Buy vs Rent House in the Bay Area

Here is a Excel spreadsheet I created to help me with the Buy vs Rent decision in the Bay Area. It takes care of inflation (for rent payments, property taxes, maint. costs, utilities, home insurance, etc.), tax savings from mortgage interest payment, and opportunity costs of the downpayment, closing costs and the monthly payments towards the mortgage. I cut and pasted the table only for the first 6 years but the rest of the figures are for 30 years. I was not able to fit all the 30 years data from Excel here. Let me know if anyone is interested in getting the Excel spreadsheet itself and I will mail it. Please let me know if my calculations are wrong or if any adjustments are necessary.

The calculations show that buying an house for $650000 is equiv. to paying $2100 in monthly rent. Various assumptions are 6.25 mortgage rate (30 term), inflation rate of 2.85%, 1.25% property tax rate, combined tax rate (state + federal) of 34.3%, after tax return on investment of 6.73% (based in current rates offered by the I-bonds) and a 20% downpayment.

                                               

Monthly   Rent	25507.10178		Inflation Rate	2.850%		Downpayment	20%
Mortgage   rate	6.200%		After tax return on investment	6.730%		Purchase Price	650000
Mortgage Term	30		Initial investment	150020		Mortgage Amount	520000

           

Property   tax rate	1.250%
Combined tax rate	34.30%
Closing costs	20020

                                                                                                                                                                                                                               

Year	0	1	2	3	4	5	6
Rent	25507.10178	26234.05418	26981.72472	27750.70388	28541.59894	29355.03451	30191.65299
Principal Payment		($6,349.40)	($6,743.06)	($7,161.13)	($7,605.12)	($8,076.64)	($8,577.39)
Interest Payment		($32,240.00)	($31,846.34)	($31,428.27)	($30,984.28)	($30,512.76)	($30,012.01)
Total Mortgage		($38,589.40)	($38,589.40)	($38,589.40)	($38,589.40)	($38,589.40)	($38,589.40)
Property Taxes		8356.5625	8594.724531	8839.67418	9091.604895	9350.715634	9617.21103
Insurance	800	822.8	846.2498	870.3679193	895.173405	920.685847	946.9253937
Maintainence costs	1200	1234.2	1269.3747	1305.551879	1342.760108	1381.028771	1420.388091
Utilities	1200	1234.2	1269.3747	1305.551879	1342.760108	1381.028771	1420.388091
Tax Deductions		($43,064.96)	($42,979.81)	($42,879.05)	($42,761.40)	($42,625.53)	($42,470.00)
TaxSavings		($14,771.28)	($14,742.08)	($14,707.51)	($14,667.16)	($14,620.56)	($14,567.21)
After Tax Owner's exp		($35,465.88)	($35,827.05)	($36,203.03)	($36,594.53)	($37,002.30)	($37,427.10)
Renter's savings		$9,231.82	$8,845.32	$8,452.33	$8,052.94	$7,647.26	$7,235.45
Future value	1058630.602	$61,037.43	$54,794.36	$49,058.25	$43,792.88	$38,964.47	$34,541.54

                             

Total   Future Value	$1,510,227.03	$451,596.42
Inflation adjed FV	$650,000.00
Breakeven monthly rent	2125.591815
		Approximate breakeven rent -   $2100.00

Comments

[A reader]

Hi,

I am actually considering buying a condo/townhouse in the bay area. If you would kindly send me the spreadsheet, that would be a great help.
Thanks so much!

-Tania

[Rent vs Own]

Well I'd say there are those who rent and those who own. There there are those who rent because they cant own because they cant afford the down payment (often times which gets swindled to buying that $50k BMW).

I own my home in the bay area and before I did, I too questioned the economics of doing so.

I bought my home which at that time seemed very pricy but has since appreciated by over 20% in value. So In a nutshell i have gained a lot of equity in the home.

Over the same period I have saved a lot of $$ on taxes. I have done so well that I am ready to buy my second home and keep my first for the renter crowd. To me this housing market stall is a super opportunity to buy more property in one of the best markets in the world.

Based on my research I will be easily able to put my home on rent and cover all my expenses. A rentaholic will end up paying for my equity. I dont think he/she will mind and neither will I. I will accumalate wealth and he/she will have a nice home to rent and flaunt to their friends. So long as such spreadsheets exist there will be enough people out there to rent. There are numerous reports that in the next 20 years the population of California will increase by another 10 million people. Both my homes are in super prime locations so i can only imagine the value of those homes in 10 years. I bet if i sustain this model, i can sell off one of those homes and fund my retirement or my kids education. I say more power to these kind of spreadsheets and the renter community.

[Andrew]

can you send me your spreadsheet Ashish?

thanks,

Andrew

[Jason]

Ashish,

Could you e-mail me your spreadsheet? Thanks.

[Mike]

Could you email me the spread sheet that you created?

Thanks

[Keith]

Can you email the base workings of your rental spreadsheet thanks

[Hemant Mandpe]

I am not questioning the validity of your spreadsheet. I am well aware of the variables used by you. I am only questioning some of the assumptions and their effect on the conclusions drawn.

A. I have not heard of a single loan that actually matured after full 30 years. As a fact of life most of the loans are paid off within ten years of their inception, either thru sale, refinance or accelerated principal payments. So a 5/7 or a 10 year fixed mortgage loan will provide you a better rate.

B. During the past seven years, the property values in this county appreciated at rate of 10.5% annually.[County Records}. This included a correction period during 2000/2001/2002. So an average annual appreciation of say 5% over next 30 years is not out of raech. Personally I can confirm that over past 23 years, this average was over 5%.

