investment could be a money loser, you could still come out ahead if you lost less than you’d pay over the years for a dorm room.

Then figure what you’d do if things did not work out as planned. If you could hang on to the property for a few extra years, the odds of making it pay might improve substantially, as housing prices are sure to rebound someday. But without your son or daughter there to look after things, you might have to pay a management firm.

Bottom line: A short time horizon adds risk to a real estate investment, and the many headaches of being a landlord make this an option only for investors with business savvy and a willingness to work.