The first homeowner in my collegiate social circle bought a barely habitable two-story Craftsman on the wrong side of the tracks. With his parents cosigning the loan and an army of friends helping him fix the place up, he turned it around in a matter of weeks and rented out three of the four bedrooms to his buddies. Their rent payments easily subsidized his mortgage payment, providing a small but helpful passive income stream.
My buddy was more resourceful than your average 20-year-old, but his story wasn’t atypical back then. Nor was the practice of co-ownership, wherein two or more non-romantic partners, such as friends or roommates, purchase a primary residence together. Indeed, had my friend’s roommates been more resourceful themselves, they might have been convinced to bring some equity to the purchase.
Since then, both practices – co-ownership and renting out spare rooms in owner-occupied housing – have grown in popularity. Here’s a closer look at why that’s the case, the benefits and drawbacks of co-ownership, and what aspiring co-owners should consider before taking the plunge.
Why Co-Ownership Is Increasingly Popular
Americans are putting off marriage longer than ever before. According to the U.S. Census Bureau, the average age of first marriage increased by about seven years from 1960 to 2016.
At the same time, Yardeni Research reports, we’re forming new households at a rate not consistently seen since the 1980s. A 2015 report by Deloitte Insights found that the proportion of single-person households more than doubled between 1960 and 2014. As Americans wait even longer to tie the knot or forgo long-term domestic partnerships altogether, the share of single-person households looks set to increase for years to come.
Since the early 2010s, these conditions combined with an expanding economy and low interest rates to cause an apartment boom in cities like San Francisco, Denver, and Washington, D.C. Millennials and Gen Zers disinclined to purchase homes of their own flocked to newly built apartment communities and older rental housing in amenity-rich urban centers.
The market for owner-occupied housing has exploded as well. The median home sale price rose from $222,900 in the first quarter of 2010 to $331,800 in the first quarter of 2018, according to the Federal Reserve Bank of St. Louis. Appreciation has been even more pronounced in booming cities. According to Trulia, the median home sale price in San Francisco more than doubled from $655,000 in January 2010 to $1.35 million in January 2018.
For millions of unattached millennials and Gen Zers heading urban, single-income households, homeownership has never seemed more remote – all the more so for those dealing with crippling levels of student debt. In expensive housing markets, many renters-by-necessity live with roommates well into their 20s and 30s, anxiously awaiting the day they can afford a place of their own.
But not everyone is so quick to go solo. Even after their finances improve, many renters stick with their housing companions or find new ones. Some even choose to purchase owner-occupied property together. When you’re simply unable to afford the house you want on your current income, buying one with a friend or acquaintance is a compelling prospect.
It’s also potentially fraught with peril. No matter how long you’ve lived with your once and future roommate, purchasing a home with someone with whom you’re not in a legal domestic partnership is not something to decide lightly.
Advantages of Buying Property With a Friend
Why buy property with a friend (or two)? These are among the most obvious benefits:
1. Two Incomes Are Better Than One
In expensive housing markets, single buyers with one income – even a relatively comfortable one – may have few options. With two (or more) incomes, you’re far likelier to scrounge up a 20% down payment and afford potentially hefty mortgage payments for years to come.
2. Owning an Income Property Becomes More Realistic
If you plan to purchase a duplex or larger single-unit home with room for renters, you’re likely to pay a premium, putting homeownership even farther out of reach on a single income.
3. Mortgage Qualification May Be Easier
Lenders underwrite everyone whose name will appear on the property title – in other words, they consider the buyer group’s cumulative income. Assuming your group’s average credit score is good, you’ll almost certainly have an easier time qualifying.
4. Your Offer May Be More Attractive to Sellers
With combined resources, you’ll have less trouble putting together a larger down payment or paying all cash, if resources permit. Cash-heavy offers are usually more attractive to sellers.
5. Opportunity to Build Equity
Homeowners build equity with every principal payment. If living the single homeowner life isn’t realistic for you, buying with a friend (or friends) is the only way to build equity in a property of your own.
6. Ongoing Homeownership Expenses Are More Manageable
A rough rule of thumb holds that homeowners should expect to put about 1% of their home’s value per year toward upkeep. This share may be lower in expensive housing markets where buyers pay more per square foot. Regardless, any cost-sharing is helpful.
Disadvantages of Buying Property With a Friend
Should you think twice about going in on a house with a friend or non-romantic partner? These drawbacks might give you pause:
1. Real Estate Is Illiquid
Even with thorough exit procedures written into your contract, severing your interest in a jointly owned home is not something you can do overnight, and selling the whole house or unit is likely to take months.
