daveinbedstuy - my point is that will have the same risk and reward as the proposed investment. As such, you cannot compare the down payment expected return to that of a risk free investment......the opportunity cost needs to be much, much higher

Posted by: mrspock at May 30, 2008 4:07 PM in response to You Have $140K Down, Where Do You Buy?

The assumptions I posted were meant to assume that housing prices are way too high with those assumptions. I believe the current income portion equates to roughly a 6.5% capitalization rate. The big question which I am unsure of is what is the required rate of return on an unleveraged basis. Since real estate is not as correlated with the market, it would suggest a required ROA of something half way between the risk free rate and the market rate.

Regarding the post from daveinbedstuy, I think it is not appropriate to compare the down payment with the risk free rate. On an unleveraged basis, there can be major swings in value. The equivalent risk adjusted return for your downpayment would probably take the Return on Equity of a basket of residential REITS and that have 80% leverage. The required rate of return on an investment of equal risk to the down payment should probably of a return of 20+%

Posted by: mrspock at May 30, 2008 3:30 PM in response to You Have $140K Down, Where Do You Buy?

These are just assumptions. The 7% is what the 30 year jumbo fixed rate is and I assume interest only. Most apartments in what some would consider the most desirable areas are not eligible for Fannie or Freddie. The maintenance doesn't change the math very much. What the model says is that if my assumptions are correct, $1000 / square foot is way too much and to make the implied rent work it would need to be 700-800 / square foot.

BTW, on Bankrate.com. 30 yr fixed = 6.02%
30 year jumbo fixed = 7.2%

Posted by: mrspock at May 30, 2008 2:18 PM in response to You Have $140K Down, Where Do You Buy?

Guest: I am assuming a market clearing price rather than an individual person's case. That should take into account opportunity cost of the alternatives in the markets.

Posted by: mrspock at May 30, 2008 1:17 PM in response to You Have $140K Down, Where Do You Buy?

Guest: First, I appreciate the discussion. My case is not on the merits of buying versus renting. I believe that in a fairly priced market, there are definate advantages. Rather, my analysis is on whether prices are high/fairly priced/low when compared to rents and whether anyone believes the model has any predictive power.

Posted by: mrspock at May 30, 2008 12:57 PM in response to You Have $140K Down, Where Do You Buy?

Guest: My assumption is an interest only mortgage to come up with the implied rent. If I used a 30 yr mortgage in the assumption, the implied rent would be much higher. I wanted to keep apples to apples and present a case based on investment merits.

Posted by: mrspock at May 30, 2008 12:26 PM in response to You Have $140K Down, Where Do You Buy?

Can someone review these assumptions and explain to me whether they seem to be correct? If they are, how can anyone justify buying an apartment based on where rents are?

Assumptions

Square Feet 750
Purchase Price 750,000
Price / Sq Foot $1,000
Maintainence 1,200
% Maintainence Deductable 33.0%


Mortgage Rate 7.00%
Effective Tax Rate 35%

Expected Inflation 3.0%
Expected Premium to Inflation 1.0%
__________

Expected Annual Appreciation 4.0%
Leveraged Appreciation 20.0%
Add: Required Cash ROI 15.0%
__________
Total Annual Return on Equity 35.0%

Total Return on Asset (unleveraged)7.0%

"Real" Purchase Cost
Cost of Apartment 750,000
Add: Capitalized Mo. Maint 212,044
__________
Total Cost 962,044

"Real" Cost / Square Foot $1,283

Equivalent Rental Cost
% Down Payment 20%
Down Payment 150,000

Monthly After Tax Mortgage Payments (Interest Only) 2,275
Add: After Tax Maintainence Costs 804
__________
Total Monthly Payments 3,079
Add: Required Cash ROI (equity down) 1,875
__________
Expected Monthly Rental 4,954

Posted by: mrspock at May 30, 2008 12:16 PM in response to You Have $140K Down, Where Do You Buy?