Tuesday, September 13, 2005

New, fascinating rent vs. buy argument!

There was an interesting article on Curbed a few days ago, a continuation of a debate about whether you should jump into the housing market now or wait for prices to drop and continue to rent. A reader had commented that you should look at the buy vs. rent question in terms of capital loss, pointing out that renting is a guaranteed 100% capital loss.
His scenario, in brief:
Cost of renting: $2000/month
Cost of buying a comparable apartment: $650,000 with 4.75% mortgage.
His conclusion: after 4 years, the value of the apartment would have to decline by more than 20%, to $511,000 or less, for buying not to be a better option, even though the monthly gross cost of buying would be more than twice as much as renting.
I tried to work out the math a little bit: the monthly cost for buying the apartment would be around $4100. (I added in an estimate of $700 monthly maintenance onto the mortgage, and used the original poster's assumption of zero downpayment.) The total rent money spent over 4 years is $96,000. The total gross monthly cost of buying over those 4 years would be $196,800. Of that, mortgage interest paid would be $119,616, and equity built would be $77,184, with an outstanding loan balance of $606,862. So I guess he's figuring if he sells for $606,862-96,000=$510,862, that is a loss equivalent to what he would have paid in rent for 4 years. Therefore if he sells for anything higher than $511,000, he wins.
But what about the almost $120,000 worth of interest he's paid over those 4 years? Even if he's in a high tax bracket and gets a lot of that back in his refund, doesn't that money have to be considered? Say he's in the 35% tax bracket-- correct my math if it's wrong, but I figure you have to add about $78,000 to bring the break-even price to $588,862. That is only about a 9.4% decline in prices before you're losing out. And that doesn't even take into account the additional maintance costs you'd pay-- say the $700 maintenance is 50% tax deductible. That is another almost $11,000 that you have to add on to the break-even price, bringing it to just under $600,000. So now prices only have to go down 7.7% before you lose.
Is a 7.7% decline over the next 4 years likely? I don't have a crystal ball, but it seems like it could happen-- it's hardly an extreme doomsday scenario, given the huge increases we've seen over the last few years.
Of course, if you don't sell at the end of 4 years, and continue to build equity, eventually the balance changes: your interest costs lessen, and the market is more likely to increase in the long term. At the end of 9 years, you would have paid at least $216,000 in rent and you'd only have to sell the place for $348,923 to break even against having rented all those years. And call me crazy, but I don't need a crystal ball to believe that a 46% decline over 9 years is highly unlikely, at least not in New York City!
There is still the problem of having to double your monthly gross payments in order to buy, which is pretty much the same boat I'm in, but this is a really eye-opening calculation. I'm going to have to factor it into my real estate analysis spreadsheet tool!


Caitlin said...

I agree that I'd want to figure my net interest and maintenance costs into my "capital loss" figures for true accuracy.

Average time to own a home is 7 years...

sorry I'm still sputtering over the cost of NYC housing...I thought Boston was bad ;)

Anonymous said...

You're going to drive yourself crazy thinking about 'when' is the right time to buy. Many people buy their homes, and live there their entire lives. Selling is not the questions. It's whether you have the means to buy, and if you feel emotional ready for it. People told me NYC real estate was going to crash when I bought my place last year. There's always going to be someone that thinks it's a bad idea.

Anonymous said...

Thanks for posting this... Everyone's always saying that if you're renting you're just throwing your money away, but what's the difference between throwing $600 at rent every month and throwing $600 at interest on your mortgate? Yes, there's some tax advantages, but overall you're just giving your money to a bank instead of a landlord.

In your example (2000 rent/ 4000 mortgage payment) doesn't it make as much sense to rent, pay 2000 and bank the other 2000, and save up for a larger downpayment, so you're paying less interest overall, as it does to pay a $4000 mortgage?

At the end of a year in the first scenario you'd have $24000 in the bank (plus interest, etc, etc,)

At the end of the first year in the second scenario- would you have accumulated $24000 equity in your home? I don't know enough mortgages to say... but I don't think so. Based on your math- not even close.

There must be a crossover point- a point where you've paid a high enough downpayment, and paid a small enough amount of interest, that you're throwing away less money on interest- even the first year owning- than you would be on rent. But I don't know enough to figure that out.