On July 15, an area newspaper reported that the Somerset County Parks Commission Director, “…pays $500 a month for a $1.5 million historic colonial home on 25 acres in the Martinsville section of Bridgewater.” It also stated that there are 10 more homes rented to employees; another one is occupied rent free.
Should homes be rented to park employees? Let’s, for a moment, assume that the answer is yes – at least tentatively. The next question then becomes: What should the rental fee be? Is there an economic answer to the question? Yes. There are valid formulas for computing rate of return (or yield) on a real estate asset, based upon maintaining a proper relationship between the value of a home and its rent.
One of these formulas is simple and provides direct results. For example, let’s assume that a property in Bridgewater is worth $500,000 and is rented to someone at $2,000 per month: The yield to the owner is 4.8% per year.
Example #2: If the rent on this same $500,000 property is reduced to $500 per month, the rate of return to the owner plunges to 1.2%, an unacceptable return to the owner, under any reasonable business scenario.
Moreover, in order to keep these examples plain, none of the owner’s cost, such as grounds maintenance, upkeep, and taxes, if applicable, have been factored in.
In the next posting, you will see the results of a similar analysis for a home worth $1,500,000.
Note: Detailed explanations and spreadsheet formulas are not in this blog to keep it as brief and clear as possible.
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