Rent vs. Buy – Where Did I Go Wrong?

[mrwrong]

Rent vs. buy discussion comes up a lot on this forum. I did my own calculation using a condo (3 bed room and 2.5 bath) in a neighborhood that I’m familiar with. The value of the condo has more than doubled in the past few years.

Purchase Price: $600,000
Down Payment: $120,000 (20%)
Interest Rate: 6.75% (30 year fixed)
Property Tax Rate: 1.25%

Mortgage: $3113
Property Tax: $625
HOA: $200 (includes insurance, etc.)
——————————-
Total Monthly Expense: $3938

Assuming a tax bracket of 34% (Federal + California) and taking out the principle portion of the mortgage (since you are building equity), your actual expense comes to $2,344/month. The same condo rents for about $2,200 – $2,500/month. It seems cheaper to buy even at today’s inflated price. This can’t be right. 🙂 Where did I go wrong?

This is assuming you are buying this condo for primary residence. If you are buying as a rental property, then it is a different story.

[no_such_reality]

You’re missing the opportunity cost of your down payment.

$120,000 invested. Say, 10% a year return, that’s $12,000/yr.

So the cost of owning is really more like $3,344/month.

[waiting hawk]

Also the neg. equity

My website tracking Temecula and South Riverside County

[sdappraiser]

Dont forget as a renter, you are still entitled to $10,000 Standard Deduction ($5,000 if your single). Many rent vs. buy calculations I’ve seem do not include the tax benefit that exists even if you don’t itemize.

You also need to factor in your opportunity cost. The $120k down payment could be earning around $5,400 @ 4.5% pre-tax every year (2 months of rent).

[bigmoneysalsa]

Two more things should be in there. The first is maintainence. No longer get to call the landlord when something breaks; you have to go to Home Depot and whip out the credit card. The second is the lost opportunity cost of your equity. Historically homes return almost nothing above the rate of inflation in the long run.

[masayako]

Also, closing cost (3-4% of the purchase price) when you sell.

[mrwrong]

Thanks for all the responses so far. Let me summarize:

1. Negative equity since housing price is going down.
Let’s say I’m going to stay in this condo for a long time and I’m going to ride out the ups and downs.

2. Opportunity cost of investing the $12,000 down payment.
I know someone suggested 10% annual return on investment. That seems optimistic. Let’s use a more realistic number, say 7%. Again assuming the 34% income tax bracket. The $12,000 will grow to $188,507 after 10 years. However, if you buy the house, you are also adding equity with every mortgage payment. Your equity actually grows to $190,555 over 10 years. Again, buying comes out ahead. I know some of you are going to say your equity is going to decline significantly for the next few years, but that is not a sure thing and also see #1 above. Plus if it’s cheaper to buy today, maybe it’s not overvalued.

3. Not taking the standard deduction into consideration.
Let’s say I already itemize. The state income tax along would make me itemize my return.

4. Not taking maitenance into consideration.
This is true, but this is a relative new condo and HOA takes care of all the exteriors. You may need to change a few bulbs and fix some leaky pipes. Let’s add $100 to the monthly expense to cover this. Note in my original post, I didn’t take rent increase into consideration. Buying still does not seem a bad idea.

Come on guys! You need to do better than this. 🙂

Mr. Wrong

[barnaby33]

Yes we do, I personally will accept responsibility for our slacki-ness. Since I have had half a bottle of MARE-LOW, its alot easier. Something is missing, oh yes the inflated rental value. I knew there was a hole in there somewhere!

Everytime someone gives you a series of calcs you attack the assumptions its based on, so let me do the same. It doesn’t really rent for that much, (Bare with me though). Since I have had the aforementioned MARE-LOW I am not in a math mood, but since you are, you can pick an arbitrary number at which it is cheaper to own then rent. That way no matter what its a win for owning.

One more thing. The oppportunity cost of 120k, not 12 at 7% amortized over lets say 10 years is 241,159.37. Thats alot of freedom you just nailed into an asset for which there is an extremely compelling series of arguments for not buying.

