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March 23, 2007
Myth #3: Rent is wasted money
(c)
copyright View From Silicon Valley, 2007. All rights reserved.
They say bad news (or is it good news?)
comes in three. (They also say memory is one of the first things to go when you get older...)
As I recall from college,
the test for the "Turtle Club" had three questions of which I can only recall the first: "What do men do standing up, women
do sitting down and a dog does on three legs?"
Get your mind out of the gutter. The correct answer is "shake
hands."
The "Great Lies" also came in threes and I can even remember two of those:
1) I'll still respect you in
the morning,
2) The check is in the mail.
Feel free to fill in the third "lie" at your leisure.
Given the
prevalence of things in threes, we wanted our third myth to be a really big one. A "myth" which was so widely held that
people would question our sanity.
Hence, "Myth #3: Rent is wasted money."
If this isn't the universally-held
belief in real estate, we'd like to hear your alternative.
As is our wont, when in doubt, we run the numbers.
All
examples assume a 30-year fixed mortgage at 6.25%, 20% down and a 1.25% real estate tax rate. Principle payments and
real estate taxes are taken from an on-line mortgage calculator. Maintenance is assumed 1% per year. (Clearly
ignoring 40- and 50-year-old shacks are routinely bought in Silicon Valley with the full knowledge they have not been
updated on 20 or 30 years and need massive renovations.)
A couple months ago, we wrote about a house near the
median $750K. Last week we wrote about a 43-year old house selling in a few days at $1.25M. In that same missive,
we thought the upper limit would finally be exceeded with another house at $1.75M, but this house also sold within a few days.
So
here we go:
Price Tot$/yr Int+Tax
$750K
$62.7K $46.5K
$1.25M $95.3K $69.7K
$1.75M $120.5K $86.6K
Everyone seems to ignore the actual $63K /$95K /$121K out-of-pocket and instead salivates at the prospect
of huge tax deductions. Nobody seems to ever stop and think through "deductible" means you only actually "save" the
deduction at the marginal tax rate.
The table could then be expanded to:
Price Tot$/yr Int+Tax Deduction
$750K $62.7K
$46.5K $17.2K
$1.25M $95.3K $69.7K $25.8K
$1.75M $120.5K
$86.6K $32.1K
In other words, out of $63K /$95K /$121K spent, the
actual tax savings is only $17K /$26K /32K. Worse, anyone pulling down enough coin to pay out $63K /$95K /$121K is hitting
the AMT at least every other year. To account for AMT eliminating your real estate tax deduction, you have to calculate
a two-year average deduction:
Price Tot$/yr Int+Tax
Deduction Ded >AMT 2-yr Avg
$750K $62.7K $46.5K $17.2K
$13.8K $15.5K
$1.25M $95.3K $69.7K $25.8K $20.2K
$23.0K
$1.75M $120.5K $86.6K $32.1K $24.3K $28.2K
So how does that $63K /$95K /$121K feel when the two-year average deduction is only $15.5K /$23.0K
/$28.2K?
In addition, there is the opportunity cost from the 20% down payment. Adding in the after-tax gain on
a 5% treasury bill:
Price Tot$/yr Int+Tax 2-yrAvg
Act"Cost" OppyCost Tot"Cost"
$750K $62.7K $46.5K $15.5K
$40.3K $4.7K $45.0K
$1.25M $95.3K $69.7K
$23.0K $65.1K $11.8K $76.9K
$1.75M $120.5K $86.6K
$28.2K $84.2K $22.1K $106.3K
Obviously,
a renter's cost is just the rent. It's very clear. It's very simple.
We know you were waiting so, finally,
here is the punch line.
A buyer's true "cost" is their total outlay minus the tax deductions, minus the principle payments
and plus the lost interest. The "final" table for this exercise is then:
Price
Tot$/yr Tot"Cost" Equiv Rent
$750K $62.7K $45.0K
$3,750
$1.25M $95.3K $76.9K $6,408
$1.75M $120.5K
$106.3K $8,858
Conclusion: We've
shopped around. You can rent properties which sell at these price points for much less than these implied rents.
This
suggests it's buyers "wasting" money, not renters.
* * * * *
The above is not intended as advice to buy, sell or
hold any stock, bond, real estate nor any other financial product or service. Invest at your own risk. (As we do ourselves.)
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