Transcript Physical Capital - University of Utah

Physical Capital Tangible goods purchased by the
household that are used up over
time. Such durable goods may
serve as an investment or means
of storing wealth.
Largest Physical Capital Investment
Made by a Family is a HOUSE.

Home Ownership rates 2006:
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US = 68.8%
Utah = 73.5%
Since 1900, home ownership has been in
excess of 40% in the U.S.
Source:
http://www.census.gov/hhes/www/housing/hvs/annual06/ann06t13.html
The Percentage of Families Owning Homes
Over Time
%
70
64.4 64.2
61.9 62.9
60
67.4 68.8
55
50 46.7 45.7 45.6 47.8
43.6
40
30
20
10
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2006
Housing appreciation
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http://www.ofheo.gov/hpi.aspx
http://www.ofheo.gov/hpi_state.aspx
Housing Prices are determined by
Supply & Demand
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Demand
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Average household size down
Average income up
Availability of substitutes down
Life cycle stage of housing
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Childhood home, apartment, starter home, family home,
empty nest home, retirement home, institutionalization
or back to family, burial vault
Supply
–
Business cycle
Benefits associated with purchasing a
home...
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tax benefits - deduction of mortgage interest payments and
property taxes from income for federal tax purposes.
appreciation - during the past 40+ years because demand has
grown at a faster rate than supply.
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vary considerably across time (near zero in 1965, 18% in 1980, 4% in
1988, 11% in 2004)
vary by geographic location
forced saving - portion of mortgage payment that goes
towards building up equity.
reduction in risk of future housing costs. (PITI)
Costs associated with purchasing a
home...
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depreciation - the wearing out (or using up) of the home.
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Can be off-set with regular maintenance -- but this is also costly.
opportunity costs of having money tied up in the purchase of
the home.
property taxes and insurance costs
risk that market value of the home may decline in the future
fixed costs of the purchase - i.e., one time closing costs.
A Cost-Benefit Approach (CBA)
to the home ownership decision
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Is it better to own a home or to rent?
The CBA of home ownership answers the
question:
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how much will I have to sell my house for at the
end of the time period, in order to get back the
dollars I spent (e.g., to break even)?
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What money do you need to get back?
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1. What is the time period over which the household plans to
own/rent?
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2. What are the one-time fixed costs associated with
purchasing the home?
– down payment
– closing costs (e.g., points, fees)
–
Do you pay these costs if you are renting?
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3. What are the recurring (i.e., monthly) NET costs associated with
owning compared to renting?
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How much more does it cost you to own than to rent every single month? You
want to get that money back at the end…
Sum of owning costs (mortgage payment, property taxes, hazard
insurance, operating and maintenance expenses) minus tax savings
– Sum of renting costs (rent, operating expenses)
4. What will the outstanding loan balance be at the end of the time
period?
–
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You have to pay off your loan when you sell
5. What will the estimated selling costs be at the end of the time period?
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You need to pay a realtor, and you want to get those dollars back
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6. Place all of these costs into future value dollars using 3% real interest rate
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Remember, all of our dollars have to be at one point in time – we are putting all of our
dollars in to the future
One-time costs (because these costs are one-time costs):
FV=PV(1+r)n
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Recurring costs (because these costs happen every single month):
 1  r n  1
FVA  PV
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
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r


Loan balance (already in future dollars; do not need to use a formula):
Selling costs:
Add up the one-time costs, recurring costs, loan balance, and selling costs, for the total
costs expressed in future value terms
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This equals the minimum required future value of the home, or the break even price
This is how much you have to sell your home for in the future in order to get back all of the
dollars that you have spent
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7. Compute the interest rate
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This interest rate is the annual rate of appreciation
that will have to occur if you are to break even on
purchasing a house rather than renting for n years.
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This converts the dollar amount into an interest rate, so
that you can compare your housing investment with other
types of investments
1
 FV  n
r 
 1
 PV 
DECISION RULE -
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If the forecasted rate of housing appreciation is greater than
the calculated interest rate, then economic benefits of home
ownership outweigh the economic costs.
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So, buy the house
If the forecasted housing appreciation rate is less than the
calculated interest rate, then the economic costs of home
ownership outweigh the economic benefits.
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So, rent
Example –
write on the same page of notes
(pg. 239)
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Original Purchase Price = $100,000
1. Time period = 8 years
2. One-time fixed costs:
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3. Recurring Net costs
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Down Payment = $10,000
Closing Costs = $3,000
Total = __________
Sum of owning costs – tax savings = $1200
Sum of renting costs = $900
Net Costs = $1200 - $900 = _______
4. Loan balance: $81,900 (get from amortization table)
5. Selling Costs: $6,000
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6. FV of one-time
costs =
FV=13000(1+.03)8
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=$16,468
FVA of recurring costs
(with monthly
compounding) =
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= $32,504
 1  .002596  1
FVA  300

.
0025


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6. Now, add up all of the future costs:
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FV
FVA
Loan Balance
Selling Costs
= $136,872
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7.
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= 0.04 or 4%
1
8
 136,872 
r 
 1
 100,000
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Decision =
if forecasted housing appreciation rates are
higher than 4%, you should buy this house