Question
You are considering an option to purchase or rent a single-family residential property in Cincinnati, OH. You can rent it for $6,000 per month, and
You are considering an option to purchase or rent a single-family residential property in Cincinnati, OH. You can rent it for $6,000 per month, and the owner would be responsible for maintenance, property insurance, and property taxes. Alternatively, you can purchase this property for $750,000 and finance it with a 90% LTV, insured conventional mortgage loan at 6% interest that will partially amortize over a 30-year period with a remaining balance of $35,000. The loan can be prepaid at any time with no penalty.
You have done research in the market area and found that:
Properties have appreciated at an annual rate of approximately 4% per year, and you expect this trend to continue for the next 3 years given excess demand in the local housing market. Beginning in year 4, you anticipate that house price appreciation will revert to its steady state of 2% per year.
Rents on similar properties have increased at 4% annually, and you anticipate that rent appreciation will remain fixed at this level for the foreseeable future.
Based on the size of your down payment and credit score, the insurer has quoted you an annual private mortgage insurance (PMI) rate of 0.50% per year of the original loan amount. Assume that you will request (and receive) cancellation of the PMI going into the month in which the original LTV ratio falls to 80%. PMI is tax deductible.
Maintenance is currently $4,250 and is expected to increase by 3% annually.
Property insurance is currently $5,000 and is expected to increase by 2% annually.
You are in a 34% marginal tax rate.
You plan on occupying the property as your primary residence for the next 15 years, at the end of which time you will sell the property.
The capital gains exclusion for a single individual would apply when you sell the property. The capital gains tax is 15%.
Selling costs would be 10% of the property value in the year of sale.
Property taxes have generally been about 1.75% of property value each year.
Based upon the after-tax internal rate of return (ATIRR), should you buy or rent this residential property for the 15-year period assuming that you wish to at least earn a 10 percent IRR after taxes on your down payment? (5 points)
Interest rates are projected to decline in the future such that you can refinance the property at 4.5% interest after ten years. Since you are effectively taking out a new loan, the lender will reintroduce PMI as 0.50% of the new loan amount. Once again, assume that you will request (and receive) cancellation of the PMI going into the month in which the original LTV ratio falls to 80%? (5 points)
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