Renting Rooms To Friends: Pros and Cons

Reader Question: Monty, I live in an apartment with several friends. I have a terrific job. I am the only one with a steady income. I am considering purchasing a home to get the tax breaks and renting rooms to them. I would not charge them full rent, and, everyone could share common expenses as a way of incentivizing them to stay. My only concern is that if several of them left it would be difficult to pay the mortgage. Can I have them sign a 5 year lease and somehow cut them in on the appreciation in value? Martin T. – Milwaukee, WI

Monty’s Answer: Hello Martin, my experience has been that when people mix “friends” and business in the sense described in your question that most often it does not turn out well. I assume everyone is sharing costs in your current rental arrangement. If friendship is the motivating factor, ignore the tax deduction and simply continue to rent with them. You can find other types of investment to protect your cash assets short of buying a home.

Run It As A Business

If you decide to proceed, increases your odds of success by choosing a proven motivator. It has to run like a business. Adjust your motives with your roommates now, before making the decision to move ahead. Share with them you have been advised against the initial plan. Tell them the plan would have to be strictly a business venture before you could go ahead. Just watching and listening to their reactions to this news will provide insights that may help you determine if you should proceed.

In general, the investment should operate like this:

• A business arrangement designed to produce a market rate return for your risk and your investment.
• Establish house rules before going ahead.
• Market rents based on independent appraisals by real estate management companies that deal regularly with housing arrangements like this. Consider paying a company to manage the property so you are not dealing with collecting rent, evicting your friends, etc. In a college town like Milwaukee, I suspect there are a number of management companies in this category.
• Treat all tenants equally.
• Other conditions suggested by the management company.

Seek Advice From Experienced People 

The lease can dictate how to share expenses. It should be constructed to anticipate turnover so new tenants can view the space and take occupancy in a timely fashion. I do not believe a 5 year residential lease is legal in Wisconsin. Check with a management company or a real estate attorney. A business plan with a financial projection would be extremely helpful as in any other business.  The management company will most likely have many of the documents necessary to operate this business in their arsenal. If they do not, continue searching for a management company.

After Grasping The Pro’s And Con’s – See A Lender

Before going too far, get a pre-approval letter from a commercial banker indicating the bank will make a loan under the circumstances your described. As a newcomer, it may be difficult to find such a lender. This is a solid reason having an experienced management company operating the project to add much needed credibility. I would not go to the lender until you have talked with a management company to understand the business. This solution requires hard work and study, but my experiences suggest to do otherwise greatly heightens the risk of failure.

Get Yourself Real Estate Educated

I do not know your background but I suspect this is your first venture into real estate. Remember my second recommendation is far behind my base recommendation. My experience in real estate is when emotions are the driving motivation, the landlord ends up getting burned, both emotionally and financially.  A beneficial course of action for you would be investing time in reading about the “ups-and-downs” when buying real estate. This web site may be a good place to start.

Good luck, Martin.