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A friend of mine owns an old house which requires renovation. They proposed me to pay for the renovation, and in exchange, I could live in the house and pay a smaller rent (or perhaps no rent for a few years). This would be legally enforced with a specific contract.

I am trying to calculate how beneficial it is for me to make this move. This depends on how long I will stay in the flat, the actual cost of the renovation, and how much money I save by paying a smaller rent for the next years. I would like to calculate how long it will take for me to amortize the renovation cost.

By not accepting the offer, I would pay around 400€/month for a flat with similar characteristics.

The cost of the reform is still unknown, but I am making the case with something ranging between 6000€ and 20000€.

Cost (€) Amortization (months) Amortization (years)
6000 15 1,25
8000 20 1,666666667
10000 25 2,083333333
12000 Base Monthly Rent (€): 400 30 2,5
14000 35 2,916666667
16000 40 3,333333333
18000 45 3,75
20000 50 4,166666667

So for a renovation cost of e.g. 6000€ it will take me 15 months to amortize the renovation cost provided I pay no rent to my friend during that time.

Now I would like to calculate the same, but assuming I am paying 200€/month instead of nothing. I am not sure how to take this into account for the amortization period.

I will be grateful for any help regarding that calculation. Also let me know if the deal makes some sense in your opinion, or any other considerations I might be missing.

Flux
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user109730
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    The calculation is named "Present Value of a Series of Equal Payments". You will find versions of the formula that account for inflation, tax, etc. – Ben Voigt Jun 01 '21 at 22:52
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    Does your country allow DIY work on rental properties? Many absolutely require that licensed contractors do all work in a rental unit. – Harper - Reinstate Monica Jun 02 '21 at 01:16
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    Do you have the money at hand or would you need to take a loan for it ? – zakinster Jun 02 '21 at 08:48
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    I did something similar once because it allowed me to use colors and materials that a landlord would not have paid for. But that was a much smaller scale - sinking 20 000 Euros of your own money into a rented property does not sound like a great idea. – Eike Pierstorff Jun 02 '21 at 11:07
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    If your friend is excited about this arrangement but you're hesitant then that means it will be bad for you. – MonkeyZeus Jun 02 '21 at 12:22
  • Up to €20K of renovation sounds like a substantial amount of work — if you weren't lending money, and were just a regular tenant, what reduction in your rent payment would you expect to receive for living in a building site for X months? If the market rate is €400/month for a flat in need of refurb, it's presumably lower again for one going through refurb. Also, consider the scenario if you'll be happy if the friend needs the house back (or sells) as soon as the work is complete. – anotherdave Jun 02 '21 at 14:35
  • Also consider that renovations have a limited lifespan. If it takes 10 years to repay you for a bathroom renovation, it may already be time for a new one when you move out. Meaning your friend won't really have gotten anything in the exchange. – Eric Jun 02 '21 at 21:07
  • I'm speaking from a US perspective, not sure if it applies in the UK. If a residential renter pays for renovations, it counts as rent (similar to your arrangement), but it counts as rent up front. Therefore, the landlord would count that renovation cost as-is for the current year because it was received up front. If the landlord paid for renovations of this magnitude, they could be amortized over a certain lifespan, lowering the actual taxes due on the rent earned. From a landlord perspective in this case, in the US, it would probably be best if you just paid rent. – ps2goat Jun 03 '21 at 04:15
  • Once renovated, do you think your friend is really going to let you rent it for 400€/month? The purpose of a renovation is to charge more for rent. You would be effectively helping your friend charge you higher rent. – MonkeyZeus Jun 03 '21 at 11:54
  • @MonkeyZeus OP specifically said there would be a contract which legally enforces the agreement. – Kat Jun 03 '21 at 19:23
  • What will be in the contract agreement? Rent that's 800€/month instead of the anticipated 400€/month? – MonkeyZeus Jun 03 '21 at 19:28

5 Answers5

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I generally find that when two things are mixed together, it doesn't end well. Your friend wants to borrow the money for a renovation, and perhaps can't borrow elsewhere, and you want to live in a nice place. Rolling these into "you pay for the renovation" and "you pay less rent" could be a disaster. Consider:

  • if the reno goes over budget, are you just expected to pay for the extra?
  • if you want to move elsewhere after just a few months, how will you be compensated for your loan?
  • if you and your friend disagree on some aspect of the renovation (I would like a larger sink or more glamourous window or fancier stairs) who makes the decision? You, because you're paying for it and living in it, or your friend, because they own the house?

I think it is far wiser to do two separate things:

  • first, loan your friend some fixed number of euros for the renovation. Interest rates are very low right now, but do charge interest, so as to be fair and arms-length about it. Choose a low fixed rate like 1 or 2% a year that is more than you would earn in savings and less than they would pay on a loan. Have a proper contract for this with repayment terms, so much a month. You don't have to do an amortization if you find that hard: just have the payment be some fraction of the principal, plus interest for the month on the current principal, so the payment will get slightly smaller over time.
  • second, rent the apartment from your friend at a fair market rate.