2. Your Mortgage May Affect Your Ability to Qualify for Other Loans
Carrying a big mortgage loan on your personal balance sheet may boost your debt-to-income ratio higher than lenders would like. If you plan to apply for other forms of credit – such as a car loan, credit card, or personal loan – soon, ask yourself whether it’s the right time to buy a house.
3. A Partner’s Shaky Finances Could Affect Yours
This is among the biggest risks of buying a house with a friend. Even with thorough due diligence, you can’t control your friends’ financial situation. Should they fall behind on their share of the payments, your credit could be affected.
4. Equal Ownership Can Create Stalemates
In a two-person partnership, 50-50 ownership can be a recipe for tension or impasses. That’s why it’s so important to make sure you see eye to eye with your co-owner before buying a house with them. The last thing you want to do is jeopardize a long-running friendship.
5. Unequal Ownership Can Create a Power Imbalance
Unequal ownership doesn’t necessarily guarantee harmony. As a minority owner, you may come to feel ignored or bullied by the majority owner or owners.
6. Improper Titling Can Jeopardize Your Stake
If your name isn’t on the home’s title, or you’re not the legal owner of a share in the business entity that owns the asset, you’re not a legal owner – even if you pay a portion of the mortgage and occupy the home. In other words, even if you’re good friends with your co-buyer, it’s imperative that you formalize the arrangement and secure a legal claim to the property.
What to Include in a Co-Ownership or Operating Agreement
No matter how well you know your partners, you must protect your interest with a co-ownership agreement that spells out the workings of your ownership arrangement in great detail. It’s similar to a cohabitation agreement you’d sign with your domestic partner, though less expansive. If you choose to create a formal business entity such as a multi-member LLC to hold the asset, the entity’s operating agreement has the same effect.
You can find affordable, generic co-ownership agreements online. NOLO has a legal guide for unmarried couples that costs under $25 and a compilation of small business legal forms for under $30. Make sure your agreement conforms to applicable state laws.
Since real estate ownership is complicated, and the universe of possible problems that could arise is vast, you’d be even better served by a customized co-ownership or operating agreement drawn up by a real estate attorney. Expect to pay several hundred dollars or more for a customized agreement drawn up by a licensed professional, but it’s a small price to pay to protect such a valuable asset.
Your co-ownership or LLC operating agreement should spell out most or all of the following.
1. Ownership Structure
First, you’ll need to determine whether to hold the co-owned house in an LLC or unincorporated ownership arrangement.
You should defer to your real estate attorney and tax professional for actionable advice. That said, bear in mind that LLC ownership may not make sense for properties that don’t produce income. Regular homeowners’ insurance may be sufficient to address liability issues that arise in the regular course of owner-occupied homeownership, and holding a primary residence in an LLC may preclude a homestead exemption on your property tax bill.
If your group plans to acquire one or more income-producing properties, a properly structured LLC may protect you from personal liability and could offer substantial financial benefits via business expense tax deductions. However, there’s a major catch for first-time buyers with limited cash reserves: Lenders rarely issue mortgage loans to business entities with few or no assets, and they may call the loan – or demand repayment in full – if you transfer the title to the entity after purchase.
The surest way to avoid this is to have the LLC purchase the property in cash. That’s a tough ask for first-time buyers with limited personal savings – even those who’ve combined forces with multiple partners – particularly in expensive markets. That said, lenders usually require larger down payments on income-producing properties; 25% or higher is typical.
2. Type of Ownership
Unincorporated homeownership partners generally use one of these two types of ownership:
Joint Tenancy
Joint tenants simultaneously acquire equal shares of the property on the same deed. Joint tenants have rights of survivorship, meaning a deceased joint tenant’s share passes at their death to the other joint tenants in equal measure without passing through probate.
When a joint tenant transfers their interest to another party, the arrangement converts to a tenancy in common. Joint tenancy is more common among married and unmarried domestic partners than unrelated ownership partners.
Tenancy in Common (TIC)
Tenancy in common is a more flexible arrangement allowing for unequal ownership and staggered acquisition. For instance, a three-person tenancy in common might arise as follows:
- Owner A and B purchase 50% of the property in January of Year 1.
- Owner C then acquires half of owner B’s stake in January of Year 5, leaving Owner A with 50% of the interest and Owners B and C with 25% each.