Do you have 120k to gamble like that, I know I don’t.

Josh

[PerryChase]

Also HOA is usually more than $200. I know of very few condo complexes that charge such low HOA. $300-400 is more like it.

Please let me us know what neighborhood you’re talking about. My dad owns a 4-BR, 3BT SFR in a neighorhood that sell for right about $600,000. Rents there are $2100. Sounds like the rents you’re using are high.

A friend is renting a 1600 sf condo at the Grande downtown for $3,000 and the HOA there are $750/month and the facilities are first rate. Seems to owner is upside down on this “investment.” One unit sold earlier this year for $865,000 but I think the owner paid more (incomplete info on Zillow) That building is a ghost town.

If condo owners can rent out their properties for $2500 in complexes that charge only $200 in HOA they are getting great rents! $200 HOA means that property has zero amenities.

Insurance should also be included in your analysis. Renters insurance is much lower than homeowners insurance.

One poster here said that he’s renting a million ++ house in La Jolla for a great deal vs. buy (please tell us again if you’re here). The more expensive the house, the greater the delta between rent and own.

As I’ve said before, I’ve looked (mostly UTC and Carmel Valley) for my elderly auntie and it’s much cheaper to rent.

I’d love to see a specific property / condo complex where it’s better to own. Please let me know so I can tell my auntie to buy there.

Also consider that many such as students and the elderly don’t benefit from the mortgage interest rate deduction.

[PerryChase]

Liquidity is also a big factor. If you have to move and you can’t unload the home, it’ll turn into a huge albatross that will suck money for years.

Realtors always say well… get that teaser rate because you can always sell and move-up in a couple of years. If you can’t sell and loose the mortgage tax deduction, then you’re in deep doo-doo.

What about a risk premium for owning? Right now, there’s no risk in renting.

[qcomer]

I am going to trust you on all the rent, buy and HOA numbers you have provided though HOA seems little conservative for new condos. Anyway, Please note that only interest in your mortgage is deductable and not your pinciple payment. Also, can anyone confirm if HOA dues paid are tax deductible? I don’t think so since they pay for water&gas utilities, exterior maintenance, etc so I haven’t included those in calculation but being a small number they should vary result by just about $70. Note that I am giving you this calculation for nealy 7-8 years as it is a very optimistic belief that you will stay in this smallish condo for 30 years considering marriage, children, job loss, emergency and everything. Here is the low down for you and please correct me where I am wrong.

BUYING:
Average Equity built per month = ~ 460.
HOA = 200.
Tax deductable Mortgage Interest + Property Tax = 3938 – 460 – 200 = 3278.
Per month aftertax return on downpayment of 120K at 4.5% = ~$480
Maintenance = 100.
Appreciation = 0.
Tax benefit if you itemize = 3278*0.34 = 1115.
Per month cost to buy = 3938 + 100 + 480 – 1115 = $3400.

RENTING:
Per month cost to rent = $2300.

AMOUNT YOU OVERPAY FOR BUYING = ~$1100 per month.

So MrWrong let me know what you think I have missed. You seemed to imply in earlier post that the principal you are building is some kind of investment that will grow but note that this growth is actually appreciation on your house which is pretty much 0% or even negative for next 5 years. Why would you like to start putting money (principal equity built for 5 years + 20% down) for next 5 years on the worst piece of investment possible in current scenario when you know that you can get the same condo for much less in next 5 years? Why not rent and use that down payment + monthly principle payment to invest in equities, precious metals, commodities, international markets, etc or diversify as you may like. Also note that these investments are much more liquid as compared to your condo, in case life throws something bad at you. Oh and I haven’t including all the costs for selling your condo (5% of condo price).

To me, since the ammount you are paying to buy is nearly 45% more than current renting price, so the price of that condo needs to come down to around 450K for me to consider it attractive. MrWrong, I hope you make the right decision.

