Macarena Yanez

A Student’s dilemma: Rent or Buy?

1. Create a decision tree outlining Scott’s Options.

2. What are the costs/income associated with Scotts decision each year over three years?
a. Rent inclusively, she pays only the tv/internet
If Scott rents an all-inclusive property, her yearly expenses will include her rent
payments and TV/internet payments:
Yearly Expense $ 510 rent $ 70 tv
s += x 12 months x 8 months
rent
[ month ][ month ]
Yearly Expense srent =$ 6,120+$ 560=$ 6,680 per year
Scott’s Bank Account beginning balance is $25,000. Each year, $6,680 will
be subtracted from this balance and 1% interest will be earned on the
remaining balance. For example:

Final Balance Year One =($ 25,000−$ 6,680) (1.001)=$

18,338 Final Balance Year Two=($ 18,338−$ 6,680 )
(1.001)=$ 11,670 Final Balance Year Three =($ 11,670−$
6,680 )(1.001)=$ 4,995
After renting for three years and assuming no yearly income as a full-time student,
Scott will have $4,995 left in her bank account. See the chart on the following page
for more detail.

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 b. Buy and charge rent inclusively (assume there are no additional closing costs)
If Scott chooses to buy a home and charge inclusive rent, her expenses and income
will greatly differ than if she had rented. The following charts show her yearly
expenses, her profit over 3 years, and then her profit after selling her house.
If Scott buys a house and rents it to friends for $550 per month per bedroom, she
will have $59,971.51 after 3 years as shown below. When she then sells the house,
and pays off her loan, her final profit will be $38,355.57 (see chart and calculations
on the next page).

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 Down Payment −$ 47,800
House Payment −$ 12,047.44 per year
Property Tax =1.4427 % x House Value ¿ Previous
Year Property Tax Year One=0.0014427 x $ 239,000=$
344.81
Property Tax Year Two=0.0014427 x ( $ 239,000 x 1.002)=$ 345.49
Property Tax Year Three=0.0014427 x ( $ 239,000 x 1.002 x 1.002)=$
346.19 Insurance−$ 1,200 per year
$ 6,000
Maintenance− =$ 2,000 per year
3 years
Hydro∧Gas=[ ( $ 130 x 4 mo.)+( $ 130 x 1.5 x 4 mo .)+($ 130 x 0.5 x 4 mo.) ]=$ 1,560 yr

Water Heater=$ 120 x 3=$ 360 per year

Hydro
/ Heater 20 % adjustment=($ 1,560+ $ 360) x 0.20=$ 384 per year
Gas
Internet ∧TV =$ 70 x 8 mo .=$ 560
3. What happens if the housing market is stagnate at the end of three years??
a. Depreciates
If the market is stagnate, Scott’s house value will be stagnate. If the house value is
the same in three years as when she bought it, the house value will technically have
depreciated because a dollar is worth less three years from now. The present value
of the house would be less than the value it was purchased at. Additionally, the
stagnate market could force Scott to sell at a reduced price to attract a buyer.
There is always risk in investment, and a stagnate market possibility is the risk Scott
will accept when she purchases a home.

b. Appreciated
If the market is stagnate, Scott’s home will not appreciate in value. What causes
appreciation? Most homes appreciate slowly over time, but key factors like location
(being in a town that is rapidly growing) or investment in
renovations/updates/remodels could result in appreciation of home value.

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 4. Based on a three-year time horizon, should Scott buy or rent? Why
Using only financial information, I would recommend Scott buy a house for the
three-year time period. The house is projected to increase in value by 2% each
year, with a final value of $240,436.87 after the 3-year period. If Scott charges
$550 per month to each of her friends for three years and then sells, she will end up
with a positive cash flow of $38,355.57 into her bank account. Her $25,000
investment will earn her a $38,355.57 return.
If Scott rents, she will slowly use her $25,000 in the bank to pay for her rent
expenses and the remaining bank balance will earn 1% interest each year. At the
end of 3 years, Scott would have $4,995 remaining in her account.
From a financial analysis standpoint, Scott should choose to invest in a new property
rather than spend money on rent that will earn her no returns.

5. If you were in Scott’s position what would you do? And Why?
If I were in Scott’s position and I were the age that I am today, I would purchase the
home. I recognize the profit that could be made from the investment and would be
happy to know that my living expenses over the 3-year period were leading me to a
positive cash flow outcome (rather than gone for good to rent).
If I were to rewind a few years and were a young college student, I am not sure that
I would make the “buy” decision. As a sophomore student, I don’t know that my
young self would be ready for the property management and stress involved with
owning a home and renting it to friends. The numbers look great, but the reality
would be difficult. My studies and grades could be negatively affected, and my
friendships could be strained – conducting business with friends or relatives is
different than conducting business with strangers. At times it can be difficult and
can lead to arguments that would otherwise not have existed. At age 19/20, I think I
would have decided to rent so as to ensure my focus was on school and not
property management.

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