Owning the house and renting it out for a profit.
Economics of Renting vs. Owning
- Thread starter The Kin2
- Start date
Owning the house and renting it out for a profit.
In other words, owning it at today's price and renting it out for $3k/month (a profit/breakeven).
That was the good old days.I like it the model, but I'm confused why you have rents increasing only 1% a year? Rents generally increase at the inflation rate. Property taxes probably increase at close to that rate too, but they are a small fraction of the overall escrowed payment (like 10% in my neck of the woods). So for a $1000 payment, the rent would increase to about $1035 the following year, but you have to subract out about 3.5% of $100 of the payment, which is $3.50. So the net rental increase would be $35 - $3.50 = $31.50 which is 3.15% of the payment. Wonder what the break even is under that scenario?
SM
Quote from scriabinop23:
In other words, owning it at today's price and renting it out for $3k/month (a profit/breakeven).
Not what I'm saying. I'm saying that the owner of the $600,000 house that is being rented out for $1500 may very well be renting it out for a profit if they purchased it 2 or more years ago. They have lots of equity and monthly profits from their rent.
The folks who decided to rent through the real estate boom do not have that equity. They haven't seen much of an increase in rent though...yet. Rents will catch up....estimates are 5+% a year for at least a few, perhaps several years.
SM
Ok, I reworked the model (see attached) assuming 3.5% inflation on rents. But since I'm lazy and didn't want to spend a lot of time with the spreadsheet, I also subtracted out the increase in property taxes from the rent increases. I also had the rents rise every month instead of every 12 months so I didn't have to hund down a bunch of excel cells. Yeah...lazy, but the answer is close to the same thing. Anyway, the break even time for rents to exceed payments is 8.5 years, and that is based on the extremes of today, which completely goes against historical averages for the ratio between rents and payments.
SM
I made a top line estimate based on the information given. If you want to come up with a discounted present value model including property and income tax rates, association fees, insurance, transaction fees, and the like, be my guest. I've been there, and I believe the main product of such an exercise is a false sense of precision.
Rents and rent equivalents are 40% of the CPI. Rent cannot change significantly, nationwide, in real terms over a 30 year time span. There can certainly be short term local fluctuations but those are inherently unpredictable and have no place in a financial model.
The historical evidence supports modelling both rent and housing prices as constant in real terms.
I agree.
Martin
True. both increase, but I wanted to give renting a fighting chance with ownership. Same thing with prop taxes. Although in CA, prop taxes are limited to 2% growth per year, but will not grow if prop values go down. I'm willing to bet prop values flatten or decrease by 5-25% over the next cycle.
I don't factor that projection in as well, to simplify and take my own bias out of it.
I don't think rents can continue to escalate at 3.5%+ a year over a long term, however. That would imply wages are going up. I don't think they will -- with higher borrowing rates on money, inflation of expenses, etc. I assume there will be negative pressure on wages, as businesses will do everything to squeeze the most out of their margins.
Also I'm not concerned with impounds on mortgages -- bottom line, prop taxes are paid by you. You could easily modify this spreadsheet to show escalating rents and escalating prop taxes. But they'll likely offset eachother.
On the other hand, the owner who purchased two years ago is not gaining interest on his home equity (as if it were in cash equivilents), and he is also exposed to a leveraged reduction in the prop value if the market corrects over the next few years. Not a position I'd like to be in, unless I was planning on keeping the property for life, and already had plenty of other cash.
You're right, I forgot insurance in my spreadsheet. A homeowner's premium will be several times a renter's comparable.
I don't think the exercise does any damage when considering the picture. Its important to look at the entire puzzle, at least when planning your finances.
And I agree about the rents - thats why I left the sheet at 1% growth, not 3.5%. Although rents might escalate at the latter rate for the next few years, they'll return back to slow growth - that is unless we somehow find a 50mil barrel/day oil field in texas in between now and then.
I've looked at the numbers before, and while you can expend a great deal of effort on unneccessary precision in minor costs, like homeowners insurance, tips to the doorman ..... etc ...
the big shifts in the numbers occur with your estimates of where housing is going as an asset class within your time horizon and, if you are a trader, your estimate of your return on the deposit funds as a renter.
Ultimately owning is being long real estate. If it goes up you win, if it tanks you lose.
A trader who rents and who takes the view that long rates are low should deduct his rent as office space and negotiate a s long term rent as possible. A rental agreement is not dissimilar to being long a call option on the 10 year yield with maturity equal to the lease length.
Real estate does go up over long periods of time - but you may be forced to move before then.
the big shifts in the numbers occur with your estimates of where housing is going as an asset class within your time horizon and, if you are a trader, your estimate of your return on the deposit funds as a renter.
Ultimately owning is being long real estate. If it goes up you win, if it tanks you lose.
A trader who rents and who takes the view that long rates are low should deduct his rent as office space and negotiate a s long term rent as possible. A rental agreement is not dissimilar to being long a call option on the 10 year yield with maturity equal to the lease length.
Real estate does go up over long periods of time - but you may be forced to move before then.