Author: Victor Menasce
Does it make more sense to rent or to purchase? We recently completed this analysis as an example case study for a project we are building. Some investors and developers only look at comparable properties when assessing the competition in the marketplace. For example, if you are contemplating 2BR apartments, they look at the landscape of existing 2BR apartments in the marketplace. However, when someone is choosing a place to live, they have more than one option to choose from.
They could Live in an apartment in a multifamily property. They could purchase a condo. They could rent a single family home. Or they could purchase a single-family home. These all could be viable options for the potential tenant.
If you’re investing in multi family apartments, your market study should examine all the alternative forms of housing to get a clear picture of the supply and demand situation in the market.
Let’s say your market analysis shows very low vacancy in multifamily properties. But if there was a large inventory of single-family homes for rent that would be very useful information. Likewise, if sale prices have increased much faster than rents, the balance of affordability might tip in favor of renting.
For many families housing affordability is a significant issue. An additional $100 per month can make the difference between affording or not.
Today we’re going to look at a specific case study that compares a 2BR apartment that rents for $1600 per month with a starter home that is priced in the market at $265,000.
At an interest rate of 4.25%, with a 30 year amortization period, and a 10% downpayment, the monthly cost of ownership between the single family home and the apartment are virtually the same. We’re within about $10 per month of each other. But that’s not the whole story.
Some of the factors that can have a significant impact are the financing terms, and the expected duration of ownership. If interest rates go up by 0.5%, then you are looking at an additional $70 per month in home ownership cost. If the bank gives you a 25 year amortization schedule instead of 30 years, then the cost goes up another $120 per month.
The other variable affecting the decision is the length of time expected in that location. Someone who expects a 2-3 year temporary assignment may elect to rent rather than buy. Owning a property for such a short time period carries significant risk to the owner. The cost of selling a property can amount to 7-10% of the total price when you take all the transaction costs into account. You need to be pretty sure that the home will go up in value by more than 10% in that time period. Otherwise you will lose equity by owning for a short time period.
The biggest difference affecting the choice between renting versus buying is the upfront cash requirement. A tenant will need to put up $3,500 in cash up front. Whereas the home buyer will need to have a 10% downpayment or about $35,000 in cash up front. Some people simply don’t have that much cash saved up. There are other high ratio loans that are mortgage insured. But these carry an insurance premium on top of the interest rate. IF that mortgage insurance is an additional 1%, you’re looking at an added cost of $140 per month. IF the buyer can afford that, the downpayment can be reduced significantly. But the requirements to qualify for a minimum downpayment loan can be more stringent in terms of income history.
When you conduct your market study, you want to make sure you are targeting a very specific demographic with your product offer. You want a solid understanding of the jobs and incomes in the immediate area. You also want to compare the percentage of people who own versus rent in the area. Some areas are highly biased towards home ownership with very few tenants. Other areas are majority rental properties. Some people who can’t afford a specific area may choose to rent in order to be located in the best school districts. This too can affect the supply demand situation.
When you are making a decision to own a rental property in a specific market, make sure you understand all potential sources of competition, including the choice to buy instead of rent.