Rent vs. Buy: An Example

By Kevin

The house shown in the photos below is in Northern Virginia's explosive real estate market. It is for sale or rent, but either way, it is way out of my price range. While I could almost afford to rent the place, I cannot afford the payments of a 30 year mortgage needed to buy the place. Sill, the divergence between the listed rental price ($3,600 a month) and sale price ($975,5000) is too large, in my opinion, but I'm not the one with a million dollars sitting around to invest.


shut_sale.jpg


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If you were to pay cash for the listed price of the house, and rent it at the listed price, you would be earning a paltry 4.4% annual return. Subtract the $8,000 in annual taxes and you're down to a 3.6% return on your investment. That's lower than a 1-year CD, which is now earning around 3.75%. And that's assuming that no depreciation has occured because of the renters, and that there are no other expenses.

Hence, these prices must really reflect an investor's belief that the price of this house will increase by several percent for the next year. Nobody is expecting double-digit increases, and some are expecting a slight downturn.

-- October 8, 2005 3:48 PM |

Comments

Bronson wrote:

[.."Hence, these prices must really reflect an investor's belief that the price of this house will increase by several percent for the next year.."]


Hmmmm.... what if the Dollars in your wallet & savings were losing 7% of their purchasing power each year, due to inflation ??

Actual monetary inflation today is at least 7% ... and rising with no end in sight.

If you knew your saved (..or borrowed) Dollars would, in 10 years, buy less than half of what they can buy today -- what would you do with those Dollars ?

Perhaps the 'problem' of overpriced real-estate is merely a symptom of something less obvious.

-- October 9, 2005 10:11 PM ∞

Dylan wrote:

If you assume 20% down, 30 year note, at 5.5% you get monthly payments around $4600. If you take into account a 20% reduction for interest you get $3700/mo. More realisticaly (for someone affording a million dollar houst) a 33% reduction for interest you get $3100/mo. I have not figured in prop tax at about 6% net (following tax deduction). Seems like a brek even to me. Ten years out the mortgage payment will increase slightly (due to decreased interest deduction) - how much will the rent increase? How about after 20 years? Also, at some point in time the property value will likely increase yeilding a net appreciation for the investment.

-- October 10, 2005 10:14 AM ∞

Brandon Berg wrote:

Dylan:

You're ignoring the opportunity cost of the equity. If you put down $200,000, you're missing out on, conservatively, $600-700 a month in interest.

-- October 10, 2005 9:15 PM ∞

howard wrote:


There might be a very different dynamic in play here - maybe the rental market in this area does not support monthly rentals greater than $4000 per month regardless of the housing value.

A renter would also likely be responsible for heating/cooling/utility costs and those could put the monthly cost over $4,000.

"Whatever the traffic will allow" cuts both ways. In this situation, the owner appears nervous and is probably having trouble covering 2 mortgage payments. A quick Google search showed this listed at $1,035,000 on August 13, 2005. Now at $975K , a 60K drop in just 2 months.

I seriously doubt that the rental price reflects the owner's expectation of future appreciation - it is more likely this is the max amount the traffic will allow for a rental that might cover most of his/her monthly obligations.

Makes me think the real estate bubble "burst" is getting closer.


outlay for mortgage, tax and insurance

-- October 12, 2005 6:39 PM ∞

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