2023

orporate Finance – Rent Vs Buy Case

SUBMISSION BY GROUP 3:
36BM05 ADARSH
36BM30 K.ABHINAV
36BM27 KHUSHBU
36BM22 HARSH
36BM52 SUDHANSHU
36BM49 SHASHWAT
1.0 PROBLEM STATEMENT

Rebecca Young moved to Toronto for a new job in an investment bank after completing her
MBA. She is in a dilemma of deciding on whether to buy a condominium or continue to live
in her rented condominium.
2.0 OBJECTIVES
The purpose of the document is to evaluate the present situation and the various scenarios
that may likely occur in the future and help Rebecca make a decision. The decision and
recommendation will be based not only on quantitative factors but also on qualitative
considerations.
3.0 CASE SOLUTION
 Assumption:
Some assumptions need to be considered to assess the case. In our calculation, the rent
growth rate (rental price inflation) was not considered, and we assumed that all the related
charges such as condo fees, repair costs and taxes remain the same, and we avoided the
general inflation rate for expenses. The total initial investment amount is considered
$140,000 (see Exhibit A1). To find the differences in her monthly payments, we assumed that
she withdrew the monthly interest from the investment account, and we did not compound
the interest. We did not consider rental price inflation, property appreciation and the general
inflation rate for all other expenses. Furthermore, we assumed that the bank does not charge
any prepayment penalty when closing the loan. Finally, we presumed she keeps aside $3,000
for housing fees (rent or buy) from other sources of income. Therefore, we used only the
additional monthly payment when calculating future gains or losses.
 Monthly Mortgage Payments:
Based on 4% APR semi-annual compounding, the effective annual rate will be 4.04%, and
accordingly, the effective monthly rate is 0.337%. Therefore, based on the 80% value of the
property, she should pay $2,544.23 as a monthly mortgage payment (see Exhibit A2).
 Opportunity Cost:
The return-on-investment rate is considered the same as the effective monthly rate of 0.337%.
Therefore, the one-month opportunity cost will be $471.33 (see Exhibit A3).
 Additional Monthly Payment (Monthly Expenses):
If Rebecca decides to purchase the property instead of renting, the difference in monthly
payment includes her buying expenses minus her rental payment. Her monthly payment in
case of purchase is $4,420.56, where her rent is $3,000. So, if she purchases the property, she
must pay $1,420.56 extra per month (see Exhibit A4).
 Mortgage Loan Principal Outstanding (See Exhibit B1):
Exhibit B1
Mortgage Loan Principal
Outstanding
 Interest/ Loan Principal Principal
Month Amount Paid Outstanding
Initial
At start 0.337% 480000.00 0 480000.00
After 2 years 0.337% 480000.00 23161.71 456838.29
After 5 Years 0.337% 480000.00 61603.11 418396.89
After 10 Years 0.337% 480000.00 136970.38 343029.62

 Net Future Gain or Loss

To find the net gain/loss for all scenarios, we will have to calculate the forecasted selling
price and deduct all initial payments and expenses, monthly difference payment, selling
expenses and the principal outstanding. For easier comparison, we could also revert the net
gain/loss values to their present value (see Exhibit B2-B5).
Scenario (a): As shown in Exhibit B2, when the price remains unchanged, she would lose in
2, 5and 10 years, $62931.73, $75630.49 and $85496.82 respectively.
Scenario (b): The condo price drops 10 per cent over the next two years, then increases back
to its purchase price by the end of five years, then increases by a total of 10 per cent from the
original purchase price by the end of 10 years; she would still lose $119931.73, $75630.49
and $28496.82 respectively. (See Exhibit B3)
Scenario (c): In case of a 2% increase annually, Rebecca would still lose $39903.73 in 2
years and $16304.43 in 5 Years. However, she would gain $39330.00 in 10 years and (see
Exhibit B4).
Scenario (d): Finally, as per Exhibit B5, if the annual increase rate is 5%, she would still lose
$4506.73 in 2 years. However, she would gain $81850.00 in 5 years and $272973.12 in 10
Years. It is evident that scenario (d), which is the most optimistic market growth forecast,
will be beneficial in 5- and 10-Year Projections.
 Conclusion:
Rebecca should consider that the mortgage payment is a recoverable cost, whereas a rental
payment is an unrecoverable cost. The unrecoverable costs when buying include property tax,
maintenance fee, general maintenance, mortgage interest and the cost of capital.
In addition, the net future gain/loss indicated in Exhibit B2-B5 depicts that given her
forecasts for scenarios (c) and (d), where she is expecting a gradual increase in property
value, she must evaluate the market value constantly and revisit her calculations.
When forecasting the property's value, Rebecca should also consider the general inflation rate
for expenses such as Condo fees, Property Tax, and General Maintenance fees, as these
expenses will probably increase based on the inflation rate. In addition, to have a better
comparison between rent or buy, she should forecast the rent growth rate (rental price
inflation) based on historical data.
Furthermore, the property's future value is significantly influenced by the local economy. As
a result, a recession increases the possibility of losing her job and being unable to pay her
mortgage and decreasing her chances of seeking employment in other regions as she may not
be able to afford to relocate. Renting provides greater freedom and flexibility than owning
since a tenant may move much more freely, and she could increase her investment monthly.
The disadvantage of renting a property is that the landlord may decide to sell it and may have
to ask her to vacate the property.
Additionally, while a 10-year fixed mortgage is the least risky mortgage option for securing
her against interest rate fluctuations, 10-year term fixed rates are often higher than shorter
periods (like 2 or 5 years). Therefore, she should assess the circumstances and, if she intends
to sell the house earlier, she should approach the bank for a shorter period fixed rate.