"Rules of thumb" for calculation of rent v. buy?

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Owen_IHB

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<p>Are there any "rules of thumb" in a rent v. buy analysis? I see some calculators on the web that require input of 15+ variables, but I was wondering if any of you have any more simple rules?</p>

<p>We are renting and have a chunk of money from a house we sold in 2006. We are trying to decide what to do.</p>

<p>A related question is I hear everyone on here talking about how we can tell that housing prices are artificially high relative to rents. Is there a simple rule of thumb calculation for that? Again, I know sophisticated internet calculators and I see the lengthy postings on that subject here, but I am looking for something that I can just do in my head.</p>

<p>I have a degree in econ. so I get the general idea that these sorts of calculations are complex and that you need to look at all sorts of variables, e.g., marginal tax rate, expected ROI for putting money down on a house v. investing in a CD or the stock market, etc., etc., the opportunity cost of sinking money into a downpayment, etc.</p>

<p>Alternatively, any ideas for good internet calculators for performing these types of calculations?</p>

<p>Thanks in advance. </p>

<p> </p>

<p> </p>
 
<p>Ask ten people and you'll get sixteen answers. Mine is this: Barring an environment of unusual interest rates, you should be able to put 20% down, carry a 30 year fixed mortgage, and have a total monthly outlay that approximates the equivalent rent. Some say that your outlay is expected to be a bit higher but that normal appreciation will make up for it. Others say that the outlay should be less than rent to compensate you for your risk exposure.</p>

<p>I guess the perspective of a property investor would be a little more aggressive than that of a typical homeowner. </p>
 
Personally, I would want to know that I could rent out my home and not bleed to death (in case I needed to relocate or something). A small monthly shortfall is preferable to a $1000-2000 loss each and every month. Right now, pretty much everything is going to cashflow <strong>very</strong> negative, which is one of the cornerstones of our bubble argument.
 
<p>Owen,</p>

<p>I am a realtor and I do rent v.s. buy analysis to determine to effective cost of buying for my clients. It really depends on your tax bracket and down payment, and other factors such as where you want to buy. You can give me your scenario and I do calculation for you.</p>

<p>I need:</p>

<p>Your income</p>

<p>Your current tax deductibles amount</p>

<p>Your target location and home price (this is critical because of Mello-roos and HOA cost)</p>

<p>Your target downpayment.</p>

<p> </p>
 
Owen,





Take the monthly rental rate times 160 to approximate the breakeven purchase price. Some may argue for a number closer to 200 based on a variety of assumptions. Houses in Irvine are currently trading for close to 300. That is as simple as the calculation can be made.
 
Yes, back when interest rates were 8% and cap rates were 10%. I saw a recent article where a commercial center in Irvine was sold with a 3.25% cap rate. Imagine taking on the risk of real estate for a rate of return lower than a bank CD?





If thing crash really bad, there may be some 100 multiplier deals out there, particularly if interest rates rise.
 
<p>Speaking of interest rates rising, just when I get happy about house price reductions I go over to the Oil Drum and read about our latest farm subsidy policy masquerading as an energy policy. Ethanol. Corn at $4/bushel. Corn, in one form or another, feeds into almost everything we eat. Food is a major component of the PCE. Inflation. Ugh.</p>

<p>What were we talking about? Oh yeah, rents.</p>
 
Thanks all.





Nirvinerealtor, I don't want to give you my actual stats because I don't want to annoy people and make this all about me, but I would like to give you some hypothetical stats because I am interested in your calculation and methodology. But tell me first what you mean by current tax deductibles amount.
 
That is not a very good calculator. Like most of the others I have seen on the web, you really have to put in ridiculous numbers to make it better to rent than to own. When the cost of ownership is double the cost of rental and the calculator says you should buy, something is amiss. Most of these calculators are probably put out there by the REIC to shill for sellers.
 
I second Irvinerenter's 160 multiplier. Make sure you use actual rents not what people are asking. Find out what comparables are rented for and use that.
 
Hello Owen,





Congraduations on cashing out in 2006!





