Stedman Place Case Write-Up

Stedman Place Case Write-Up

1. Describe the Linton’s current dilemma, as well as the tradeoffs of owning versus renting.

Linton’s landlord is charging Beth and Jon a 20% increase to their current rent, so they are now contemplating whether to continue leasing at a higher rate or buying a similar home next door. Both work in the city and the couple will leave in five years to return to Northern California.  Below are the tradeoffs associated with owning versus renting:

Renting

• Benefits: Their current nest egg of $150K in treasury bonds has very little risk (since its backed by US government). Also, treasury bonds are more liquid than real estate investments, which could be an important factor considering the couple’s desire to move back home to California in five years
• Considerations: Because treasury bonds are a safe investment, the payoff is lower. The couple is relatively young and will be high earners due to their law and medical professions, so they are able to afford taking financial risks at this point in their lives

Buying

• Benefits: The house is located in what seems to be a good submarket given the close commuting distance to downtown Boston.  Further, the house itself seems to be of good quality, with three bedrooms, two bathrooms, state-of-the-art kitchen, and a deck overlooking a small yard. Perfect for young professional couples or families, which is something to consider when it comes time for Beth and Jon to sell the house or rent it out once they move back to California
• Considerations: There has been a softening in the Boston housing markets, with prices at an all-time high. Given the cyclical nature of real estate, the couple should be concerned about an upcoming housing bubble

1. Discuss the adequacy of the Linton’s down payment in light of their overall financial situation. How much do the Lintons need to earn per year to comfortably afford the ownership of 14 Stedman Place? Hint: Examine this on the basis of the recommended maximum 28% ratio of monthly PITI (principal, interest, taxes, insurance) to monthly gross income.

Using a 20% down payment, the Linton’s would need to make about $150,000 a year (please see below) in order to achieve their 28% ratio of monthly PITI (I included maintenance to this calculation; I don’t think they would want to defer maintenance and slumlord themselves). This seems adequate given the couple’s combined big law firm and residency salaries.

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1. What should the Lintons do? Should they buy or continue to rent?

Given that the couple is relatively young and both have high salary occupations, I would recommend they buy. I ran two calculations below. One is a liquidity analysis which shows the couple spends less money cumulatively over five years with the home purchase, and a returns analysis illustrating that the real estate investment achieves better returns than the treasury bonds.

Below, you can see initially that in the first four years, the couple spends less money by renting. However, the couple will ultimately spend less money by the end of their five years by buying. This analysis assumes the couple will sell their property at a 5.5% cap rate for $638k, a 50 bps widening from the implied going-in cap rate (you can see details of the real estate investment calculations below on page 3).