UnThreaded | Threaded | Whole Thread (10) | Ignore Thread Prev | Next
Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75802  
Subject: Sould you own or rent? Date: 4/1/2004 9:40 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
This morning your parents kicked you out of the family home (you're 42, after all). You're having a bad day until you get a phone call telling you your Aunt Selma died and left you $200,000 cash. Your day brightens considerably.

Should you plunk that cash into a new home, or rent a home and invest it elsewhere? Do you go for Home Equity (HE), or an Alternative Investment (AI)?

You pop open Excel and compare HE to AI and determine which provides the highest return.

HE gives you two advantages over AI. First, you can sell you home tax free up to $250K/$500K single/married (your investment tax rate is 20%). Second, you get to live in your home, so there's no rent to pay.
How to account for these? For the first, you decide to use after tax investment dollars when comparing AI to HE. For the second, you must determine the Equity Discount (ED)- the difference between what a homeowner pays to live in a home he owns and what he would pay to rent or live in a home with a mortgage. You determine the ED in your area is 60%- on other words, if you had to pay $1000 per month in total costs to rent or own with a mortgage, you'd only pay $400 if you owned the home outright. This $400 would go to property taxes, maintenance, and insurance.

Finally, you realize you need a Gross Rent Multiplier, or GRM. The GRM determines the how much house you can get for your rental dollar. In your area, you determine the GRM is 12. The means the landlord will rent you a home for 1/12th the value of the property annually.
With this information, you know your $200,000 home will rent for $1,389 per month, or $16,667 per year. (The GRM is 12, and 200,000/12 = $16,667). If you buy the home, it will cost you $556 per month or $6,667 per year in expenses (the ED = 60%, $1,389*.6=$556).
You expect inflation to be 3% per year, and you estimate your home will appreciate at the same rate (meaning it will not appreciate in real terms).

Assuming no transaction costs, your AI would have to return 10% per year to equal a home appreciating at only 3%. The math works like this: 10% after 20% taxes = 8%. Then you reduce by inflation/home appreciation (3%) to arrive at 5%. 5% of your $200,000 investment is $10,000, the same as the annual difference in cost between renting and owning ($16,667-$6,667=$10,000).

Obviously the results can change dramatically depending on your assumptions, but it is a pretty strong argument for home ownership. Any comments or corrections are welcome.

Nick
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (10) | Ignore Thread Prev | Next

Announcements

The Retire Early Home Page
Discussion on accelerating retirement day.
Pencils of Promise - Back to School Drive
"Pencils of Promise works with communities across the globe to build schools and create programs that provide education opportunities for children."
Managing Your Wealth
Our own TMFHockeypop from Rule Your Retirement fame on the TV show Managing Your Wealth.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement