Looking for a home in New York City can be frustrating and complicated. Once you know where you want to live, you need to evaluate whether you should you rent or buy that new roof above your head.
Understanding the costs of renting vs. ownership is an important starting point in deciding which choice to make. However, choosing to rent or buy is not just an economic decision. There are a number of other important factors that must be evaluated.
Issue 1: Permanence
There are people who are reluctant to make a long-term commitment to a specific apartment or geographic area.
According to Bellmarc records, the average length of time a homeowner stays in a Manhattan apartment is five years. People living in large apartments, particularly if they have children in school, stay somewhat longer. People in smaller apartments, particularly if they are young and single, tend to stay for a shorter term.
Permanence is a state of mind with most buyers. Very few actually stay in their apartments for the long term. Instead, the home they buy is merely the right apartment for the moment, until a better opportunity or a change in lifestyle warrants a new alternative.
Issue 2: Fear
The responsibility of home ownership and the magnitude of the decision can be intimidating, especially to those with no prior experience or with a negative experience.
Fear is a legitimate reason for not buying an apartment, especially considering the size of the investment and the potential risks. Almost everyone experiences some degree of anxiety when faced with the prospect of buying a home. Usually, however, lack of knowledge is what precipitates the fear and uncertainty.
Acquiring even a bit of knowledge about the advantages and disadvantages of home ownership can make you feel a lot more confident that you are making a wise decision. Performing a full “rent vs. buy” analysis will enable you to better understand the economic consequences of each alternative.
One mistake some buyers make is to seek a “needle-in-the-haystack” apartment that outshines all others. These buyers view literally hundreds of properties without making any offers. It is as if they are afraid to commit themselves because they believe that the “special one” is just around the corner. If you find yourself in this position, I propose that it would be wise to take a second look at apartments that you previously rejected. Consider whether there is a lower price, even if that price is substantially lower, where the apartment could meet your needs. If so, put in a low offer. Sometimes these bids end up in great deals. However, think about justifying your offer. Create an appropriate reason why your bid is a reasonable figure for the seller to consider.
A good exercise is to mentally create the apartment you desire and determine a price you would be willing to pay for it. Then, look in the newspaper. Is that price consistent with prices asked for comparable properties? Ask a broker if the apartment and price you are seeking is achievable. If the broker says no, ask him or her to give you supporting information. It is essential to be informed. Knowledge of the market will give you the confidence to put in bids in order to take advantage of opportunities.
Issue 3: Economic Trends
The risks and returns of buying a home may be viewed as less than ideal in light of current economic trends. I recall reading a newspaper article predicting that the real estate bubble was about to burst. The writer noted that prices were ridiculously high, and that any day the entire market would collapse. The writer was Alexander Hamilton; the era was the late 1700s and homes were selling for about $100.
Perceptions of inflated real estate values are nothing new. However, I would place my bet that real estate values will continue to increase. Consider this: according to bank rules for mortgage lending, up to 40% of your income can be applied to the cost of carrying a home. Therefore, for each dollar your salary increases, your ability to carry a loan increases by about forty cents. However, this is the cost to carry the loan, not the principal amount. The principal is determined by dividing this extra money by the available interest rate. For example, if the rate is 10%, this additional forty cents can support an additional loan amount of $4.00. Simply stated, for every dollar your income goes up, you can afford to borrow four dollars more. Do you know anyone who would be happy next year without an increase in their income? I don’t. More income equals more mortgage, which in turn equals higher values.
Add to this a declining supply: the number of new apartments currently being built in NYC is insufficient to replace the depleting housing stock of obsolete apartments. New York is experiencing a net reduction in dwelling units each year.
The conclusion is clear: even if everything stayed the same and supply and demand were in balance, the effect of inflation would naturally increase prices due to the leveraging effect of borrowing. However, supply is not keeping up with demand, and incomes are rising dramatically so the impact on prices is even more significant.
There’s no question that real estate values go through economic cycles. However, after every decline, prices have risen to more than they were at the high point of the prior cycle. Few investments have as good a long-term track record.
Issue 4: Life Objectives
Buying a home may be viewed as inconsistent with one’s current life objectives. Everyone has their own set of priorities. It’s not surprising that some people don’t look upon home ownership as one of their life objectives. The following are some key points these people should consider:
- A home is the epitome of security. It is the one place where you can feel safe from outside pressures and influences. In terms of personal growth and development, homeownership is frequently considered the “next step.”
- For most people, a home is the best financial investment they will ever make, one which will provide their greatest source of wealth accumulation.
- Many banks prefer to lend to homeowners rather than renters, because the real estate they own represents a significant and tangible asset which is valuable security. Presently, accounting rules require that the value of your home be listed on your personal financial statement at its current fair market value rather than its initial cost. This means that your home is accumulating tangible wealth in the form of increased creditworthiness without your having to sell it.
Home ownership provides many benefits beyond the obvious. If you believe home ownership is inconsistent with your life objectives, it is probably because you are not looking at all the possible opportunities owning a cooperative or condominium apartment can offer.
Issue 5: Liquidity
To some people, liquidity is like an insurance policy against the effects of future uncertainty. Using your available cash to buy a home may eliminate this protection. If the funds you’re thinking about investing in real estate are essential to maintaining your lifestyle, you should think twice. On the other hand, purchasing a home is often the first step toward creating wealth. You build equity both through your home’s appreciation and through yearly tax savings.
You can also use your home to get cash by means of an equity credit line. This is a bank line of credit which uses the appreciation you built up in your home as security for the loan. Funds can be borrowed and paid back at will, and interest is only charged on the balance outstanding. The rate of interest on an equity credit line is normally very attractive, and the interest charge is tax deductible as homeowner interest as long as the borrowed principal amount does not exceed $100,000. An equity credit line allows you to tap into the accumulated wealth in your home as and when funds are needed. Equity credit lines are available from most major banks or from mortgage brokers at no (or minimal) cost.
Rent or Buy?
Follow these four steps to do a “Rent vs. Buy” analysis. The question you will be answering is: On a monthly after-tax basis, is it cheaper to rent an apartment or to own an apartment? In order to answer this question, you must:
A. Select a prospective apartment to buy.
B. Select a prospective apartment to rent.
C. Determine the tax rate applicable to your highest-earned dollar by combining the federal rate with the New York State and New York City rates. Make sure to adjust your New York State and City rate by your federal rate, since state and local taxes are deductible on your federal tax return. To do this, multiply your state rate by (1.00 minus your federal rate). For example, if your income is $200,000 and you are married filing jointly, you are in the 36% federal tax bracket and the 10.6776% state and local tax bracket. This would compute to an after-tax state and local rate of 6.833% (This figure was computed by multiplying 10.6776% x (1.00 -.36) = 6.833%). Thus, you have a combined total rate of 42.833% (36% federal plus 6.833% state and local taxes after adjustment).
D. Find the maintenance charge on the apartment you have selected as a prospective purchase and determine the tax-deductible portion. You should be able to obtain this figure easily by asking the broker or the seller. In the absence of specific information, brokers generally use 50% of the maintenance fee as an approximation of the deductible portion.
Step 1. On a worksheet, write down the amount charged for renting the prospective apartment.
Step 2. Now enter the full maintenance charge for the prospective purchased apartment. Make sure you take the monthly amount and multiply it by 12 to come up with the annual sum. Then, put the percent associated with the tax deductible portion (consisting of the real estate tax and building mortgage interest as a percent of the gross maintenance payment) in a second column. Finally, multiply the yearly maintenance charge (gross amount) by the tax deductible percent to compute the Yearly Tax Deductible Amount.
Step 3. Multiply the proposed purchase price of the apartment by 75% (.75). This is the assumed amount to be financed. On the Debt Service Payment List (next page), select the interest rate factor that you think would be applicable to your loan and identify the yearly payment per $1,000 of loan. This yearly payment consists of the interest charge on the funds borrowed as well as the principal repayment based on a 30-year amortization schedule. Multiply the yearly payment per $1,000 of loan by the mortgage amount you calculated above (75% of the purchase price). This figure is your yearly loan payment, or Debt Payment. To determine the tax deductible interest amount, multiply the financed amount by the pure interest rate (the interest rate excluding any principal amortization). The product of this calculation is the Tax Deductible Amount. For example, if you borrow $300,000 at 10%, your annual tax deductible interest payment would be $30,000.
Step 4. Total the gross Maintenance and Debt Payment figures. Then total the Tax Deductible Maintenance and Debt Payment figures.
Step 5. Add the Federal Tax Rate and the State and Local Tax rates, adjusted for federal taxes, to determine the Total Tax Rate. Multiply the Total Tax Deductible Amount by the Total Tax Rate to arrive at your Computed Tax Effect. The Computed Tax Effect is the cash value of the tax deduction you received from ownership of the purchased property.
Step 6. Subtract the Computed Tax Effect, from the Total Gross Payment, to determine the After-Tax Ownership Cost. Divide this by 12 to determine the After-Tax Monthly Cost.
Step 7. Compare the Applicable Rent for the Apartment, with the Monthly Cost, Net of Tax, of Ownership. The difference between the two figures is the Difference, Rent vs. Ownership: Monthly Cost. If this figure is a positive number (i.e., the rental number is higher than the ownership figure), then ownership will cost you less each month than renting.
Debt Service Payment List
The monthly or yearly amount of payment per $1,000 of loan that must be made at varying levels of interest to fully amortize a loan over 30 years
Interest — Per Month Rate/Per Year Rate
- 7.0% — $ 6.66/$ 79.92
- 7.25% — $ 6.83/$ 81.96
- 7.5% — $ 7.06/$ 84.72
- 7.75% — $ 7.17/$ 86.04
- 8.0% — $ 7.34/$ 88.08
- 8.25% — $ 7.52/$ 90.24
- 8.5% — $ 7.69/$ 92.28
- 8.75% — $ 7.87/$ 94.44
- 9.0% — $ 8.05/$ 96.60
- 9.25% — $ 8.23/$ 98.76
- 9.5% — $ 8.40/$ 100.92
- 9.75% — $ 8.60/$ 103.20
- 10.0% — $ 8.78/$ 105.36
- 10.25% — $ 8.97/$ 107.64
- 10.5% — $ 9.15/$ 109.80
- 10.75% — $ 9.34/$ 112.08
- 11.0% — $ 9.53/$ 114.36
- 11.25% — $ 9.72/$ 116.64
- 11.50% — $ 9.91/$ 118.92
- 11.75% — $ 10.10/$ 121.20
- 12.0% — $ 10.29/$ 123.48
Advantages of a Rental Property
- No risk of ownership: The increase or decrease in real estate values is not an issue for renters, since they have no money at risk.
- Limited duration: Renters can limit the length of time they wish to stay in a property without worrying about selling it upon leaving.
- Broader service: Usually, more services are expected by a tenant in a rental property than by a unit owner. For example, in a rental, if appliances are in need of repair or the walls need to be painted, the landlord is usually responsible, while in a cooperative or condominium these are the responsibility of the apartment owner.
- Liquidity: The renter’s financial assets remain available for an alternative investment, which may have a higher economic return than owning a home.
Disadvantages of a Rental Property
- No economic gain: Real estate, over the long term, has usually proved to be an excellent investment, offering attractive economic returns and favorable tax treatment when the property is sold. This tax benefit is not available to renters.
- No tax advantages: The tax deductibility of interest and real estate taxes frequently make it cheaper to own than to rent.
- Aesthetic: Renters are usually reluctant to make significant improvements in their apartments since they know their investments won’t bring them any financial returns. Indeed, many landlords prohibit alterations of the property. Therefore, it is not easy to customize rental property to fit the lifestyle of the tenant.
- No permanence: A renter is subject to the terms of a lease, which includes limits on the duration of his or her occupancy. The tenant may have to move at the end of the lease term.
This article has been edited and excerpted from The Ultimate Guide to Buying and Selling Coops and Condos in New York City by Neil J. Binder (Nice Idea Publishing, 2001). The co-founder and co-owner of The Bellmarc Companies, Neil Binder’s cutting-edge information makes this guide indispensible for anyone looking to buy, sell, or relocate in Manhattan.