C. A sustained 6.5% return on the investment outside your home, is not easy to find.

D. If we Use these two assumptions, at the end of ten years, the the property value should reach an estimated $ 1,058,782 giving you a gain of 1,058,782*0.95-650,000 = $ 355,852 against 71,718 if you invest in current I-Bonds @ 6.5%.

In effect, if you raise the future value of the home to $ 2,809,263 after 30 years, we both may end up with close to similar conclusion and further if you allow for the dynamic nature of the mortgage rates and use say a 6% mortgage ratefixed for ten years, I suspect we will be on the same page.

I do not have your spreadsheet, but if you agree with these assumptions, please try these numbers and let me know what you find.

By the way, I am in full sgreement with your observation on what you can find for $ 650k to buy vs. $ 2,100 to rent here; but that is a seperate issue.

[Ashish Hanwadikar]

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5. To buy a house, @ 20% you are investing $ 130,000. If property value appreciates @ a very modest 2.5%; at the end of ten years, it will be worth $ 832,056. If you sell the house at that time, and the cost of sale is say 5%, your actual appreciation would be 832,056*.95-650000 = 140,452. If this was your principal home, there is no tax.
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What about the principal payment you made during the 10 years? You would have to calculate the return on that amount and not on the initial downpayment. Also, you will have maintain the house, pay the property taxes, home insurance, and so on.

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6. Against this, if you invest same 130,000 @ 6.5% and are in 34.3% tax bracket, at the end of 10 years, you will have earned $ 71,718. This assumes that there are no withdrawals and the interest/dividend is re-invested. This is half of home owner's return.
Or else, you take your monthly mortgage payments, add maintainence expenditure, home insurace, property taxes and then subtract monthly rent that you will currently pay to rent a similar house and then invest/withdraw the resulting amount from the original investment you made from the downpayment (plus other initial expenses). Also, you also consider the fact that rent, monthly maintainence expenses, and home insurance will probably increase at the rate of inflation. You also take into account the tax savings from the property taxes and the interest payment portion of your mortage expenses. And then you find out either the breakeven rent at a given rate of outside return (6.73% risk-free or 11.4% with risk) or you find the required return for the given amount of monthly rent in order to breakeven. For the first part, I have calculated that monthly rent of approx. 2100 is equivalent to owning an house of $650,000 in today's environment in the Bay Area. I believe that I can rent a 3 BD, 2 Bath house in a good neighborhood in the Bay Area for $2100. If I were to buy that house or similar one it is going to cost me much more. What do you say? The spreadsheet that I did does all these calculations and more.

[Hemant Mandpe]

Am I missing a point!

5. To buy a house, @ 20% you are investing $ 130,000. If property value appreciates @ a very modest 2.5%; at the end of ten years, it will be worth $ 832,056. If you sell the house at that time, and the cost of sale is say 5%, your actual appreciation would be 832,056*.95-650000 = 140,452. If this was your principal home, there is no tax.

6. Against this, if you invest same 130,000 @ 6.5% and are in 34.3% tax bracket, at the end of 10 years, you will have earned $ 71,718. This assumes that there are no withdrawals and the interest/dividend is re-invested. This is half of home owner's return.

7. Now, review the two basic assumptions and determine which is more conservative. A modest 2.5% property appreciation over 10 years against sustained 6.5% return outside your home. Come up with your own assumptions and then make up your mind.

4. Do not get fooled by the media hype on bubble. Call that a correction. If you have any chance to speak to homeowners who are owning for ten years, they can provide you with a good appreciation factor and how have the past bubbles affected them.

5. Read these comments with my initial reaction posted here on Jan 12th. I am still optimistic that if you can afford, you will join the other 2/3rd of the population in this country.

[iulian]

Hi,

I'm interested in getting the Excel spreadsheet and emailing it to me will be highly appreciated.

Thanks and keep up with good work.

[girish]

I created my own version of a buy versus rent calculator (see URL if interested).

For comparison sake, I used your numbers (650,000, 20%, etc.) and if I assume an annual 3% increase in home value for 30 years then I arrive at the $2100 monthly rent to breakeven.

Can I get a soft copy of your spreadsheet. A couple of things I wanted to look into were:
1. The way you took inflation, tax break into account.
2. Would I be right in calling the 6.73% rate of return you used an "opportunity cost?" In other words that is the amount one would have made in other investments if he decided to rent.

[Half Sigma]

I know lots of people who pay more than $2100/month JUST IN REAL ESTATE TAXES.

Furthermore there is maintenance of the house which has to average at least $500 or so a month.

Renting is a very thrifty and sensible option, especially at the peak of a housing bubble.

[Ashish]

I haven't really spent time on understanding Green Space restrictions. I am just trying to figure out if everything remains constant (inflation, interest rates, rent in real terms, house prices in real terms etc.) whether renting is better or buying.

Yes, property values may appreciate more than 2.5% and interest rates may go down. However, given the very low interest rates, I would bet more on rising interest rates and falling property values.

[Old Whig]

I was just reading an article today that said that buying property in that area is a horrible investment, but they were speaking of real estate investments and not of buying vs. renting homes where you want to live.

Do you believe the Green Space restrictions will last a long time? If you do, then that return you mention would be worth it, I think.

[Hemant Mandpe]

Good effort. Suggest a few variations be added to the analysis which should influence the decision making process for the following reasons.

1. In this dynamic society, you may not keep the same loan for full thirty years, nor you may stay in the same home for that long a period. A refinance may improve your interest rate at no cost in future. Property values may appreciate at a rate higher than the inflation.

2. If you assume that within five to seven years, your goals might change.
3.If property values appreciate at an annual rate of 2.5% which is historically a quarter of what has been achieved, the actual return on the property you own will be significantly higher than the rental property.
4. If so, try 10% down if the payments are palatable.

You may come to a different conclusion.