Rent Versus Own Analysis

Rent versus Own Analysis

When analyzing whether to invest in a home it is important to take into consideration the cost of renting. If the current economic situation of the investor is that where the cost of renting is more beneficial than investing in a home, they should take that into consideration.

In our example we are analyzing the cost of investing in a town home in West LA for sale at $800,000. We have enough money for a 20% down payment and are financing the rest of the purchase with a fully amortizing mortgage loan at 4% for 30 years. Some additional considerations for this analysis. For owning, we expect the property value to grow at 3% per annum, insurance and maintenance are expected to be $500 each in the first year and grow at 3% per annum after that. Marginal tax rate is 28% with property tax rate as a percentage of home value at 1.5%. The owner is expected to own the home for 5 years and sell it incurring a selling expense expected to be 5%. For renting, you can find a similar town hoe can be rented for $2,000 per month and the rental growth rate is expected to be 3% per annum.

I created the framework for making a rent vs owning comparison using this info.

In this section it sums up what you would be paying each year in mortgage payments which for the first year will be $36,665.49, which was calculated by using the payment function in excel to get the monthly payment then we multiply that by twelve. To get the balance at the end of each year you must create a table that has the beginning balance, monthly payment, interest, amortization, and ending balance. Once you have that info you will get your yearly interest and yearly amortization by summing up twelve months. With this information you can see how much you would still owe at the end of five years and the breakdown of how much your payment went to interest and amortization per year. In this table you can also see how much your property has grown by year five as well as how much more you will be paying in rent at the end of year five.

With the table constructed and our rental and mortgage payments known we can now calculate our cash outflows for the next five years.

We start with before-tax cash flows since purchasers of residences have special tax incentives not available to renters. So for these cash flows we add up all our expenses that a renter does not have to consider and we get a first year cash outflow of $49,665.49 with it increasing to $51,297.11 in year five.

Now that we have the cash outflows before taxes we can now incorporate the special tax deductions that are available to a homeowner.

As you can see property tax and interest expenses are tax deductible