Reference no: EM132836077

You have the choice of purchasing or renting a three-bedroom condo in Miami, Florida. The purchase price of the condo is $585,000. The condo can be rented for $2,500 per month. If you purchase the property, you intend to finance the acquisition with a 90% loan to value ratio loan with a fixed 4.25% annual interest rate and monthly payments for 30 years. The mortgage has a 1% loan fee and no discount points. In addition to these financing costs, you will have to pay $2,500 in closing costs when you purchase the property. Over the operating years, you expect to pay an annual property tax of $2,750, maintenance and repair expenses of $2,100/year, and hazard insurance of $800/year. You expect these operating expenses will increase 3%/year over an expected 5-year holding period. You would have to pay utilities and a condo fee if you rented or owned, so these expenses may be omitted from your analysis. You expect rents and property values to increase 3% per year. When you sell the property, you have to repay the outstanding balance on the mortgage, without penalty, a six percent brokers' commission, and additional closing costs amounting to $2,000. You are in the 28% marginal income tax bracket for ordinary income and can take full advantage of the mortgage interest and property tax deductions, and that you are able to avoid paying taxes on the capital gains. Finally, you discount expected after-tax cash flows associated with owner-occupied housing at 7%.

1. What is the present value of the expected after-tax cost of renting?

2. What is the present value of the expected after-tax cost of owning?

3. Should you buy or rent?

4. What would the monthly rent have to be to make you indifferent between owning and renting (other things equal)?

5. What would the purchase price have to be to make you indifferent between owning and renting (other things equal)?

6. What would the expected appreciation rate in the market value of the property have to be to make you indifferent between owning and renting (other things equal)? Answers should go to hundredths of a decimal (i.e., 4.25% entered as 4.25).

7. Approximately how long until owning is cheaper than renting? Round your answer up to the whole number of years.

8. What would the present value of the expected after-tax cost of owning be if you take the standard deductions and so do not benefit from tax deductions available in homeownership (hint: it's the same as assuming you are in the 0% marginal tax bracket)