The real cost of ownership versus renting analysis

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usctrojanman29_IHB

usctrojanman29_IHB

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I've been reading through a lot of the threads on here and I think that some of the calculations regarding ownership vs. renting analysis is a little off because it doesn't take into effect for the tax benefit of ownership (writing off interest and property taxes, including mello roos).



Using the following assumption using a 2bed/2bath 1,250sf living area, it looks like the breakeven $/sf is equal to $300/sf if the rental rate is $2/sf (basically what TIC charges for newer apartment complexs in Irvine).



7% - 30 year fixed mortgage

100% financed (not like you'll be able to do this, but I used it to be conservative)

$300 per month association

$2/sf rental rate

30% marginal tax rate (state & federal)

1.6% tax rate (includes Mello Roos)

$2,500 rent

$375,000 purchase price



(monthly mortgage payment + montly tax rate + monthly HOA) - (tax benefit for interest + tax benefit for property taxes) < monthly rent



($2,495 + $500 + $300) - ($650 + $150) = $2,495 which is approx. what your rent would be



Obviously the $/sf breakeven increases if you finance less than 100% of the purchase price and it decreases if the comparible rental $/sf is lower (for older properties). But to me it looks like $300/sf for condos +/- 5-10% may be the bottom for the prices of condos assuming if they are newer (less than 8-10 years old) located in desirable part of Irvine and interest rates for 30 year fixed mortgages remain 7% or lower. So I would say comp out what the rents are going for per SF in the area/s that are you interested in buying and use the above fomula to determine whether the property is fairly valued before you make any offers.
 
It would appear you left out insurance, which is unnecessary on a rental or at least less costly, and maintenance costs... As IR pointed out to me long ago, you can't necessarily compute tax savings on marginal rates as some homebuyers would lose partial benefit of standard deduction. If enough income is made such that state income tax withholdings would push someone into itemizing territory, tax benefit at marginal tax rates would work.



Also, for the most part, deducting mello roos is essentially cheating on your taxes so you have factored breaking the law into your calc. Everyone does it, but if you want to compare apples-to-apples, they should probably be on the same legal basis...
 
Mello-Roos is not a legal deduction. If audited and assessed, compliance will cost the taxes on the deduction, and penalties, and interest. Risk evaluation should also be calculated, on both the chances of getting caught while cheating on taxes and property depreciation.
 
[quote author="ipoplaya" date=1214310732]It would appear you left out insurance, which is unnecessary on a rental or at least less costly, and maintenance costs... As IR pointed out to me long ago, you can't necessarily compute tax savings on marginal rates as some homebuyers would lose partial benefit of standard deduction. If enough income is made such that state income tax withholdings would push someone into itemizing territory, tax benefit at marginal tax rates would work.



Also, for the most part, deducting mello roos is essentially cheating on your taxes so you have factored breaking the law into your calc. Everyone does it, but if you want to compare apples-to-apples, they should probably be on the same legal basis...</blockquote>
Typically insurance is included in the HOA dues so that is covered. If you want to be more conservative, throw another $50/month in for insurance. Mello Roos may be typically illegal to deduct from your taxes, but it is included in your semi-annual tax bill for whatever reason (other states send over seperate mello roos bills from the property tax bill). Again, you can tweak my assumption as you want to be more of less conservative but the numbers don't lie. Btw, you also get the benefit of other itemized tax deductions when you have enough of them like for state income taxes, personal property taxes, and charitable contributions.
 
[quote author="awgee" date=1214339057]Mello-Roos is not a legal deduction. If audited and assessed, compliance will cost the taxes on the deduction, and penalties, and interest. Risk evaluation should also be calculated, on both the chances of getting caught while cheating on taxes and property depreciation.</blockquote>
Ok then, reduce your tax benefit for property taxes by 1/3 to get back to a 1.1% tax rate or $50 in this case.
 
[quote author="usctrojanman29" date=1214342375]Btw, you also get the benefit of other itemized tax deductions when you have enough of them like for state income taxes, personal property taxes, and charitable contributions.</blockquote>
Exactly correct, which is why every analysis of ownership vs. lease needs to be done on a individual basis. Rarely, does a formula apply. It would cost approximately twice to "own" than to rent for our present personal living situation.
 
Can you update your numbers to include maintenance costs? In our brief foray into ownership we were stunned at the amount of money we needed to spend on maintenance. Things like furnaces, ac's, hot water heaters, roofs, windows, etc. aren't annual expenses but they are big chunks of change when you do need to replace them.
 