[lamoneyguy]

1. Negative equity since housing price is going down.
Let’s say I’m going to stay in this condo for a long time and I’m going to ride out the ups and downs.

Sure, if your time horizon is legitimately that long for the same place in the same location. IF prices decline, you are stuck for several years or more. You may decide 3-5 years from now that you want to take a job in another city or whatever, but you’re stuck. A lot of people talk themselves into believing that they plan to stay in the same place for “a long time” in order to justify overpaying today.

2. Opportunity cost of investing the $12,000 down payment.
I know someone suggested 10% annual return on investment. That seems optimistic. Let’s use a more realistic number, say 7%. Again assuming the 34% income tax bracket. The $12,000 will grow to $188,507 after 10 years. However, if you buy the house, you are also adding equity with every mortgage payment. Your equity actually grows to $190,555 over 10 years.

You removed the principal paydown from your earlier calculation, then put it back here for equity buildup. Can’t have it both ways. Either you include equity in your monthly nut, or you don’t.

Also as someone else stated, your initial numbers don’t work. Maybe you took a tax deduction for the entire PITI, but they don’t make sense.

[no_such_reality]

Principle.

Mr. Wrong, you already excluded the principle from your initial cost math.

If you want to add it back in, that’s good, but compare apples to apples. Renting $2000-$2500. Owning $2800+

First, after ten years, your cumlative principle payment is only $70,555. Of, course, that increases your monthly cost back to $2800+ the downpayment after tax deductions. Total value of down and principle: $190,555 as you stated. That is, of course, plus or minus, any gain or loss in housing value.

Secondly, the Future value of the down payment plus the principle payment at 7% is $341,012. If you go to a higher rate, it climbs higher. At 8.5% return, it’s $388K. At 10%, it’s $442K. Less taxes, hopefully long term capital gain taxes. Remember, your principle payment increases a little bit each month.

Personally, I think 7% is way too low, you have bank savings accounts paying 5%. While you may think it’s high, 10% is in reality, lower than the historical return of the stock market.

In the end, you’ll make the numbers work any way you want them to. It’s garbage in, garbage out. And assumptions in reallity, are just a form of garbage.

Basically, the difference in equity growth even at a mere 7%, means to balance, the house needs to appreciate 30% over the next 10 years.

[powayseller]

Your argument uses an overpriced rental. This is an example of twisting numbers to make a point.

The landlords on this forum use a GRM of 8 to determine whether a home makes sense to purchase as a rental. If a unit can be rented for $2200/mo., then a reasonable price to pay for it is $211,200. (2200 * 12 * GRM of 8).

My rental is $2200/month, and it is worth $450K. The landlord’s PITI is $2658 *, and his repair/maintenance costs are $375/month. So he is underwater by $ 825/month.

He is also losing equity. The place was worth $575K in January, but now a similar unit listed at $500K has been sitting since February. He is losing 10% of purchase price annually, in addition to losing money on the cash flow.

——-
*Calculations. The landlord would be paying, at 6.75%, $2918 according to an online mortgage calculator. In the first year, the after-tax interest paid is $1670 (450K * 6.75% – 34% tax rate). Less than $400/month goes toward principal, according to the amortization table. So the after-tax interest and principal is $2070. Add HOA $180, property taxes of 1.25% (after taxes .825%) = 468, homeowners insurance = $ 100, total = $2658. Now add 1% for repair/maintenance = $375.

[PerryChase]

Tax savings is overstated because the mortgage interest deduction should be not the total amount of interest but the delta between the standard deduction ($10,000 for married) and itemnized deduction. Interest the first year on that $480,000 loan is about $32,250 + $7500 tax = $39,750. Your “extra” tax deduction is therefore $29,750 for a tax savings of $10,115/year at 34% or $843 per month.

The buy/rent analyses I’ve seen tend to overstate the potential tax savings, especially for people in the lower and middle income tiers with few itemized deductions other than interest and property taxes.

Most buyers don’t understand any of this and take for granted whatever the loan officer (working in concert with the RE agent) tells them.

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