Retrieve the Excel spreadsheet. Review the base-case calculations of the own-versus-rent decision. Note that with the base-case assumptions and an expected 1-year holding period, renting is preferred to owning by $21,898 (cell B63); that is, the net present value of the cost of renting is $21,898 less than the net present value of the cost of owning. With a 5-year expected holding/analysis period, owning is preferred to renting by $2,303.
Do any of the base-case assumptions seem unreasonable to you? If so, which ones and why?
Assuming a 5-year holding/analysis period, what happens to the incremental value of owning relative to renting if the mortgage interest rate is 3.0% instead of 3.5%? Hold everything else constant. Does this result make sense? Explain
D E F G H I J K L JOWN- 2 3 4 5 6 7 8 9 10 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% B 1 Homework #1: Owning Versus Renting: An Economic Analysis 2 3 COST OF OWNING VERSUS COST OF RENTING 4 YEAR 1 5 6 COST OF RENTING: 7 Initial Monthly Rent (5) $1,300 8 Expected Annual Rent Change (s or %) 2.0% 9 10 COST OF OWNING: 11 Purchase Price (S) $275,000 12 Expected Annual Price Change (s or %) 2.0% 13 Required Down Payment (or % of purchase price) 0.20 14 Acquisition Costs ($ or %) 1.50% 15 Financing Terms: 16 Annual Contract Int. Rate (%) 3.50% 17 Loan Term in Years 30 18 # Payments/Year 12 19 Origination Fee (s or %) 1.00% 20 Discount Points (S or %) 0.00% 21 Operating Costs: 22 Annual Property Tax (s) $5,000 23 Annual Increase in Property Taxs (%) 2.0% 24 Annual Maint. & Repairs (5) $2,000 25 Annual Increase in Main. & Rep. (%) 2.0% 26 Annual Home Owners Insurance (S) 27 Annual Increase in Insurance Premium (%) 2.0% 28 Selling Costs at Disposition: 29 Selling Commission(%) 6.0% 30 Other Closing Costs ($ or %) 2.0% 31 Tax Rate at which Mtg Int. and Prop. Taxes are Deducted (%) 22.0% 32 After-Tax Discount Rate (%) 3.50% COMPUTED VALUES: Loan Amount Monthly Payment Annual Debt Service Origination Fee Discount Points Down Pmt w/o Acq/Fin Cats Acquisition (not fin.) Costs $ After Tax Equity Investment Annual Rent in Year 1 $220,000 $987.90 $11,855 $2,200 SO $55,000 $4,125 (561,325) 15,600 (Assume all rent payments are made at end of each year) $1,000 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% M N N P 0 R S T U V W X YEAR 1 2 3 4 5 6 7 8 9 10 11 LOAN AMORTIZATION MORT. BAL. AT BEG. OF YR less MORT. BAL. AT END 170339 220000 215778 211406 206878 -215778 -211406 -206878 -202189 202189 -197334 197334 -192305 192305 -187098 187098 -181706 181706 176122 -176122 -170339 DEBT SERVICE less PRINCIPAL REDUCTION INTEREST EXPENSE 11855 -4222 7633 11855 -4372 7483 11855 -4528 7327 11855 -4689 7166 11855 -4856 6999 11855 -5028 6827 11855 -5207 6648 11855 -5392 6462 11855 -5584 6271 11855 -5783 6072 25206.5 -17076 34568.9 -17076 -17247 44186.1 -17076 -17247 -17422 54065.6 -17076 -17247 -17422 -17601 64215.1 -17076 -17247 -17422 -17601 -17784 74642.7 -17076 -17247 -17422 -17601 -17784 -17971 85356.5 -17076 -17247 -17422 -17601 -17784 -17971 -18163 96365 -17076 -17247 -17422 -17601 -17784 -17971 -18163 -18359 107677 -17076 -17247 -17422 -17601 -17784 -17971 -18163 -18359 -18560 119301 B D E F G H I J K 1 2 3 4 5 6 7 8 9 10 ($15,600) ($15,072) ($15,912) ($29,926) ($16,230) (544,565) ($16,555) ($58,992) ($16,886) (573,209) ($17,224) (587,221) ($17,568) ($17,919) (5101,029) ($114,637) ($18,278) (5128,049) ($18,643) (5141,265) (57,633) ($5,000) ($12,633) ($9,854) (57,483) ($5,100) ($12,583) ($9,814) ($7,327) ($5,202) ($12,529) ($9,773 ) ($7,166) ($5,306) ($12,472) ($9,728) ($6,999) ($5,412) ($12,411) (59,681) (56,827) ($5,520) ($12,347) ($9,631) (56,648) ($5,631) ) ($12,278) ( ($9,577) ($6,462) ($5,743) ($12,206) (59,521) (56,271) ($5,858) ($12,129) ($9,461) (56,072) ($5,975) ($12,048) ($9,397) A 33 34 YEAR 35 COST OF RENTING: 36 Annual Rent 37 Cummulative PV of Renting Costs 38 39 COST OF OWNING: 40 Tax Ded. Operating costs 41 Interest 42 Property Tax 43 TOTAL BEFORE TAX COST 44 TOTAL AFTER TAX COST: 45 Non-Ded. Operating costs 46 Principal Payment 47 Maintenance & Repairs 48 Insurance 49 TOTAL NON-DED. COSTS 50 AFTER TAX OPER. COSTS: 51 52 REVERSION: 53 SELLING PRICE 54 less SELLING COMM. 55 less OTHER CLOSING COSTS 56 less MORTGAGE BALANCE 57 CASH FLOW FROM REVER. 58 59 Total Cash Flow If Sold 60 PV of Owning Costs If Sold 61 62 TENURE CHOICE: 63 Incremental Benefit of Owning vs. Renting 64 YEAR (54.222) ($2,000) ($1,000) ($7,222) ($17,076) ($4,372) ($4,528) ($2,040) ($2,081) ($1,020) ($1,040) ($7,432) ($7,649) ($17,247) ($17,422) ($4,689) ($2,122) ($1,061) (57,872) ($17,601) ($4,856) ($2,165) ($1,082) ($8,103) ($17,784) ($5,028) ($2,208) ($1,104) ($8,341) ($17,971) ($5,207) ($2,252) ($1,126) (58,586) ($18, 163) ($5,392) ($2,297) ($1,149) ($8,838) ($18,359) ($5,584) ($2,343) ($1,172) ($9,099) ($18,560) ($5,783) ($2,390) ($1,195) (59,368) ($18,765 $280,500 $286.110 $291,832 ($16,830) ($17,167) ($17,510) ($5,610) ($5,722) ($5,837) (5215,778) ($211,406) ($206,878) $42,282 $51,816 $61,608 $297,669 $303,622 $309,695 ($17,860) ($18,217) ($18,582) ($5,953) ($6,072) ($6,194) (5202,189) (5197,334) ($197,334) (S192,305) $71,666 $81,999 $92,614 $315,889 $322,206 ($18,953) ($19,332) ($6,318) ($6,444) (5187,098) ($181,706) $103,519 $114,724 $328,650 ($19,719) ($6,573) ($176,122) $126,237 $335.223 ($20,113) ($6,704) ($170,339) $138,066 $25,206 (536,971) $34,569 ($45,553) $44,186 ($54,070) $54,066 (562,521) $64,215 ($70,907) $74,643 (579,226) $85,356 ($87,478) $96,365 ($95,662) $107,677 ($103,779) $119,301 ($111,828) ($21,898) 1 ($15,626) 2 ($9,504) 3 ($3,529) 4 $2,303 5 $7,995 6 $13,551 7 $18,975 8 $24,269 9 $29,437 10 D E F G H I J K L JOWN- 2 3 4 5 6 7 8 9 10 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% B 1 Homework #1: Owning Versus Renting: An Economic Analysis 2 3 COST OF OWNING VERSUS COST OF RENTING 4 YEAR 1 5 6 COST OF RENTING: 7 Initial Monthly Rent (5) $1,300 8 Expected Annual Rent Change (s or %) 2.0% 9 10 COST OF OWNING: 11 Purchase Price (S) $275,000 12 Expected Annual Price Change (s or %) 2.0% 13 Required Down Payment (or % of purchase price) 0.20 14 Acquisition Costs ($ or %) 1.50% 15 Financing Terms: 16 Annual Contract Int. Rate (%) 3.50% 17 Loan Term in Years 30 18 # Payments/Year 12 19 Origination Fee (s or %) 1.00% 20 Discount Points (S or %) 0.00% 21 Operating Costs: 22 Annual Property Tax (s) $5,000 23 Annual Increase in Property Taxs (%) 2.0% 24 Annual Maint. & Repairs (5) $2,000 25 Annual Increase in Main. & Rep. (%) 2.0% 26 Annual Home Owners Insurance (S) 27 Annual Increase in Insurance Premium (%) 2.0% 28 Selling Costs at Disposition: 29 Selling Commission(%) 6.0% 30 Other Closing Costs ($ or %) 2.0% 31 Tax Rate at which Mtg Int. and Prop. Taxes are Deducted (%) 22.0% 32 After-Tax Discount Rate (%) 3.50% COMPUTED VALUES: Loan Amount Monthly Payment Annual Debt Service Origination Fee Discount Points Down Pmt w/o Acq/Fin Cats Acquisition (not fin.) Costs $ After Tax Equity Investment Annual Rent in Year 1 $220,000 $987.90 $11,855 $2,200 SO $55,000 $4,125 (561,325) 15,600 (Assume all rent payments are made at end of each year) $1,000 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% 22.0% 3.50% M N N P 0 R S T U V W X YEAR 1 2 3 4 5 6 7 8 9 10 11 LOAN AMORTIZATION MORT. BAL. AT BEG. OF YR less MORT. BAL. AT END 170339 220000 215778 211406 206878 -215778 -211406 -206878 -202189 202189 -197334 197334 -192305 192305 -187098 187098 -181706 181706 176122 -176122 -170339 DEBT SERVICE less PRINCIPAL REDUCTION INTEREST EXPENSE 11855 -4222 7633 11855 -4372 7483 11855 -4528 7327 11855 -4689 7166 11855 -4856 6999 11855 -5028 6827 11855 -5207 6648 11855 -5392 6462 11855 -5584 6271 11855 -5783 6072 25206.5 -17076 34568.9 -17076 -17247 44186.1 -17076 -17247 -17422 54065.6 -17076 -17247 -17422 -17601 64215.1 -17076 -17247 -17422 -17601 -17784 74642.7 -17076 -17247 -17422 -17601 -17784 -17971 85356.5 -17076 -17247 -17422 -17601 -17784 -17971 -18163 96365 -17076 -17247 -17422 -17601 -17784 -17971 -18163 -18359 107677 -17076 -17247 -17422 -17601 -17784 -17971 -18163 -18359 -18560 119301 B D E F G H I J K 1 2 3 4 5 6 7 8 9 10 ($15,600) ($15,072) ($15,912) ($29,926) ($16,230) (544,565) ($16,555) ($58,992) ($16,886) (573,209) ($17,224) (587,221) ($17,568) ($17,919) (5101,029) ($114,637) ($18,278) (5128,049) ($18,643) (5141,265) (57,633) ($5,000) ($12,633) ($9,854) (57,483) ($5,100) ($12,583) ($9,814) ($7,327) ($5,202) ($12,529) ($9,773 ) ($7,166) ($5,306) ($12,472) ($9,728) ($6,999) ($5,412) ($12,411) (59,681) (56,827) ($5,520) ($12,347) ($9,631) (56,648) ($5,631) ) ($12,278) ( ($9,577) ($6,462) ($5,743) ($12,206) (59,521) (56,271) ($5,858) ($12,129) ($9,461) (56,072) ($5,975) ($12,048) ($9,397) A 33 34 YEAR 35 COST OF RENTING: 36 Annual Rent 37 Cummulative PV of Renting Costs 38 39 COST OF OWNING: 40 Tax Ded. Operating costs 41 Interest 42 Property Tax 43 TOTAL BEFORE TAX COST 44 TOTAL AFTER TAX COST: 45 Non-Ded. Operating costs 46 Principal Payment 47 Maintenance & Repairs 48 Insurance 49 TOTAL NON-DED. COSTS 50 AFTER TAX OPER. COSTS: 51 52 REVERSION: 53 SELLING PRICE 54 less SELLING COMM. 55 less OTHER CLOSING COSTS 56 less MORTGAGE BALANCE 57 CASH FLOW FROM REVER. 58 59 Total Cash Flow If Sold 60 PV of Owning Costs If Sold 61 62 TENURE CHOICE: 63 Incremental Benefit of Owning vs. Renting 64 YEAR (54.222) ($2,000) ($1,000) ($7,222) ($17,076) ($4,372) ($4,528) ($2,040) ($2,081) ($1,020) ($1,040) ($7,432) ($7,649) ($17,247) ($17,422) ($4,689) ($2,122) ($1,061) (57,872) ($17,601) ($4,856) ($2,165) ($1,082) ($8,103) ($17,784) ($5,028) ($2,208) ($1,104) ($8,341) ($17,971) ($5,207) ($2,252) ($1,126) (58,586) ($18, 163) ($5,392) ($2,297) ($1,149) ($8,838) ($18,359) ($5,584) ($2,343) ($1,172) ($9,099) ($18,560) ($5,783) ($2,390) ($1,195) (59,368) ($18,765 $280,500 $286.110 $291,832 ($16,830) ($17,167) ($17,510) ($5,610) ($5,722) ($5,837) (5215,778) ($211,406) ($206,878) $42,282 $51,816 $61,608 $297,669 $303,622 $309,695 ($17,860) ($18,217) ($18,582) ($5,953) ($6,072) ($6,194) (5202,189) (5197,334) ($197,334) (S192,305) $71,666 $81,999 $92,614 $315,889 $322,206 ($18,953) ($19,332) ($6,318) ($6,444) (5187,098) ($181,706) $103,519 $114,724 $328,650 ($19,719) ($6,573) ($176,122) $126,237 $335.223 ($20,113) ($6,704) ($170,339) $138,066 $25,206 (536,971) $34,569 ($45,553) $44,186 ($54,070) $54,066 (562,521) $64,215 ($70,907) $74,643 (579,226) $85,356 ($87,478) $96,365 ($95,662) $107,677 ($103,779) $119,301 ($111,828) ($21,898) 1 ($15,626) 2 ($9,504) 3 ($3,529) 4 $2,303 5 $7,995 6 $13,551 7 $18,975 8 $24,269 9 $29,437 10