IMO you're in a very good "cash" position right now, and not under any pressure to buy (like 1031 exchagne or rapidly apperciating market). You can afford to wait and shop for your next home leisurely.
 
<p>Yep the 160 mulitplier is a good number I use between 130-160 as a nice range. Unfortunagely in Irvine, it is tremendously stupid number here. I'd wait a few months and see if you can get better number than 300ish or so.</p>

<p>And Momopi, I'm sorry but I resemble that crack about 1031!</p>

<p>good luck</p>

<p>-bix</p>
 
I have done quite a bit of calculating on that, and there’s not a “simple” calculation or “rule of thumb” that can be used. There are a number of assumptions you must make, and those assumptions can sway things drastically. First of all, you must factor in assumptions for the different rates, such as mortgage rate, tax rate, inflation rate, appreciation rate, and rental increase rate. Once you do that, you can calculate the mortgage, interest, tax deductions, and calculate an NPV of the cash flows based on no down payment. Another important factor is the time horizon before cashing out (or buying if you’re renting), since this will determine your outlay. I use a historical appreciation rate of OC (7.7%), 3.5% inflation and rental increase rate, 38% tax rate, and 6% loan to come up with approximately a 230 to 1 ratio. So a place that will run you $2400 to rent – a 3/2, 1600sf townhouse in Irvine – should run you around $530K, which I believe is about $100K under today’s comps. Of course, as you move the various rates around, you will see different results.
 
gepetoh,





Quick calculations are estimates. They tell you in a flash whether or not a property warrants a more detailed financial analysis. The number does change based on the currently available terms and costs for financing. If you don't use simple calculations you will waste a lot of time jousting with windmills.





When running your calculation keep in mind the 7.7% OC appreciation rate is measured to the top of a massive bubble. House prices cannot go up faster than wage inflation for very long because it requires people to put higher and higher percentages of their incomes toward housing. A 230 to 1 ratio is not where you will break even on rents much less have positive cash flow. If you are counting on appreciation to make the numbers work, you are a speculator and not an investor. Speculators get destroyed in bear markets. Many are going to learn that the hard way.
 
<p>Lots of great feed back. Thanks everyone. Here's a scenario ripped straight from the headlines. </p>

<p>42 Juneberry is for sale for $1.238 million. MLS no. <a href="http://realty.wgcs.com/myhouse.html?st=1&seq=18&so=1">S479651</a> . I happen to know that it the tax + mella roos rate is about 1.8%. The HOA are about $175.</p>

<p>34 Honey Locust is for rent for $4,950 per month. MLS no. <a href="http://realty.wgcs.com/myhouse.html?st=1&seq=5&so=1">S480612</a> . It looks like basically the same house, although I imagine there are differences in upgrades. It is not clear to me if a renter has to pay HOA dues. I don' t know what is typical around here. (Actually I moved here from out of state).</p>

<p>If you use gepetoh's multipler of 260, then the calculation is $4950 x 260= $1.287 million. So the rent v. buy analyis is pretty much even, with buying maybe being a slighly better deal. Did I do that correctly?</p>

<p>nirvinerealtor, how do the following hypos play out?</p>

<p>Hypo 1: 250 K down payment, income of $200k</p>

<p>Hypo 2: 500 K downpayment, income of $250k</p>

<p>Hypo 3: 750 K downpayment, income of $300K</p>
 
<p>IrvineRenter,</p>

<p>I agree with you, and as I said, the number are based on assumptions, but my calculations aren't very complex. It's just based on those assumptions and simply discounting back to present value. The 7.7% is pre-run up, and covers 1981-2001. With the run up, it's 9%+. I don't think that's the right number, and I don't even necessarily agree with 7.7% since that only covers 1 run-up and 1 downturn. However, I was just basing it on history, nothing more. Doesn't mean I agree with the growth rate. </p>

<p>The 230 to 1 is merely based on what the breakeven is given the going rental rates, and have nothing to do with price appreciation of housing. It is actually based on a flat market, since the NPV used does not take into account appreciation. But it does take into account a 3.5% rate of increase in rental prices. </p>
 
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