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You are considering an option to purchase or rent a single residential property. You can rent it for $ 4 , 6 0 0 per
You are considering an option to purchase or rent a single residential property. You can rent it for $ per month and the owner
would be responsible for maintenance, property insurance, and property taxes. Alternatively, you can purchase this property for
$ and finance it with an percent mortgage loan at percent interest that will fully amortize over a year period. The loan
can be prepaid at any time with no penalty.
You have done research in the market area and found that properties have historically appreciated at an annual rate of percent
per year, and rents on similar properties have also increased at percent annually; maintenance and insurance are currently
$ each per year and they have been increasing at a rate of percent per year; you are in a percent marginal tax rate
and plan to occupy the property as your principal residence for at least four years; the capital gains exclusion would apply when
you sell the property; selling costs would be percent in the year of sale; and property taxes have generally been about
percent of property value each year.
Based on this information you must decide
Required:
a In order to earn a percent IRR after taxes on your equity, should you buy the property or rent it for a fouryear 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
percent IRR after taxes?
c Approximately, what level of rents would make you indifferent between owning and renting for a fouryear period? Assume that a
percent aftertax IRR would be the minimum you would need to earn on capital invested in the home.
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