Should You Buy a Rental Property to Lease to Your Adult Children?
Imagine you’re fortunate enough to have a 23 year-old daughter who just settled into medical school (or any other multi-year commitment). Let’s call her Med-Student Mary, and she’s a responsible gal devoted to her calling in medicine. She’ll be in the same city for the next few years at least… should you buy a rental property for her to live in and pay you rent?
If Mary will be living there for the next 5-8 years through her internship and residency, that’s a great head start on paying down your mortgage. She gets below-average rent and a caring landlord, you get a responsible, trustworthy tenant who you are reasonably sure will remain in the rental unit for years to come. Since turnovers are the costliest event most landlords have to worry about, you can actually make more money on the rental property than the neighboring landlords who are charging more rent.
You could make Mary responsible for paying for repairs and upgrades, or perhaps you agree to split the cost of repairs with her. This way, she (hopefully) won’t ignore a growing problem in the property in order to avoid paying for it.
By the time she moves on, you may have accrued some serious equity in the property. Maybe part of the agreement you have with Mary is that she finds responsible successor tenants (likely other medical students a few years behind her), thus removing the pain of vacancy and turnovers.
You also now potentially own investment real estate in a different state or country, diversifying your investment portfolio and exposing you to a new market.
…are many. Maybe Mary has a sudden change of heart, and decides six months after you buy the rental property that medicine is not for her? You would be stuck with a distant property that you now must find a way to lease out and manage indefinitely.
What happens if Mary fails to pay the rent? Will you evict your daughter? Legally, eviction is the only tool available to landlords of irresponsible tenants, so your options are limited.
If Mary damages the property, how will you ensure that she repairs the damages? Just like with the non-payment problem, your enforcement options are limited if Mary turns out not to be so responsible after all.
If the property has multiple bedrooms, will Mary have roommates? Who will choose and screen the roommates? What if Mary pays her portion of the rent but the roommate doesn’t? What if the roommate throws a huge keg party, and a drunken guest falls off the balcony and smashes the roof of the foyer, causing $40,000 in damages and requiring another $50,000 in medical bills? Before shelling out tens of thousands of dollars to invest in a rental property, you need to think through these kinds of eventualities.
Then there’s the local market itself, which you presumably know nothing about. Sure, Mary says “I have to live in Federal Village, it’s where all the young professionals live!” But the chic neighborhood where all the young professionals show off how rich they are is usually not a recipe for buying low and renting/selling high; you would have needed to buy ten years ago, before it was all the rage. Maybe the best neighborhood for your investment is the still-slightly-dodgy neighborhood that the artists and hipsters are just discovering and slowly starting to gentrify. But as a parent, you may not want your daughter to live there.
The point is that what is best for your wallet is often not what’s best for your personal relationships, which is where making an investment as large as a rental property is tricky when family is involved. As the investor and landlord, you have a lot more to lose than your child does. You will be taking on a huge range of risks by investing in a distant market you know nothing about, and entrusting that investment to your child.
How It Can Still Succeed
Despite the challenges outlined above, there are still ways you can mitigate these risks. One approach is making your child a minority partner in the venture: they contribute a portion of the down payment, and co-sign the mortgage note, and own a percentage of the property. This way, they have some skin in the game.
You should also do just as much due diligence in your property hunt as you would do for any other investment property. That means spending plenty of time in the neighborhoods you’re investigating, getting to know them intimately. It means understanding the local rental market, the local demographics, the local forecasts for housing and other construction.
Hard as it may sound, you should be prepared to file eviction on your children just like any other tenants if they fail to pay the rent. You should also consider building additional deterrents into the lease agreement, that may turn the personal relationship to your advantage. If Mary fails to pay the rent, maybe there are consequences that have nothing to do with the property, such as you ceasing to store her belongings at home, or selling her car stored in your garage, to cover the lost rent. Or perhaps she loses her ownership interest if she fails to pay the rent or collect the roommates’ portion of the rent.
The more skin your child has in the game, the more accountable you can hold them, and the more likely they are to treat the property with respect. Adult children can make perfect long-term tenants and investment partners, creating value and equity for both of you… but only if you spend some forethought on ways to avoid potential disputes and risks.