[quote author="awgee" date=1214342810][quote author="usctrojanman29" date=1214342375]Btw, you also get the benefit of other itemized tax deductions when you have enough of them like for state income taxes, personal property taxes, and charitable contributions.</blockquote>
Exactly correct, which is why every analysis of ownership vs. lease needs to be done on a individual basis. Rarely, does a formula apply.</blockquote>
I will agree with you, but my forumla is a good place to begin and can be adjusted as needed as it has a lot of variables in it. I'm a finance guy, so I can't help of come up with things like these. haha
 
[quote author="SacRenter" date=1214342904]Can you update your numbers to include maintenance costs? In our brief foray into ownership we were stunned at the amount of money we needed to spend on maintenance. Things like furnaces, ac's, hot water heaters, roofs, windows, etc. aren't annual expenses but they are big chunks of change when you do need to replace them.</blockquote>
To throw maintenance into the formula, just come up with a reasonable estimate as a percentage of cost. I think a conservative figure would be $1/sf for condos as a monthly maintenace reserve which would translate into an expense of $100 per month in my example as you have an HOA to handle your exterior maintenace (maybe $2/sf for homes).
 
[quote author="awgee" date=1214343365]I am a tax guy, and can not help but see many financial blunders.</blockquote>
Oh no, don't tell me we have more than one CPA on the board. haha I'm an ex PwC auditor who saw the light and got into banking, but I get to dabble a bit in simple corporate tax returns.
 
You're comparing to small IAC apartments. Private rentals are closer to the $1.5 sf.



HOA insurance only covers the superstructure, i.e. outside walls, it does not cover inside, i.e. the kitchen cabinets, carpet, etc.



Interesting post though, even with premium rents and missed expenses, you top out at $300/sf for small condos, which typically reflects a substantial price premium over larger places and SFRs.
 
You also need to add in opportunity costs as well as depreciation costs of owning currently. After just the depreciation costs it turns into a VERY ugly number fast.

good luck

-bix
 
[quote author="biscuitninja" date=1214348319]You also need to add in opportunity costs as well as depreciation costs of owning currently. After just the depreciation costs it turns into a VERY ugly number fast.

good luck

-bix</blockquote>
The equation looks at a home more as a place that you live versus looking at it as an investment for a speculator, that's why there isn't any appreciation or depreciation adjustments in there.
 
I agree that the tax deduction should be part of the equation. Why did you pick 30%? If you are 25% Federal, then aren't you 9.3% with the State? I suppose I should look up the two thresholds, but we don't make all that much and are at 9.3% with the FTB.
 
[quote author="biscuitninja" date=1214348319]You also need to add in opportunity costs as well as depreciation costs of owning currently. After just the depreciation costs it turns into a VERY ugly number fast.

good luck

-bix</blockquote>


What's the depreciation of renting?
 
[quote author="stepping_up" date=1214364176]I agree that the tax deduction should be part of the equation. Why did you pick 30%? If you are 25% Federal, then aren't you 9.3% with the State? I suppose I should look up the two thresholds, but we don't make all that much and are at 9.3% with the FTB.</blockquote>
Just rounded down to a nice even figure of 30%. That number can be revised based upon whatever the true marginal tax rate is.



As someone mentioned, my equation does not take into account opportunity costs of the capital used to purchase a primary residence but on the other side the equation does not factor in the amortization of the loan as time goes along.
 
[quote author="usctrojanman29" date=1214363516][quote author="biscuitninja" date=1214348319]You also need to add in opportunity costs as well as depreciation costs of owning currently. After just the depreciation costs it turns into a VERY ugly number fast.

good luck

-bix</blockquote>
The equation looks at a home more as a place that you live versus looking at it as an investment for a speculator, that's why there isn't any appreciation or depreciation adjustments in there.</blockquote>


I agree. If you don't look at appreciation, then you shouldn't look at depreciation.

I think that owning should always cost more than renting initially. You're making those extra payments in expectations of rising rents and home values.



My aunt pays $1300/month for her mortgage for her 4 bedroom house. If she was to rent it now, she should get at least $2600.

Point is, if you keep waiting for owning to be cheaper than renting, you'll never own.



I wouldn't mind owning a condo that costs $200-500/month more than renting.

I wouldn't mind owning a house that costs $600-900/month more than renting.



I think it's the people who are paying 2-3K/month more than the rental equivalence that are hurting right now.

I know a friend who's paying approximately $4500/month for his mortgage. I bet he can rent it out for $2500. That must really suck to be losing 2k a month. On the hand, my aunt is saving $1300/month from having bought back then.



I think that if you have a high income, then buying is not a bad idea if it costs within $1,000 of rent.

But if you make moderate income, then should only buy if it's within $500 of rent.
 
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