Corin Anderson (magellanic) wrote,
Corin Anderson

Rent vs. buy

On a blog I read the author predicts the upcoming implosion of California's housing market. Yeah, I know, it's sorta like predicting it'll rain later this year. The interesting bit I lifted from her discussion was a really simple metric for the rest vs. buy argument: she suggests you should buy if the property cost is less than 200x your monthly rent. Whither does this metric come? So I poked around with Excel to try arrive with this as well.

For convenience I've assumed that a buyer/renter actually has the cash in order to buy the property; the money is either used to pay for a house or invested at a modest rate. Computing something similar using mortage rates, down payments, etc., should be straightforward.

In the BUY column I counted: $P for the property, 0% appreciation in property value, 1.5% property taxes, and about $4,000 in annual expenses (gardener, Merry Maids, and some maintenence), and $1,400 in homeowners insurance. Let's never mind about electricity, gas, etc. -- renters pay for these things, too, and these are small compared to other terms.

In the RENT column I counted: $M for the monthly rent, $P for an initial investment of at 5.0% after taxes, $2,800 in expenses (storage locker, Merry Maids, renters insurance).

For BUY and RENT I compute the value of the total investment ($P + appreciation - expenses) after N years; let's just use 2 for now, I don't plan too far into the future. I now want to adjust P and M such that the difference in the RENT and BUY investments after N years is about zero. Some fiddling later I arrive at: $P/$M = 178 or so.

Interesting -- there's some truth to this 200 multiplier after all. For grins let's change some other variables. Let's be generous and assume 2% annual appreciation in the house but over 5 years. 5% after tax investment return may be too optimistic -- let's lower that to 3.5%. Our multiplier is now 375 (give or take, the ratio depends on the range of $P and $M). That is, if I find a property offered at less than 375x my monthly rent, I should buy. Assuming, of course, these numbers.

I guess this shouldn't be too surprising -- I'm basically comparing two investments -- a house and some unspecified investment vehicle, and the raw expenses of each living condition. But having a single number as a rule of thumb *is* pretty handy.

Oh, and, if you think I missed some big term somewhere, please shout out.
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