This is the age-old real estate story — should I rent or buy? I recently had my first eye exam as an adult, and at the age of 41, I was advised by the ophthalmologist to purchase reading glasses. I guess it is a rite of passage and something many of us go through at some point in our lives. During the exam, I had a lengthy discussion with my doctor about his personal real estate situation. He is looking to move his primary residence from the suburbs to the City and was wondering what would be the best fiscal move, renting or buying. I reviewed in detail the numbers with him and I thought it would be beneficial to share what we discussed.
The doctor wants a small to mid-sized two bedroom in Chelsea in a newer building. On average, this will cost him either $8,500/mo. in rent or $2,000,000 to buy plus about $2,800 in taxes and common charges per month. Given his age, he believes he would live in the home for fifteen years before he’s completely retired and moves south. His initial inclination was to rent, given the upfront expense associated with a purchase. His analysis is below:
– Renting: $8,500 a month, with some small one-time expenses.
– Buying: $400,000 down payment (20%) and approximately $80,000 in closing costs. Furthermore, the monthly mortgage would be approximately $8,000 and the monthlies again would be another $2,800 a month.
So, the first year expense for the rental is $102,000 while the expense for buying is $609,600, a savings of roughly a half million.
A complete analysis:
I suggested that he not only look at the first year expense but the overall net expenses over the fifteen years. The analysis below:
Let’s start with the rental scenario. Rents have been increasing at about 3.85% per year (average over the past 20 years). If we assume the same average rate increase for the next fifteen years the doctor’s overall payments will be $2,019,789 with the last year monthly rental of $14,424.
Now let’s look at the cost of owning. There is the $480,000 ($400,000 plus $80,000) at closing. On top of that, he will have $10,800/mo. in mortgage and common charges. The mortgage expense will stay constant (assuming a 30-year fixed rate loan). But the taxes and common charges will increase each year, and for this analysis, we assume the same 3.85% as we did for the rental scenario. This results in the doctor paying $2,105,342, with a final year monthly payment of $12,751.
Adding the down payment and closing costs of $480,000, the total dollar outlay over the fifteen years for the purchase scenario is $2,585,342. When compared to the $2,019,789 for the rental scenario, there is a saving of $565,553.
But wait, there is additional number crunching.
When you own your primary residence you are commonly entitled to a tax deduction or rebate. Assuming the doctor is in the 40% marginal tax bracket, he would receive a yearly tax deduction that would total $345,600 over the 15 years. These deductions are realized by the doctor in his annual tax returns — $28,000 in the first year and approximately $19,000 in the last year. The tax benefit will decrease as the interest expense becomes a smaller and smaller portion of the debt service. Also for this analysis, I assume the taxes to be half of the $2,800 monthly payment and the common charges be the other half. Here again, the property taxes are tax deductible and reduce the overall net expense.
The tax deduction for the interest and property tax expenses reduces the net benefit of renting to $219,953.
But wait, there is additional number crunching.
When you are done renting you move out and there are no other considerations. When you move as an owner of the property there are many other considerations. So let’s look at that math.
In our example, the apartment is purchased for $2,000,000. I am not about to guess how much the market will increase in the next 15 years. So let’s use the same growth assumption used previously of 3.85%, even if it’s probably conservative. At an annual rate of growth of 3.85%, the home would be worth $3,394,071 in 15 years. Subtracting the balance of the mortgage ($1,028,488) and closing expenses ($280,000) the net proceeds to the doctor would be just over $2 million.
There will be an insurance expense, both for a homeowner and a renter. Renter’s insurance is much cheaper so the additional cost for homeowner’s insurance will be about $50K over the 15 years unless you can bundle to reduce the overall insurance expense. Also, owners have more upkeep expenses, including repairs to appliances, plumbing, wiring, etc. but these are usually smaller expenses. Buying is more time consuming (in most cases) and stressful and I am not touching the capital gain taxes on the sale (there is plenty to discuss and should be a separate conversation with your accountant).
So in the end, owning will cost the good doctor about $1,850,000 less than renting. Another way to look at it, renting will cost the doctor $2,019,789 over the 15 years or purchasing will be $154,159 out of pocket. On a monthly basis, the average monthly rent would be $11,221 while owning would be $856 a month.
This is a very basic analysis of “Rent vs. Buy.” If you are currently analyzing this situation there are many other considerations to take into account. We would highlight co-op expenses versus condo expenses which could save the doctor about $130K upfront and about $250k over the life of the loan. Also, the doctor may not want to sell the property when he moves south. The property could convert from a primary residence to an investor property providing rental income for the doctor. If the doctor decided in the 16th year of ownership to rent instead of selling it, he would realize about $26,000 in gross profits. He would have plenty of flexibility to either wait and pay off the mortgage and realize a larger profit or pass the asset along to family through a trust or as part of his estate.
Bottom line, it is fiscally smarter to purchase instead of renting, assuming your time horizon is greater than 5 years. If your friend or advisor tells you differently, they are just flat out wrong.