Tenants in common do not have rights of survivorship by default; a deceased tenant in common’s ownership share transfers to their estate, and thence to their heirs. However, tenants in common may give the partnership precedence over its members’ heirs by writing a “right of first refusal” clause into their ownership agreement.
3. Insurance
Standard homeowners insurance usually provides sufficient liability protection on owner-occupied properties that don’t produce income. If you plan to rent to non-owner tenants, however, you’ll need additional protection – generally, landlord insurance or umbrella insurance, depending on the nature of your ownership arrangement. Check out Allstate’s primer on landlord insurance to learn more.
You must take out umbrella insurance on an individual basis. Consult with an insurance agent about what’s suitable for your situation, then write a clause into your agreement stipulating minimum coverages for each co-owner.
4. Ownership Share
This applies to tenancies in common and corporate ownership structures only. In two-person partnerships, splitting ownership 50-50 is tidy, though many co-owners agree to designate one partner as the property manager, or the person responsible for making executive decisions about things like routine maintenance, repairs, and code compliance.
In LLCs and TICs, ownership is typically proportional to the partners’ capital contributions, or their shares of the down payment (if financed) or cash payment (if bought outright). If you contribute 50% of the purchase price and your two junior partners each contribute 25%, you’ll own half the property. If you’re dividing up the loan payment in proportion to partners’ ownership shares, make sure everyone can handle the required monthly payment. (More on that below.)
5. Responsibility for Repairs & Maintenance
As noted, it’s sensible to designate a point person responsible for making decisions – hopefully in consultation with the co-owners – about routine repairs and maintenance. That’s doubly true if you plan to have non-owner tenants living in the property. They need to know who to contact when issues arise.
You’ll also want to identify trusted parties capable of completing this work. It helps to have a handyperson in your co-ownership group. If you don’t, research and get references for third-party service providers.
Finally, you’ll need to determine how to pay for necessary repairs and maintenance. Splitting the cost according to each partner’s ownership share is logical unless you can agree on another arrangement.
Don’t forget to commission a home inspection before you close. A thorough, professional inspection should identify most major issues that could arise in the first few years of homeownership, such as a furnace or water heater nearing the end of its service life.
6. Responsibility for Improvements
You don’t want to trust your maintenance point person to unilaterally commission major home improvement projects. After all, not all home improvement projects increase resale value. In two-person partnerships, a consensus-based system is preferable, unless the ownership share is unequal. In multi-person groups, votes weighted by ownership share make sense.
Ideally, contentious votes over home improvement projects won’t be necessary. In your co-ownership or operating agreement, identify realistic renovations and value-enhancing projects and spell out timetables for their completion.
7. Responsibility for Utilities
Logistically, it may be easier to have one co-owner’s name on the home’s utility accounts. In your operating agreement, spell out that it’s this person’s responsibility to pay utility bills on time and in full, and that the other co-owners must compensate the payor before each payment due date. Since ownership share doesn’t correlate to water or energy consumption, consider requiring each co-owner to pay an equal share.
8. Tax Management
Stipulate how your ownership group will handle home-related income tax deductions – most significantly, mortgage interest and property tax payments.
First, you’ll need to determine which co-owners, if any, plan to itemize their deductions; many taxpayers don’t. Those who do plan to itemize will need to decide how to divide them, whether proportionally by ownership share or with one co-owner taking 100% of allowable deductions. Consult with a tax professional to determine what’s permissible here.
If the asset is owned by a business entity, you’ll need to stipulate how home-related expenses are divided up for business expense deduction purposes. Generally, co-owners deduct their shares of eligible expenses. The universe of permissible business deductions may be larger than home-related personal deductions; for instance, you may be able to deduct your share of home insurance and utility payments. However, the loss of the homestead exemption could offset this benefit. Speak with a tax professional before drawing up this section of your agreement.
9. Tenant Management
If the property has extra rooms or units, determine whether you’ll rent out those spaces to non-owner tenants, and if so, spell out tenant management logistics in your agreement, including:
- Setting up a separate bank account to collect and distribute rent payments and handle tenant-related expenses
- Determining each owner’s share of rental income
- Designating a contact person for tenants
- Setting rents (with allowances for future increases)
- Drawing up a standard lease agreement for new tenants (again, with allowances for modification)
- How to handle future tenant-related decisions (for instance, to cease renting to non-owners)
10. Exit Strategy
Your co-ownership or operating agreement must include clear, comprehensive provisions for owners to enter and exit the arrangement. These provisions must account for scenarios such as:
- A co-owner’s death with or without a will
- A co-owner’s wish to sell their stake in the property
- A co-owner’s unexpected financial hardship
It’s common for unrelated co-owners to include “right of first refusal” clauses in co-ownership agreements. Should one co-owner pass away or move to sell their stake, right of first refusal gives the remaining co-owners priority over the departing co-owner’s heirs or counterparts. They can choose to buy out that stake before it passes on to a relative, for example.
