Buy or Rent? A Framework to do this Calculation
Real Estate ·There are many popular online buy or rent calculators such as the New York Times calculator to help us think through before making one of the biggest financial decisions. I want to write this post to go beyond the binary “buy or rent” decision and explain the numbers behind the “equivalent rent” we see.
Costs behind Buying
Here is a non exhaustive list of 8 major costs that come with the buying decision. Factors marked with (*) is to indicate tax implications (which do not necessarily lead to tax savings)
- Interests payment to Mortgage (*)
- Property Tax (*)
- Interests forgone on down payment (*)
- HOA
- Home insurance
- Maintenance: 0.5% to 1% yearly
- Buying/Selling closing cost: about 2%-3%
- Buying/Selling agent commission: about 3%
- Utility
Since I am more familiar with the NYC real estate market, I want to break down these costs using a typical (yet imaginary) NYC 1-bedroom-1-bathroom condo that’s listed for 💰1 million.
I also assume my holding period is 5 years to linearly amortize the closing cost and agent commissions. My tax assumption is that I am in the 24% bracket. My downpayment is 20%, which is 200k. This means I need 800k of mortgage. After using some online mortgage calculators, I figured that my interest is around 45k per year (assumed my mortgage has around 6% interest rate).
- Interests payment to Mortgage: 45k
- Property Tax: 10k (it’s based on NYC’s actual assessment, but it’s fair to assume that it’s about 1% of what you paid for this condo)
- Interests forgone on down payment: 10k * (1-24%) (given the current high interest environment, I assumed that I could make 5% on my 200k downpayment)
- HOA: 12k (about $1000 per month for typical NYC 1b condos)
- Home insurance: $1k
- Maintenance: $5000
- Buying/Selling closing cost: 4k per year if I amortize 20k over 5 years of holding period
- Buying/Selling agent commission: 6k if I amortize 30k over 5 years of holding period Utility: $1k
I just need sum up the above numbers to calculate the total cost of buying a condo, which yields 87.1k per year. Dividing it by 12 months, we are paying an equivalent rent of $7258/month!
Costs behind Renting
The list for renting cost is not as daunting as the buying cost list above.
- Rent
- Utility
- Interest forgone on security deposit
- Broker commission (landlords sometimes pay for this)
Since most rental buildings or landlords are required to maintain decent living conditions, we don’t need to pay for maintenance costs.
Rental market in NYC has been crazy since the pandemic. A 1 bedroom could have a price range from $3000 to $6000! I took the average of the price extremes I observed ($4500) to illustrate a calculation we could do to compare the rental cost with that of buying. I also think given the living conditions, the $4500 rental apartment is a fair 🍎-to-🍎 comparison to the $1M condo.
- Rent: $4500/month
- Utility: $100/month
- Interest forgone on security deposit: $225 * (1 - 24%) /month
- Broker commission: $375/month, by amortizing broker fee of $4500 over 12 month lease term
Adding up the above costs gives me $5146/month.
Conclusion for my NYC Example
In my NYC case, the cost of buying a condo is ⚠️$2112⚠️ more expensive than renting every month. In annual terms, buying costs 23.3k more than renting in NYC. No wonder NYC has the most millionaire renters.
Tailor this Framework to Your Situation
The calculation above is to illustrate a simplified framework I used when trying to understand the result and inputs in the online buy or rent calculator.
We also need to note that the buying/renting costs will vary significant across different regions. As interest rate changes, the interest related factors will also reflect different costs and potentially change the result.
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