Question

Rent vs Own You are considering an option to purchase or rent a single residential property....

Rent vs Own

You are considering an option to purchase or rent a single residential property. You can rent it for $4,000 per month and the owner would be responsible for maintenance, property insurance, and property taxes.

Alternatively, you can purchase this property for $300,000 and finance it with an 80% mortgage at 7% interest, 25 year - fixed. The loan can be prepaid at any time with no penalty.

You have done research in the market and found that properties have historically appreciated at an annual rate of 4% per year. Rents on similar properties have also increased at the same rate. Maintenance and insurance are currently $2,500 each per year and they have been increasing at a rate of 4% per year. Property taxes have generally been about 3% of the property value each year. If you purchase, the plan is to occupy the property for at least four years. Selling costs would be 7% in the year of sale.

Based on this information you must decide:

 In order to earn a 10% internal rate of return, should you buy the property or rent it for a four-year period of ownership?

Please show work in excel!

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Answer #1

We should buy the property since NPV of cash outflows under owning the property are less by $63,536 than renting.

Workings 1 Cost of Property Year Value $ 3,00,000.00 $ 3,12,000.00 $ 3,24,480.00 $ 3,37,459.20 $3,50,957.57 2 Property Tax (nDiscount Rate 10% 4 Rent Year Rent Per Month Rent Per Year $ 4,000.00 $ 4,160.00 $ 4,326.40 $ 4,499.46 $ 48,000.00 $ 49,920.0

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