Wednesday, March 15, 2006

Buy or Rent? - Real Life Example

Here's what I think is a fairly good and practical example for why to buy or rent a place.

A 5 family (4 one bedroom, 1 three bedroom) building is for sale.
It currently can rent all 1 bedrooms for $800 and the 3 bedroom for $1300.
Since this would require a business loan, it would require 20% down and 8% interest on the remainder.
Yearly expenses (taxes, upkeep, utilities, insurance) comes to $20k per year.
At what price would you consider buying this?

Say it's $500k, that means $100k down + say $15k closing, then $32k in interest per year.
Fully rented it generates $54k per year (or $34k after expenses).
Would you buy this or rent at $800 and use the $115k to invest in something else? Let's assume the inspections check out and it's in a decent place in town.


Blogger Medicated Money said...

Great scenario! I think that it comes down to a few variables that could not be answered without seeing the place in person or understanding the area. However, in assuming that everything is favorable with those variables, I would buy the apartment complex. Here is why:

Buying the complex is going to cost you $1,056,619 if you take a mortgage of $400,000 @ 8% over 30 years. This breaks down to $35,220 yearly mortgage or 2,935.06/month. If you rent the complex out, you will have to pay $1,220/year in out-of-pocket expenses. If this is truly in a good area, your investment will be worth $1,297,359 in 30 years considering the property increased in value @ 4%/year.

If you invest the money (115K) @ 8% for 30 years and are paying 15% in taxes with a moderate 3.1% in inflation, your total investment would be $827,628. In addition, if you invest an addition $1,220/year (your out-of-pocket expense), your total investment would be $993,062

I think I either way, you probably are going to do well, but I believe that the property is the better investment, at least for me. Now, for the variables:

-Do you mind being called in the middle of the night to fix a problem at the property?
-Is the location a quality location with a history of positive increase in property wealth?
-Are you going to make at least 8% on your investment each year? Will you do better than that more years then less?
-Will you fall into the 15% tax bracket?
-Could you live in one of the apartments and consider this your primary residence?

I think the main point is that one will choose either one or the other; but the reasons they choose a certain one will probably be completely different then why someone else choose that same one.

3/15/2006 3:26 PM  
Anonymous Phil said...

There's somewhere in the country where a 5 family apartment building sells for $500K and a 3 bedroom apartment rents for $1300? I think these numbers are way off and radically alters the equation.

3/15/2006 3:31 PM  
Blogger Gigi said...

Buy, live in one unit, hire a partime maintenance person.

3/15/2006 5:29 PM  
Blogger RS said...

Phil...amazingly enough, we are talking about the northeast here, hour and a half north of the city to be more precise.

Gigi...agree, I personally would hate the late night "my toilet is broken" calls.

MM...just out of curiousity, how come you take into account taxes in the investment scenario, but not in the house scenario? I was also wondering what the $1220/year in out-of-pocket expenses was?

The other problem with this all is coming up with $100,000 to put down. Not a very easy task.

3/15/2006 8:48 PM  
Blogger Medicated Money said...

the extra $1,220 is from the yearly mortgage minus 34k 'profit' after expenses. The reason I did not include taxes on the property scenario is because it was already calculated in the scenario ie "yearly expenses (taxes, upkeep, utilities, insurance) comes to $20k per year." I did not research the actuality of these numbers, just went with the variables presented. For those not known, they were either an educated guess or a common number enter. This could and would be completely different if the actual numbers were known and used, or very different from those figures that were assummed. Just my $0.02!

3/16/2006 12:16 AM  
Anonymous Phil said...

MM forgot to mention one thing in the calculations, and that's risk.
Investing 115K @ 8% for 30 years is a low-risk investment. It's slightly below historical stock market returns and it's over a long time. Owning a diversified portfolio of index funds takes no effort. Owning an income-generating property is like having a job, unless you pay someone else to run it, which cuts into profits. Owning a single property has much larger amount of risk than owning mutual funds, so it's apples to kumquats.

In general, I think the amount of risk associated with owning an apt. complex vs. index investing does not match the possible reward.

3/16/2006 12:33 AM  
Blogger Medicated Money said...


You are absolutely right that risk was not calculated in the equation. With every investment, risk is one of the main variables that will change one's expectations. In a controlled experiment (such as this discussion), risk is minimal for either scenario. Real world is, obviously, a different story. My main goal was to show the calculations if, and this is a big if, all variables were kept to a mininal or controlled.

If I had $115k available and looking for a place to invest, I would not be searching for a apartment complex. However, if a favorable opportunity presented itself and I was in the position to take advantage of it, I would deeply consider it!

3/16/2006 12:05 PM  
Blogger DD said...

The other thing about a business loan is the maturity is much sooner than home mortgage. Looking at a 10 year maturity where the rate is renegotiated. Expenses did include property and school taxes at the time. A $1500-$2000 annual maintenance/upkeep cost was assessed. That could possibly be a little low.

3/16/2006 1:38 PM  
Blogger RS said...

"In a controlled experiment (such as this discussion), risk is minimal for either scenario. Real world is, obviously, a different story."

With regards to your statement, this is real world. This isn't just a hypothetical question...this is truly being considered. Not sure if that would change any of your conclusions, but just wanted to let you know.

3/17/2006 1:22 PM  
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