case5

Case study 6 Rent vs Buy

Executive Summary

Rebecca Young is a recent MBA graduate, who is faced with a common problem that many people face in today's world which is deciding whether to rent or buy a place to live. This decision entails comparing and contrasting numerous moving parts, such as rent payments, purchase price of the property, monthly mortgage payments, down payments, interest rates, and valuation of the property today and in the future. Most importantly, this decision involves the concept of time value of money: whether a sum of money today will be worth more in the future by purchasing rather than renting a place to live.

1. Determine the required monthly payments for the mortgage

Montly Pmt

$2,524.90

2. Determine the “opportunity” costs, on a monthly basis, of using the required funds for closing (i.e., down payment plus all closing costs), rather than leaving those funds invested and earnings the monthly effective rate determined in part (a)

Monthly Opportunity Cost

$ 462.83

3. Determine the monthly additional payments required to buy versus rent (include the monthly opportunity costs determined in part (b))

Total Difference

$ (1,392.73)

4. Determine the principal outstanding on the mortgage after: a. 2 years b. 5 years c. 10 years

2 years	$456,609.33
5 years	$417,858.88
10 Years	$342,109.16

5. Determine the “net” future gain or loss after 2, 5, and 10 years under the following scenarios, which Rebecca Young has determined are possible after some “due diligence” regarding future real-estate prices in the Toronto condo market: a. The condo price remains unchanged b. The condo price increases annually by an annual rate of 2 percent per year over the next 10 years. c. The condo price increases annually by an annual rate of 5 percent per year over the next 10 years.

	Sell after 2 years	Sell after 5 years	Sell after 10 years
a	$ (63,336.26)	$ (82,116.79)	$ (118,829.69)
b	$(120,336.26)	$ (82,116.79)	$ (61,829.69)
c	$ (40,308.26)	$ (22,790.73)	$ 5,997.13
d	$ (4,911.26)	$ 75,363.70	$ 239,640.25

6. As Rebecca Young, what decision would you make? Describe any qualitative considerations that could factor into your decision.

Considering the profit/loss matrix and all other factors, I would choose to keep renting the condo. This conclusion is based on a number of different data points as well as some qualitative factors.

First, there is a monthly cost advantage to purchasing the condo rather than renting.

The opportunity cost of not investing the $140,000 closing fee and the ongoing monthly costs of buying end up being greater than the cost of continuing to rent her current condo at the rate of $3000/month. While paying $3000/month in rent may appear and feel like you are losing more money than if you had purchased the condo outright, when all fees and costs are considered, the $3000 per month is the more cost efficient option.

Then you look at the profit/loss matrix and see that, after deducting all costs and sales proceeds, she would only make a profit in three of the possible twelve price scenarios.

Furthermore, in two of the three scenarios where Rebecca makes a profit, she must hold onto the condo for ten years and hope that the price of the condo rises significantly year after year. For someone like Rebecca, who is young and values mobility, holding onto the condo for 10 years to make a profit does not seem like a good outcome. Rebecca had expressed a desire to move to a house within the next 5-10 years, and if this goal is met, purchasing the condo would almost certainly result in a loss on the transaction. Given all of the known factors, Rebecca's decision to continue renting her condo is the most cost effective.