If your objective is to live in the house for 5 years, and earn a minimum of 10% return on your equity investment, would you buy or rent? Explain

Financial Management

You are considering an option to purchase or rent a house – single residential property.

You can rent it for $1,900 per month and the landlord would be responsible for property maintenance, property hazard insurance and property real estate taxes. However, you would spend $120 per year on rental insurance that covers you for liabilities and theft/vandalism.

Alternatively, you can purchase the property for $210,000, and finance it with an 80% mortgage loan at 3.6% interest (i.e., 0.3% per month) for 30 years. The loan is a fixed rate loan and has no pre-payment penalty – that is there no penalty if the loan is closed prior to the original 30-year term.

You have done research on the property and found that:

1) historical property appreciation rate for that area is 2.7% per year
Historical rental growth rate for that area is 2% per year

2) Hazard/liability/theft insurance is expected to be $1,000 per year and escalating at 3% per year

3) Maintenance is expected to be $1,200 per year, and escalating at 3% per year

4) Your marginal tax rate is 22%

5) Capital Gains exclusion will apply when you sell the property (meaning you will incur any capital gain tax when you sell)
6) Selling costs including real estate commission = 7% of the sales price
7) Property tax is 2% of market value.

Answer the following questions.

If your objective is to live in the house for 5 years, and earn a minimum of 10% return on your equity investment, would you buy or rent? Explain

If your objective is to live in the house for 3 years, and earn a minimum of 10% return on your equity investment, would you buy or rent? Explain

Assume you want to live in the house for 4 years and earn a 12% rate of return on your investment. How much can you pay to buy the house achieve that target?

Assume you live in the house for 5 years. Keeping other things constant at the original problem values, obtain a graph that shows property appreciation rate on the x-axis and the IRR on the y axis (for 5 years of ownership). Run the model repeatedly and get the results on a table to get the graph. Show the graph below. Comment on the results.

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