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Buying a House vs. a Condominium as a Rental Property. Group 2 EGR 403 Section 02. Team Members: Samuel Mebasser Tim Craig Bryan Hannah Michael Lai Henry Phan. Scenario. 30 Year Old Engineer Making $85K Annually Planning to Retire at Age 60
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Buying a House vs. a Condominium as a Rental Property Group 2 EGR 403 Section 02 Team Members: Samuel Mebasser Tim Craig Bryan Hannah Michael Lai Henry Phan
Scenario • 30 Year Old Engineer Making $85K Annually • Planning to Retire at Age 60 • Looking to Invest in Either a House or Condo as a Rental Property • Looking for a 10% Minimum Attractive Rate of Return
Option #1 – Buying The House • 4 Bedroom, 3 Bathroom house located in Pasadena. • 2,232 Square Feet • 2 Car Garage • Built in 1979 • Selling Price: $587,000 • Estimated Appreciation: 8% Annually
Option #2 – Buying The Condo • 2 Bedroom, 2 Bathroom Condominium located in Pasadena. • 1,113 Square Feet • 2 Car Garage • Built in 1981 • Selling Price: $399,000 • Estimated Appreciation: 4% Annually
Cash Flow Diagram - Home $5,469,240
Cash Flow Diagram – Condo $1,249,230
Non Recurring Costs • Loan Origination Fee • Underwriting Fee • Processing Fee • Loan Document Preparation Fee • Credit Report • ALTA Title Policy • Tax Service • Recording Fees • Escrow Fee • Loan Tie – In Fee • Third Party Property Inspection
Engineer Receives an annual raise of 5% Property Taxes are 1.25% of Property’s market value Insurance is .3% of Property’s market value Additional Costs and Benefits
Monthly Payments On Loan • Loan Term is 30 Years with 6.5% Fixed APR • Down Payment is 20% of Purchase Price, Therefore, Loan covers 80% of the purchase price House • Loan Amount is $469,600 • Monthly Payments on 30 year loan are $2968.19 Condo • Loan Amount is $319,200 • Monthly Payments on 30 Year Loan are $2017.56
Tax Savings • A.G.I. = Rental income – deductions • Schedule E deductions • Insurance costs • Auto and travel expenses • Management fees • Mortgage interest • Repairs • Supplies • Property Taxes • Depreciation (MACRS) • Association fees (Condominium only)
Number of Years Property kept after paid off. APR Annual Appreciation of Property Down Payment Percentage Annual Rent Inflation Rate Loan Term House Monthly Rental Condominium Monthly Rental Sensitivity Analysis Parameters
Sensitivity Analysis • Number of Years Property kept after paid off.
Sensitivity Analysis • APR
Sensitivity Analysis • Annual Appreciation of Property
Sensitivity Analysis • Down Payment Percentage
Sensitivity Analysis • Annual Rent Inflation Rate
Sensitivity Analysis • Loan Term
Sensitivity Analysis • House Monthly Rental
Sensitivity Analysis • Condominium Monthly Rental
Sensitivity Analysis Summary • Lower Interest Rates translate into higher IRR • Less Down Payment will yield a higher IRR • It is wise to keep the house after it is already paid off, but keeping the condo after it is paid off will decrease the IRR • If the inflation rate of rent increases at a very high rate (>10%), the condo will eventually have a higher IRR than the house
Summary Assuming the 30 year, 6.5% APR Loan where the owner sells the house after 30 years with a MARR of 10% • The IRR of the house is 13.49% • The IRR of the Condo is 9.52% • The Incremental ROR of the two options is 17% • Since the Incremental ROR is larger than the MARR, The higher cost alternative is chosen Therefore, the Engineer should buy the house for a greater return on his money
Resources • Jhdcpa.com • www.irs.gov • Tarbell Realtors • Essentials of Engineering Economic Analysis. Newman, Lavelle, Eschenbach