Real Estate Investment: Return On Investment and Cash Flow Calculation

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Renting vs Buying

Should I buy a house or should I keep renting? This is the question that has been asked by a lot people before they are ready to jump into real estate. There're tons of reasons that people buy houses. Some people won't even think about it until they are married. Some people will wait until they have their first kid. Others start thinking when they can't find any apartment and reasonable priced rental home to accommodate their growing family. Those are actually wrong reasons to buy from a financial point of view. I would say you should start thinking as soon as you find your first job. You need fair amount of time to save for down payment. You also need time to watch the market closely to find the right entry point.

Don't just jump in because you heard that everyone is making money in real estate. Just like stock market, when the market is up and most people are making money, it may signal the market is at some dangerous point, -- if there's anything we can learn from history. Nice thing about house market is that the trend won't turn over night like stock market. You have plenty of time to respond. And not every economic downturn will cause housing market to crash. And even when it happens, every area is different. Read Evaluate Housing Price to understand the current house price level.

Assume you have accumulate enough down payment and are financially stable and plan to stay at the same area for at least several years, the next question you want to ask is whether it makes financial sense for you to buy a house instead of renting one? To answer your question, you need to do a research on your local market.

For example

You are living in a house with 1200sqft and paying a rental of $1100 a month. Now with the help of a realtor, gather some data to see how much it costs if you buy a similar house in the same area. Here, let's assume it will cost you $140,000 to buy a similar size house in the same area. Assume you put down 20% and borrow 80% of mortgage. Assume property tax is around $2,000 and insurance around $500. Assume your tax bracket is around 23% and the current mortgage rate is 6%. Assume you plan to stay at least 5 years. To make it simple, let's assume no rental increase and no appreciation of the house. Let's put the number in our All-in-One Real Estate Investment Calculator to see what we get.

Click on image for larger graph in new window. rent1

From the calculation, you can see even without appreciation, you still save money on buying than renting. But if you have a better investment way that can generate higher than 11.97% return on your initial investment(mostly down payment) on house, then you should still consider renting.

What about we have a 2% inflation and the same rate of appreciation on house? How does the number look like now.

Click on image for larger graph in new window.rent1

Assume the house price is $200,000 with $3000 property tax and $800 home insurance,

Click on image for larger graph in new window. rent1

From above calculation, you can see that in a higher priced area without appreciation, you'd better rent than buying. Even you put the money in a checking account, you can generate a better return than -1.5%.

Usually a high priced area the rental is higher as well. The house price in long term is evaluated by rental price and personal income.

In an overpriced area like California, Seattle and New York, it may make sense to rent instead of buying. But in most area of the country, buying is usually a better financial choice in long-term.