Wednesday, January 21, 2009

World Without Appreciation

In a world where the value of a residential real estate purchase cannot include the anticipation of any appreciation, how might the condo versus TIC financial equation change?

Historically TICs were priced lower than condominiums in the City - until the real estate boom, in which case they approached some parity. (Meaning TICs were as outlandishly high priced as other kinds of residential property.) Now that we are back to earth (or at least falling toward some new and unknown terra firma) how does an investment in a TIC stack up against an investment in a condo? When I say an investment I don't mean how much money will you make (since those days are over as far as we can see), but how much money will you spend for the same priced TIC versus a condo.

Let's start with a basic calculation of mortgage costs, not including property tax, insurance, and association fees. We are going to assume the property costs $500,000 and the buyer is putting 20% ($100,000) down. We are also going to assume that our buyer is golden and can qualify for the best possible mortgage out there.

A condo buyer could finance a $400,000 mortgage at about 5.4% these days. The loan would be fixed rate with a 30 year term and 30 year amortization. (That means the mortgage payment would not change for 30 years unless the owner chose to refinance.) Monthly mortgage payments would be $2,246.12. After 30 years the condo would be paid off, at a total cost of $808,604.34 - $400,000 principle and $408,604.34 interest.

A TIC owner can get a fractional loan at about 7.25%. (That is just a ballpark. Fractional loan rates are not as widely published as traditional mortgage rates. Depending on the property the rate could actually be another quarter or half percent higher.) The 7.25% loan would be a fixed rate with a 5 year term and a 30 year amortization, meaning the owner would be required to refinance after just five years. Monthly mortgage payments would be $2,728.71. After 30 years the total cost of the loan would be $982,333.84 - $400,000 principle and $582,333.84 interest.

However, because the TIC loan only has a five year term, over the course of 30 years the TIC owner would (in theory) have had to pay closing costs five more times on his or her loan - because every five years when the loan termed out he or she would need to go back to the bank and re-apply. So let's add $15,000 more - $3,000 for each closing. (At least that's the way I understand it.)

I am thinking that in a world without appreciation all things being equal (square footage, location, condition and quality of the unit), a TIC should be priced at 25%-30% less than a condo. Or be at least 25% more spacious and fabulous.


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