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Investing Strategies

How to NOT Own “Animal House” (Offsetting Risk in Student Housing)

animalsDoes the mere mention of “student housing” fill your mind with scary thoughts about out-of-control drinking parties and costly property damage?

It shouldn’t.

As we continue our ongoing Student Housing series with Doug Fath, today’s lesson will explain how to avoid every student housing investor’s worst nightmare: owning a coed disaster magnet like the notorious bachelor pad featured in John Belushi’s iconic Animal House movie.

But first, if you need to catch up on Doug’s previous lessons, or if you are unfamiliar with Doug’s impressive qualifications as Mogul’s favorite “student housing sherpa”, take a few moments to check-out (i) his initial introduction to this lucrative investing niche and (ii) the first two installments of our current series:

Up to speed?  Splendid!

Now let’s take a few minutes to learn exactly how Doug uses a “magic lease” to avoid owning his own version of Belushi’s personal playground…

Toga Parties & Magic Leases

Doug: Everyone's seen the movie Animal House, right? That’s what most investors picture when they think of student housing – the Delta Fraternity house.

Investors fear college students will ruin their investment property… but, surprisingly, they don’t.

belushi1Mainly this is because we have what I call the “magic lease, and there are so many beautiful things about it.

Usually, when we are doing low-income housing, we're pretty much relying on the breadwinner of the household to pay the bills. So, if the breadwinner loses their job, that's it… They're not paying their rent, and then we’re chasing them down.

With a “magic lease”, more than one person is responsible, because several students signed that lease. More importantly, we also have additional co-signers (aka “parents”) that signed the lease as well.

And the lease also includes language to address Joint and Several Liability, which I can explain best by giving you this example:  Even if each college housemate was paying 500 bucks a pop, each person is still liable for the full amount of rent.  So, they're technically ALL on the hook for the full $2,000 every month.

Now let's say a roommate’s parent loses their job, and they suddenly can't pay their portion of the rent for student housing. The other parents aren’t going to let this ruin their credit, so your rent still gets paid.

You see, the clause for Joint and Several Liability actually serves as a policing mechanism by having all of them sign, and even acts as a policing mechanism to help collect the rent.

We don't have to call and follow up with these tenants anymore. We simply send an email to everyone (including the co-signers and tenants) saying that their rent hasn’t been paid. We don’t have to target one person… It’s just like, “Hey, make sure you get this rent paid.”

belushi2And it works the same way for damages. If work must be performed in excess of the security deposit we collected, then not only are the tenants responsible, but the co-signers are responsible, as well.

I can tell you, from my company’s own experience, we've never had damages above the security deposit.  But, if it was a situation where the security deposit didn't cover certain damages, I believe it would still be a non-issue, because we have Mommy and Daddy on the hook.

And with our properties, we’re either building from the ground up or we're performing a full-gut renovation – so everything in there is brand new.  (As a result, we're also able to get a little bit higher rent.)  And when you give tenants a nice place to live, you attract a better quality tenant, and they often keep the place the way they found it – even when it comes college students that party.

Mogul: The Joint and Several Liability clause is very interesting. But I have another question for you…

Would you also apply that clause in a multi-unit building, where the units are separate, and you have, say, six people in a rooming situation? Does the magic lease still apply here?

Doug: Yes.  Although you will frequently hear student housing investors refer to our magic leases in terms of student housing “units”, I consider a student housing unit to be an apartment.  So you could say that the Joint and Several Liability includes everyone within that apartment.

But… if we also have a duplex, for example, which has two units (two apartments), and if each apartment has four bedrooms and two baths… Then although the eight bedrooms are contained within a single building, the Joint and Several Liability is only one lease per apartment (unit) – so there would be a total of two leases, each with its own clause for Joint and Several Liability.


Do It To It! Immediate Action Steps

Protect Your Assets with Joint & Several Liability – Create your leases using a Joint & Several Liability clause, in order to (i) maximize your ability to collect full rent payments and (ii) minimize your need to pay for costly property damages.

Remember That “You Get What You Pay For” – Remember that you can attract higher quality tenants by investing higher-quality assets.

Stay Tuned – Stay tuned for more helpful lessons in this series about Student Housing with Doug Fath…

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