This part of your agreement should also spell out considerations for situations such as:
- When co-owners can eject a troublesome partner from the agreement
- How much notice a departing co-owner is required to give before selling or transferring their stake
- Appraising the fair market value of the home in preparation for the transfer or sale of a co-owner’s stake (or the entire property’s sale)
- Each remaining co-owner’s contribution in the event of a buyout (for instance, do remaining co-owners buy out in proportion to their current ownership stakes?)
Other Considerations for Co-Owners
These considerations may not appear in your co-ownership or operating agreement, but you’ll want to carefully think about them before buying real estate with a friend.
1. Local Ordinances
Some municipalities have occupancy ordinances restricting the number of unrelated people living in the same housing unit. For instance, before a zoning change went into effect, my hometown of Minneapolis set a limit of five unrelated people per housing unit. Two-person co-ownership groups should be fine everywhere, but you’ll want to confirm that larger groups conform to local law.
2. Timeline
How long do you want to own the place? Even when exit strategies are spelled out in binding form, divergent timelines could cause complications down the road. If you expect to exit the arrangement after five years, your partner expects to hold onto the place for 20 years, and neither of you has the means to buy out the other, your partnership is a ticking time bomb.
3. Lifestyle
In my own experience, “opposites attract” doesn’t apply to roommate relationships. If you’re disinclined to endure a yearlong lease with a difficult housemate, you probably don’t want to spend the better part of a mortgage term with one. Before entering into a mutual property ownership arrangement, have frank conversations with prospective partners about things such as:
- Smoking habits
- Pet ownership
- Social life (to the extent that it affects other owners or tenants; for instance, frequent guests or parties at the house)
4. Mortgage Rate
When evaluating multi-buyer mortgage applications, lenders don’t consider only the best credit score on the deed. Under normal circumstances, they average the buyers’ scores. If your credit score is higher than your partners’, this means your loan rate is likely to be higher than if you’d purchased the home on your own.
5. Credit Rating Risk
Joint ownership means joint responsibility. Even if you’re good for your share of the home’s expenses, your partners might not be. Should one of your co-owners fall on hard times and become unable to make their payments, and you’re unable to pick up the slack with the rest of your co-owners, the delinquency may appear on your credit report and adversely impact your credit score. If the loan becomes seriously delinquent, the lender may foreclose on the property.
6. Debt-to-Income Ratio
Even if you’re splitting a mortgage with one or more partners, you’re personally responsible for the entire loan. In other words, when calculating your debt-to-income ratio, credit bureaus use the loan’s full remaining balance, not just the portion you pay directly. Lenders are wary of borrowers with high debt-to-income ratios. According to the Consumer Financial Protection Bureau, the maximum debt-to-income ratio to receive a qualified mortgage – a loan with certain built-in consumer protections – is usually 43%.
7. Financial Capacity
Before agreeing to purchase a home with a friend or group of friends, have a frank, thorough conversation about your respective financial positions. You don’t want your co-owner’s inability to repay their share of the mortgage to affect your credit or, in the worst-case scenario, deprive you of your home. Share financial statements, including your liquid assets and liabilities, and proof of income with the entire ownership group.
Separately, you’ll want to run a credit report and background check – yes, even on your friend – to identify potential red flags that might not be apparent from their personal balance sheet.
An Alternative to Co-Ownership: Renting to Your Friends
If you’re not keen on cooperating – and cohabitating – with one or more co-owner friends, consider an alternative: purchasing a home outright and renting out rooms in the house to your friends. Charging fair market rent to one or more non-owner housemates is a great way to subsidize your mortgage, insurance, and property taxes, offsetting the cost of homeownership and rendering affordable a home that might otherwise remain beyond your financial reach.
Here’s an overview of the process and legalities of renting spare rooms or units in your owner-occupied dwelling to friends.
1. Local Ordinances
Make sure your house or unit, and the room you plan to rent, conform to all applicable local ordinances. For instance, your local housing authority may require basement bedrooms to have egress windows large enough to crawl through.
More serious restrictions are less common, but still important to follow. Some localities prohibit homeowners from renting rooms to unrelated people altogether, for instance. Others require owner-occupants to obtain rental licenses.
