Would You Pay $225 a Month For This 900 Sq. Ft. Unit at 5th and Idaho in Santa Monica?
Ed used to rent in Santa Monica. He paid $225 per month on a modern 2 bedroom one bath North of Wilshire on 5th St. This was 1971. Ed looked at the possibility of purchasing a home that year North of Montana. It was a 2 bedroom 1 bath teardown on Georgina West of Lincoln. Selling price $55,000. With 7% interest rates in those days, and 20% down, the mortgage, property tax, and insurance would have been a whopping $351 per month.
Today that property, with a 2/1 teardown on it, would be worth well over $3,000,000. Ed could have purchased the property, done nothing to it, and paid it off as of 2001. Ed, who was 25 at the time, would have been rent free at 55 years old, and today, at 69, would not have had a mortgage or rent payment in 14 years.
Not all property appreciates that quickly. Ed looked at a new 3/3 townhome, in Culver City, at the same time as the home in Santa Monica. The cost was $49,000. So the monthly payments were only $320 including mortgage, property taxes and insurance. Today that townhome is worth $850,000 with a suggested rent of $3,500/month. If Ed had taken a loan in 2001 of $21,153 to repay his original investment plus interest from 1971 ($9,800 invested plus $11,353 of interest), and continued to have a mortgage payment plus adjusted property tax and insurance, his payment in 2015 would be about $240 per month.
In the Rent vs Buy decision, most pundits look at issues like current monthly cost comparison between renting and buying, transaction costs such as real estate and loan fees, and emotional benefits and detriments. But what about the very real issue of locking in your rent?
Rents go up about 3% per year. Nationally, rents have increased by 40% since 2000. If you bought the townhouse in Culver City in 2000, you would have paid $600,000. The monthly cost would have been under $2,000 then and maybe $2,300 now with increasing property taxes and insurance. Your locked in $2,300/month compares favorably to the current market rental rates of $3,500. In another 5 years that rent is likely to be over $4,000/month.
The value of the townhouse has also gone up by 41% since 2000, which is nice, but over the last 15 years that property has been as low as $533,000. So counting on the property valuation increase part of the rent vs buy equation can be problematic in the short term, should you need to sell in a down market. But… locking in your “rent” is generally going to be a great reason to buy over most periods in history.
What does this mean to you?
If you are ready to buy now, you can still capture crazy-low interest rates. If you are planning to stay in the home for many years, this will be a huge benefit over time. You can also make the purchase without worrying much about the affect of higher interest rates on the value or the potential resale.
If you really want to purchase, but you are not ready now, the potential interest rate increase will not likely make your monthly payment out of reach. But you shouldn’t hold your breath thinking prices would come down. The price increases are likely to continue, unless there is a recession.
If you are looking for an investment property for the long term, the obvious conclusion is that taking advantage of low interest rates makes huge sense. While property values are high right now and inventories or low, a sharp buyer can still find excellent investment opportunities.