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Tags: client education | investing | real estate
A client wants to make a down payment on a house for his son as a wedding gift. But he’s not sure if it would be better to do that or to pay the rent on a nice home for them for the first few years. He asks you what you think, knowing that he will have to pull money from the account he has with you to make the down payment. This Website Is For Financial Professionals Only
Whether it’s better to buy or rent a home may not be a question many investors often ask. But the Census Bureau says home ownership has fallen to 65.4%. That’s the lowest level since 1997. And only 8.8% of rentals were vacant in the first quarter, the lowest level since 2002.
Rents are growing at a rate of 2.5%. Housing supply coming into the market is not even close to matching the demand for rentals. So it looks like rents will keep rising over the next 12 – 18 months. The number of homes for rent is declining because the overall decline in inventory of homes for sale. Average rent growth in 2013 could reach 5% in 2013.
This indicates that investing in rental homes while the housing market gains strength may be a good idea. Home sales are improving—they were strong during the first quarter, despite the decrease of 2.6% in March. And interest rates are still quite low.
So when a client is on the buy side, putting some figures down will help him make a more informed decision when the economy is still in flux.
This client has found two houses he’s considering for his son and daughter-in-law to be. The first house has an asking price of $499,000. His son has a promising future and your client is thinking it would be great to start them out with a nice house in a good neighborhood.
But he’s not sure whether buying the house in this environment would be a smart thing to do, especially since it's difficult to get a fixed rate on a jumbo loan.
The person who owns this house was told he’d be lucky to get $350,000 out of it. So he’s thinking of renting it for $2,200 per month for about two years. He doesn’t want to take less than he paid for it and he thinks the market will be better by then.
For both the seller and your client, this house makes more sense to rent than to buy. After two years, the cumulative outlay will have been a total of $54,559 for renting compared to $103,700 for buying. That would be a savings of $49,141.
The calculation includes $696 spent in renter’s insurance and assumes a $2200 deposit will be returned after the second year.
The buying calculation includes a $99,800 down payment, a selling value of $519,160 in two years, and all closing costs, property maintenance, insurance, utilities, and renovations.
The renter’s totals do not include utilities although it is usually the renter’s responsibility to pay them. Even with the inclusion of utilities, the renter’s cumulative outlay over two years for this house is $57,007. That’s still better after two years by $46,693, or 45%.
On a less expensive house, say with a $265,000 asking price and a rent of $1350 per month, it still makes sense to rent. The cumulative outlay over two years is $33,479 compared to $56,227. That’s a difference of 22,748, or 40%. Hike the rent on this home to $1600 a month and the tables turn in favor of buying.
Renting either of these homes would cost less over a two-year period than buying. It would also give the client two more years to grow his assets.
It also may make sense for the client to buy one of these homes and rent it to generate income after his son and daughter-in-law move out.
Whether to rent or buy can also be a consideration when looking at a second home. You can input other data and make adjustments using an interactive calculator.
If the economy continues to improve, asset growth over the two years could also occur in a potentially more favorable market environment. And if the Fed really does keep rates low until 2014, then two years out could also be a better time to offer his son that down payment.
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