You are considering an option to purchase or rent a single residential property. You can rent it for $5,400 per month an
Posted: Wed Mar 30, 2022 3:49 pm
You are considering an option to purchase or rent a single
residential property. You can rent it for $5,400 per month and the
owner would be responsible for maintenance, property insurance, and
property taxes. Alternatively, you can purchase this property for
$205,100 and finance it with an 80 percent mortgage loan at 4
percent interest that will fully amortize over a 30-year period.
The loan can be prepaid at any time with no penalty.
You have done research in the market area and found that (1)
properties have historically appreciated at an annual rate of 2
percent per year, and rents on similar properties have also
increased at 2 percent annually; (2) maintenance and insurance are
currently $1,551.00 each per year and they have been increasing at
a rate of 3 percent per year; (3) you are in a 24 percent marginal
tax rate and plan to occupy the property as your principal
residence for at least four years; (4) the capital gains exclusion
would apply when you sell the property; (5) selling costs would be
7 percent in the year of sale; and (6) property taxes have
generally been about 2 percent of property value each year.
Based on this information you must decide
Required:
a. In order to earn a 10
percent IRR after taxes on your equity, should
you buy the property or rent it for a four-year period of
ownership?
b. What if your expected period of
ownership was to change to five years? Would owning or renting be
better if you wanted to earn a 10
percent IRR after taxes?
c. Approximately, what level of rents
would make you indifferent between owning and
renting for a four-year period? Assume that a 5 percent
after-tax IRR would be the minimum you would
need to earn on capital invested in the home.
residential property. You can rent it for $5,400 per month and the
owner would be responsible for maintenance, property insurance, and
property taxes. Alternatively, you can purchase this property for
$205,100 and finance it with an 80 percent mortgage loan at 4
percent interest that will fully amortize over a 30-year period.
The loan can be prepaid at any time with no penalty.
You have done research in the market area and found that (1)
properties have historically appreciated at an annual rate of 2
percent per year, and rents on similar properties have also
increased at 2 percent annually; (2) maintenance and insurance are
currently $1,551.00 each per year and they have been increasing at
a rate of 3 percent per year; (3) you are in a 24 percent marginal
tax rate and plan to occupy the property as your principal
residence for at least four years; (4) the capital gains exclusion
would apply when you sell the property; (5) selling costs would be
7 percent in the year of sale; and (6) property taxes have
generally been about 2 percent of property value each year.
Based on this information you must decide
Required:
a. In order to earn a 10
percent IRR after taxes on your equity, should
you buy the property or rent it for a four-year period of
ownership?
b. What if your expected period of
ownership was to change to five years? Would owning or renting be
better if you wanted to earn a 10
percent IRR after taxes?
c. Approximately, what level of rents
would make you indifferent between owning and
renting for a four-year period? Assume that a 5 percent
after-tax IRR would be the minimum you would
need to earn on capital invested in the home.