It may be that you give your friend a cheque for 400 each month and they give you one for 405 at first, which falls as the loan goes down and so the interest amount goes down. It may seem silly to exchange these payments. But it won't seem silly if you move out, stop paying rent, and still get your loan payments. It won't seem silly if the loan ends, fully paid back after whatever time period you agreed, and you keep paying rent. It removes all the armwaving about "but by this time on a loan we would be paying far less interest, so really you should now be paying at least a little rent." It also lets your friend work out their taxes accurately and fairly, knowing both their expenses and their income for this property.

As a nice side effect, all the reno decisions and obligations are on your friend, not you. They choose the materials, the appliances, the finishes. If it goes over budget they find the money. If it goes under they benefit. They might ask you what colour you like, because you're their friend and tenant-to-be, but they are the ones who will own and pay for things like the roof and the stove and the tub, so they are the ones who will choose that. A huge source of conflict evaporates.

Note: If the idea of lending a friend tens of thousands of euros worries you, if you know the bank won't lend it to them, if you aren't comfortable with contracts, if you're concerned the friend might not repay you, or that your friendship would be hurt by having a financial aspect to it, then that should be a reason not to do this at all. Making the loan more informal and the repayments be in rent relief doesn't alleviate any of the worries I've just listed, if anything it would add more to them (my first set of bullets) or make them less clear and more something to argue and disagree about later.

Kate Gregory
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    Lending a friend money for a renovation might be far-wiser than paying for the renovation as a tenant, but for many people it's best not to get involved with lending money to friends. – Hart CO Jun 01 '21 at 14:48
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    in fact one benefit of this approach is that it makes it clear you're lending a friend tens of thousands of euros, and encourages you to think about why you're doing that. – Kate Gregory Jun 01 '21 at 15:15
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    Thanks for your point of view on this, sounds like a pretty reasonable advice. – user109730 Jun 01 '21 at 17:22
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    Lending large amounts of money to a friend is a nice way to lose a friend and some/most/all the money. Even with a contract, the friendship will not feel the same until the money is paid back in full, if, indeed, it ever is. – ARich Jun 02 '21 at 00:11
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    On a money site the advice isn't to write up a decent contract covering a few scenarios, both save money on taxes.... No the advice is to give out a loan at 5% below the market rate. On a money site 20+ upvotes for giving a friend a loan - with probably little to no way to enforce payments... for way way under market. I think most understand this is basically a home equity loan which have been hovering at around 6% for a while. – blankip Jun 02 '21 at 03:52
  • @ARich Well, in this case there is collateral. He will be living in the friend's house. A place to stay is a basic need, and it is certainly an asset to have a cost free place to stay for X months. Good luck getting an eviction order if it turns out the landlord owes YOU thousands. I would agree with you if there was no collateral. – Stian Jun 02 '21 at 09:23
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    If the friend needs a loan, he should get it from a bank. If a bank won't give him a loan, it's probably because he's a bad risk. If he prefers some other arrangement, it's probably because he doesn't want to put up collateral. –  Jun 02 '21 at 11:26
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    @blankip I signed papers for a mortgage YESTERDAY at 2.2%. Not everyone lives in the USA. I chose a number that is market rate where I live. – Kate Gregory Jun 02 '21 at 13:01
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    Agreed with others - lending comes with HUGE risks. Banks are equipped to mitigate those risks. An individual lender is not. Lending money as an ordinary citizen, whether to a friend, or anyone else, is a bad idea. There is almost no gain to be had for the level of risk it represents. If the landlord needs to borrow, they should borrow from a bank. – J... Jun 02 '21 at 13:36
  • @StianYttervik Collateral (though I’d hardly put glorified “crashing at my friend’s house” as collateral) doesn’t change what I said. If the situation has deteriorated enough to begin the eviction process, the friendship has been lost, which is one of the things I said was at risk in this situation. – ARich Jun 02 '21 at 13:58
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    @blankip I would say a situation like this has much more 'enforceability' of repayment of the loan, given that the OP would be living in the house. In most cases of lending friends money, the only way to get repaid is for the friend to write a cheque. Nonetheless, this answer very clearly outlines the problems associated with doing so, and in fact by reframing the problem as loan + rent vs the OP's mixed thinking, highlights that risk quite well. – Grade 'Eh' Bacon Jun 02 '21 at 15:40
  • "I signed papers for a mortgage YESTERDAY at 2.2%". Mortgage interest rates are much lower than unsecured loans because they are far less risky to the lender. If you default on your mortgage the lender can take your house. An unsecured loan should defnitely be charged at higher than 1 or 2% considering the relatively high risk. See also @BenCrowell's comment for why this is the case here. (note: I agree with the answer overall, just not the proposed interest rate). – JBentley Jun 04 '21 at 09:00
  • I would REALLY avoid involving money in a friendship, if at all possible. Too many ways for things to go wrong, resulting in grief for both of you. To quote Patrick Rothfuss: 'There are two sure ways to lose a friend - one is to borrow, the other is to lend.' – CharonX Jun 15 '21 at 06:42
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Since your friend is the owner of the property, he will be the owner of the renovated property. Unless you gain ownership on part of the property in exchange of your investment, your arrangement is equivalent of you lending 6k€-20k€ to your friend and him repay you in rent discount.

