Question

You bought your house for $350,000 ten years ago and now it needs repairs (you pay property taxes of $3,000 per year). You consult a renovations company and it quotes you $40,000 to fix everything. You are thinking about simply selling your house (no repairs) for $425,000 and buying a bigger one for $610,000 (property taxes of $3,200 a year). You would be paying $1,100 a month in interest to the bank, but also collecting $800 rent from a tenant. In five years, you think you will be able sell your current house for $475,000 (with repairs completed). Also, in five years, you expect the new house to be worth $635,000. Assuming a five-year time frame, which is the better option for you?

Answer 1

To determine which is the better option, we need to calculate net outflow for the 5-year time frame for both the options.

Option 1 : Repair Current House and sell it after 5 years and then buy new house.

Outflows = Repair Cost + Annual Property Taxes + Cost of new house after 5 years.

= 40,000 + (3,000*5) + 635,000 = $ 690,000.

Inflow = Sale price of current house after 5 years = $ 475,000.

Hence, Net Outflow over 5-year time frame = $ 690,000 - $ 475,000 = $ 215,000.

Note : Purchase price of current house 10 years ago is a sunk cost and hence is irrelevant for our decision.

Option 2 : Sell Current house now and buy a new one.

Outflows = Cost of new house now + Annual Property Taxes + Interest

= 610,000 + (3,200*5) + (1,100 * 12 * 5) = $ 692,000.

Inflows = Sale price of current house now + Rent

= 425,000 + (800 * 12 * 5) = $ 473,000.

Net Outflow = $ 692,000 - $ 473,000 = $ 219,000.

Since, Option 1 has lower net outflow, it is better. Hence, better option is to Repair Current House and sell it after 5 years and then buy new house.

Note : Interest rate / discounting factor is not given in the question, hence impact of time value of money has to be ignored.