2. Insurance
Standard homeowners insurance may not provide adequate liability protection for your tenants. An umbrella policy may be your most cost-effective option. According to the Insurance Information Institute, you can expect to spend between $150 and $300 per year for a $1 million umbrella policy.
3. Tenant Vetting
Yes, they’re your friends, but you can never be too careful. Subject them to the same credit and background checks you’d run on unknown tenants. These reports shouldn’t cost more than $50 each, and you can eat the cost if you’re feeling generous.
4. Drafting a Lease
Again, you can never be too careful. Draft a formal lease agreement spelling out your respective rights and obligations. Your lease should also cover details of your living arrangement, such as:
- Whether pets are allowed (and the rules governing them)
- Responsibility for utilities
- Common area access and duties
- Rules governing overnight visitors
- Rules governing personal space (for instance, under what circumstances can you enter your tenant’s room, and how much notice must you give?)
- Security deposit collection, return, and forfeiture
5. Collecting a Security Deposit
No matter how responsible you believe your friend to be, accidents can happen. So collect that security deposit.
Exact rules vary by state, but landlords can generally collect security deposits equal to one or one-and-a-half months’ rent. In your lease, spell out how the deposit is held – usually in escrow – and the circumstances that may reduce the security deposit refund.
Pros of Renting Rooms to Your Friends
Why rent a spare room or unit to your friends? Beyond the obvious benefit of subsidizing your own housing, these are among the biggest advantages.
- Your Friends Are a Known Quantity. Most of us have cringe-inducing stories about bad roommates. Friends can be bad roommates too, but the fact that you know them socially should give at least some indication of how they’re likely to act in close quarters.
- You Don’t Have to Advertise the Place. Once your friend agrees to rent the place, you can skip straight to signing the lease – no need to open up your personal space for showings.
- Friends May Feel Social Pressure to Respect Your Space. Whatever their natural inclinations, your friends may feel social pressure to be model tenants, lest they burn any bridges.
- Friends May Be More Inclined to Help Around the House. Likewise, your friends might be inclined to go above and beyond around the house – cleaning common areas, mowing the lawn, shoveling snow, and so forth – particularly if you’re cutting them a break on rent or utilities.
- Your Friends’ Rent Payments Increase Your Reported Income. While rental income is taxable, money is money. In the short term, the extra funds may reduce your debt-to-income ratio, a boon for your credit score. Over time, your rental income might fund home maintenance, improvements, and non-housing expenses, or it might pad your tax-advantaged retirement account.
Cons of Renting Rooms to Your Friends
These are among the biggest drawbacks of renting space to your friends.
- You May Have to Be the Bad Guy. Hopefully, you never have to demand back rent from your friends or threaten eviction. But you should prepare yourself for the possibility. If you’re put off by the idea of playing the “bad guy” with your friends, consider renting to people you don’t already know.
- An Unequal Power Dynamic Could Damage the Relationship. Even if your landlord-tenant relationship never comes to a head, the mere fact of an unequal power dynamic could erode your relationship over time. After all, your tenant-friend is essentially a paying guest in your home.
- Your Decision Not to Formalize the Relationship Could Backfire. You might be tempted to rent to a longtime friend on a handshake basis. In the unfortunate – but not unheard-of – event that your friend causes serious damage to the property or skips out with rent due, you could find yourself out thousands of dollars and stuck searching for a new tenant on short notice.
- You May Feel Pressure to Cut a Break on Rent or Utilities. Even if you take the prudent step of drawing up a legally binding lease and accepting a security deposit, you may feel obligated to show good will by cutting your friend a break on rent or covering utility costs out of your own pocket. If you don’t want to feel bad about charging fair market rent to someone you’ve known for years, you might want to rent to a tenant you don’t know well.
- You Need to Be Able to Afford the House in the First Place. If you can’t scrounge up funds for a down payment in the first place, this whole exercise is moot, and you’re back to looking for friends willing to enter into a joint ownership agreement.
Final Word
Under any circumstances, buying a house is a life-changing decision. Buying a house with a friend, or multiple friends, presents a whole host of considerations that single or married homebuyers don’t need to take into account.
That said, buying a house with one or more non-relatives could be your only realistic shot at owning a home before your gray hairs start to come in. If that’s not motivation enough to explore non-traditional ownership arrangements, perhaps you’re ready to rent for life.
Are you thinking about purchasing a house with a friend, or buying a house on your own and renting to people you know?