Others have already addressed the issues of this arrangement and the need to dissociate the loan and rent as two separate and independent arrangements in order to contain the risk/reward for each party.

But the real question in my point of view is: why would you loan up to 20k€ to a landlord while yourself is just a tenant ?

You may want to first prioritise your own investment before helping other invest your own money.

You need to understand that your friend, as the owner, will make a profit on this investment (in real estate capital gain) which will most definitely exceed the initial investment.

In order for this arrangement to be fair, you would need to make a profit as well in your investment, so you would need to charge interests which will have to be taken into account in your calculation.

If you don't have the money at hand, there's no point. You can't borrow money from an institution only to lend it to someone else. No respectable institution will let you do that and for good reasons.

If you do have the money, you need to ask yourself : is this the best way to invest my money ? Lending money is a high-risk low reward business which is better left to professionals.

In the interest of your friendship, a much better arrangement would be for your friend to take a loan from a bank (more competitive for him) and you to invest you money elsewhere (more profitable for you). You can still rent the property and help you friend in the renovation process (design, material choice, construction work supervision, etc.).

If your friend can't get a loan from an institution, you would need to ask yourself : why would I put myself in a situation regarded by all professionals on the market as either too high-risk or not profitable ?

zakinster
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You don't need a spreadsheet.

In the first case, you are looking for the number of months m where

400m == 6000

The initial €6000 investment covers 15 months of rent.

If you pay some additional rent of €200 on top of the initial investment, the equation becomes

400m == 6000 + 200m

where solving for m yields m = 30.

This doesn't take into account any tax laws that may have something to say about this arrangement. Is your investment a loan, and if so, is there a nominal amount of interest that you must charge in that case? Is any part of this transaction considered income for either party? For that, you'll need to at least specify a country for someone (not me) who is familiar with the applicable tax laws.

chepner
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    The time value of money (opportunity cost) is also important to consider Paying 6000 euro now in order to recover 6000 euro several years from now yields an ROI of zero percent, and is effectively losing money when you consider any other investment option. – Nuclear Hoagie Jun 01 '21 at 16:30
  • It was pretty easy then, thank you for the answer! – user109730 Jun 01 '21 at 17:23
  • @NuclearHoagie That's true, but if we're only talking about 2-3 years, the volatility of the market makes it difficult to account for that. It becomes more important when you consider longer terms, like 15-30 year mortgages. – Barmar Jun 02 '21 at 14:20
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    @Barmar Assume 10k is used for renos. 2% interest rate would yield 200 EUR per year lost. So roughly speaking, forgoing interest would be equivalent to the OP giving his/her friend 500 EUR of free money if it took 2-3 years to pay off. – Grade 'Eh' Bacon Jun 02 '21 at 15:37
  • @Grade'Eh'Bacon Where can you get 2% interest these days? In the US, CD interest rates are generally less than 0.5%. Is it significantly better in the EU? – Barmar Jun 02 '21 at 15:40
  • @barmar You are thinking about interest rates on deposits - you need to look at interest rates on collateralized loans - ie: market rates on mortgages or similar products. Why are these rates higher? Because the risk of a mortgagee defaulting on their loan is higher than the risk of a bank defaulting on the deposits you hold there [which may be covered by the government under law anyway]. The key is that in this case the lender [the OP] would be taking on risk by loaning money to a friend, and should be compensated for that. 2% would even be low, in my opinion, given the risk... – Grade 'Eh' Bacon Jun 02 '21 at 15:43
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    @Grade'Eh'Bacon OK, now I understand you. So we have to include the missing interest in the calculation, not just the loan principal. – Barmar Jun 02 '21 at 15:46
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Easiest to think of it this way:

The market rate for the flat is 400€/mo.

  1. If you need to pay 0€/mo rent, you save €400 each month. Thus it takes 6000€/(400€/mo) = 15 months to get back your investment.

  2. If you need to pay 200€/mo rent, you save 200€ each month. Thus it takes 6000€/(200€/mo) = 30 months to get back your investment.

As an additional point; I don't think it makes any sense to loan any amount of renovation money to your friend, no matter the contingencies.

ruohola
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The other answers address the numbers and legal arrangements.

Also let me know if the deal makes some sense in your opinion, or any other considerations I might be missing.

Consider the money a gift to your friend. Are you willing to give that much money to your friend?

Do not move forward with this arrangement unless the answer is yes. It's not really a loan unless you are willing to collect the debt. If your friend fell into misfortune, would you be willing to, for example, take possessions or garnish wages to recover your money?

If you can't afford to give the money, you should stick to more clearcut arrangements.

mp3
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