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Rahul Surana

14 Sept 2021

Case Analysis #1: The American Dream

The Hanlons have a number of real estate options available to them in the current housing

market and their financial situation. Each comes with varied purchase prices between $250,000

to over $400,000, boasting various sizes, bedroom counts, and amenities. The first and current

living option available is to continue living in their current luxury apartment. The apartment

comes in at a modest $1,600 per month including utilities. It holds 1,000 square feet of living

space and comes with amenities such as a swimming pool, security, and an exercise room. They

also had built a community of friends living in the same complex. Additionally, the location is

convenient for both Lisa and Tom in terms of commute to work. On the negative side, the traffic

in the area was bad and continued to get worse. On top of that, the rent situation was not building

the couple any equity.

Another option is purchasing one of 400 townhouse units being newly built at Fairhill.

The purchase price is at an average $300,000 per unit, which is easily affordable by the Hanlons.

It would result in a low down payment and allow them to comfortably afford mortgage

payments. As an added bonus, the realtor claimed that the value of the units would appreciate by

20% in the first year, allowing the Hanlons to pull out their initial investment with added profit.

The living space, however, was considerably smaller according to Lisa. The location was

inconvenient and would add the cost of an extra vehicle to the equation. The finishes and fixtures

were also of lesser quality than their current apartment.

The next option the couple explored was Devonshire style homes adjacent to the

apartment towers in which they currently reside, starting at $300,000 and providing a lot of room
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for customization and upgrades. The average cost of purchasing one of these is approximately

$400,000 which is considerably higher than the other options available. The living space was

more than double that of Fairhill, however, coming in at 2300 square feet plus basement and

patio. The finishes and fixtures were also more up to par with where the Hanlons live now.

However, the property was located on a swampland and extremely close to the highway,

makingtraffic noise a considerable problem.

The final option the couple considered was a large home located on Maplewood Road.

The home was extremely spacious, boasting 3500 square feet of living space and four bedrooms.

The asking price was also well below the couple’s budget at $250,000. The home itself, however,

would need about $100,000 in additional work within the next year. The carpentry, painting, and

restructuring of the layout of the home was bound to take up a substantial amount of time, not to

mention maintaining cleanliness in such a large space.

The front-running factors mentioned for each property were square footage, asking price,

finishes, and location. Each came with its own set of negatives and positives driving the couple’s

decision.

The Hanlons’ combined net yearly income is $150,000. Assuming they intend to put no

more than 28% of that towards living expenses ($3,500 per month), the couple can afford a

yearly mortgage or rent of about $42,000.

The cash down payment can be done in a variety of mortgage structures. The following

analyses will be made using the Devonshire home assuming a $405,000 purchase price, 8.5%

interest rate, and a 30 year mortgage. The first and lowest option would be to utilize the

government First Homeowner Assistance (FHA) loan which would allow them to put down a
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mere 3.5% down payment. This is only available for the very first purchase of a home, so the

couple should utilize this low down payment if they have an option that keeps them under the

$3,500 monthly payment limit. The FHA loan would have them place a down payment (DP) of

$14,175 which would result in a monthly payment (MP) of $3,338 per month. While cutting it

close, this option would leave a modest $162 per month in the living cost budget for unexpected

expenses. The next potential structure would be to put down 5% and finance 95% of the

purchase. This would have them paying a DP of $20,250 and end up with an MP of $3,291. A

still comfortable DP and MP they can easily afford. Another option would be to kick it up to the

traditional 80/20 structure where the couple would put down 20% of the cost upfront. It would

result in a much larger DP of $81,000 and a MP of $2,824. While the monthly payment would be

considerably low, the DP is over 50% of their combined yearly net income which is not a viable

option. The couple should try to make the smallest down payment possible while still

maintaining a monthly payment below their budget, so the best option here is to utilize the FHA

loan and put down 3.5%.

There are a number of qualitative options the couple has to consider alongside just

numerical factors. These include square footage, cleaning, location, amenities (backyard/front

yard, patio, etc), neighborhood, commute, and potential gains to be realized when the house is

sold. The real estate decision will affect the couple’s lifestyle in that it could change their

comfortable morning commute routine, investment strategy, or change the community within

which they mingle. Investment profits, while an attractive feature, is something that must be

attributed to the unknown, as there is no way to guarantee against a marketwide crash or

depreciation of land and the asset. Future development of the area is also left to the unknown and

must be considered when choosing an option.

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My recommendation to the Hanlons, which will also be used as the base case in my

sensitivity analysis, is to purchase the Devonshire home for $405,000, with a 3.5% down

payment, assuming a 8.5% fixed interest rate. This would give them both a low down payment

and affordable monthly payment with a cushion for unexpected expenses.

One variable we can sensitize in this case is the purchase price. With $405,000 as the

base case, we can assume a margin of ±$20,000. At $385,000, the DP drops to $13,475, the MP

drops to $3,175, and my recommendation to purchase the Devonshire home is maintained. At a

lower purchase price, the couple is given additional room for extra living expenses. However, at

$425,000, the DP increases to $14,875 and the MP increases to $3,499. This MP would make me

change my recommendation to either putting more money down and lowering that amount, or to

continue living in the apartment until their combined net income rises. This way the FHA

opportunity would not be wasted. Another variable we can sensitize would be the interest rate.

While 8.5% is common, it is not guaranteed. Allowing a margin of ±0.5%, at a low estimate of

8%, the MP would drop to an affordable $3,200, in which case I would maintain my buy

recommendation. At a higher estimate of 9%, the MP would rise to around $3,477 in which case

I would revise my recommendation to either putting more money down and lowering that

amount, or to continue living in the apartment until their combined net income rises once again.

All in all, the Devonshire home proves to be a reasonable investment in the couple’s future and

building equity while maintaining their financial independence.