I recently had lunch with a good friend of mine who’s about to have a baby girl. Through the course of our conversation I said, “Have you ever thought about buying a house for your baby?”
There was a bit of an awkward pause, and she responded, “What do you mean?”
I then started to tell her about the concept of buying a rental property for your child as a legacy asset. It could be used to pay for college. It could be a place to live when they turn 18 (or 21). It could be sold to launch a business, or it could be held as a rental.
Most new parents I know have an existential moment pretty early in the pregnancy where they wake up in a cold sweat worried about how they will pay for it all.
The traditional path is to open a savings account for you newborn, and then fund it with your own money and gift deposits from family and friends. The thought is that the parents will make regular contributions to the account and it will be a nice nest egg in 15 years.
Let’s jump into the numbers.
Say you opened the account with $10,000 and deposited $100 a month every month until your child turned 15. The best savings accounts right now are offering around 2.5% APR interest.
So what would that be after 15 years?
$36,402. Not bad.
Let’s say you did a similar plan, but invested in the stock market. Let’s give yourself an 8% APR. After the same 15 years, your balance would be $67,903. Much better, right?
What about a 529 Plan? If you’re unfamiliar, this is a government sanctioned savings plan to be used for higher education expenses. There are a lot of features with 529s, but one that catches many people’s eye is the ability to buy tuition credits at todays prices that can be used in the future.
Personally, I think 529 plans are awesome, as long as you are 100% sure your child will be going to college.
Now, back to my original point. What about buying a house for your baby?
First the bad news, in the Puget Sound area, your initial investment will be more than $10,000. Most likely much more. But stick with me because I think I can convince you that it’s going to be worth it.
Let’s imagine that we are going to buy a “bread and butter” rental that’s close to a University, tech hub, or large employer. Thankfully, there’s plenty to choose from in our area.
For the sake of argument, let’s look at the real estate equity created in a $200,000 rental property with a 20% down payment and a 15-year amortized loan at 5.0%. (As I’m typing this, you can actually get 15-year loans down in the threes, depending on your credit score, but I digress.)
For the sake of our conservative example, let’s give ourselves two possible scenarios. First, let’s assume that the house never appreciates in value. Our down payment is $40,000 – so that’s the immediate equity position. In 5 years, our equity is $80,708. In 10 years, it’s $132,952 and the house is fully paid for in 15 years and it is worth $200,000. Keep in mind, it’s not that’s putting in money month after month. That’s your renters paying the mortgage with their rent checks.
That’s the best performance of anything we’ve looked at so far. If you’re wondering, “Well, what if I just put $40k into the stock market along with $100 per month, what would that look like?”
Good question. Your account would be at $167,111. But you wouldn’t own a house free and clear.
That’s the beauty of real estate. At the end of 15 years, you own the house and the mortgage has been paid for by renters. You now have an asset that is generating nothing but profit for you.
One more scenario with this house. Let’s assume that the property goes up in value over this 15 year time frame. While I can’t guarantee this, does anyone think houses in the Seattle area will be worth less than they are today in the year 2034?
If we assume a 5% per year increase in value, our numbers look even better.
Our immediate position is still $40,000. But in 5 years, we’re at $135,964. In 10 years your equity is $258,731, and when the house is paid off in 15 years, your equity would be $415,786.
To wrap up our thought experiment, if you bought this house when your child was born, you’d have 3 more years of rents coming in with the place fully paid off. When your kid graduates high school, you have a boatload of options.
After your initial down payment, the place virtually pays for itself. Obviously there are maintenance and taxes along the way, but you get my point.
My lunch pal was definitely interested as we finished up our meals, as I hope you are too.
If you want to explore something like this for your family, don’t hesitate to reach out to me: email@example.com.
*House example from Windermere’s “Invest In Your Children’s Future Through Real Estate” article.