Comparing Assessments – Part II

Let’s assume that after adjusting for all the factors in my earlier post on comparing Chicago condos with different assessments you are still left with a choice between two condominiums that have different assessments. How do you then factor in that difference – especially if the condo with the lower assessments has a higher price?

Let’s start with a simple approach for making that comparison, based upon an example where the difference in assessments is \$100/month and your mortgage interest rate is 5%. In that case the extra \$1200/year in assessments is approximately equal to the interest you would pay on an additional \$24,000 purchase price (\$1200/.05). In other words, for the same monthly outlay you could afford a \$24,000 more expensive home or buying the home with a \$100/month assessment is equivalent to spending an additional \$24,000 on a home. In fact, most buyers intuitively take this into account by looking at their total monthly outlay in terms of mortgage, taxes, and assessments.

That’s the basic concept. It gets more complicated (doesn’t it always?)

First, there’s the tax benefit of a mortgage. If your marginal tax rate is 25% then the after tax cost of mortgage interest is really 3.75%. So that \$100/month is really equivalent to paying an extra \$32,000.

But I’m not done. It gets even more complicated. Really complicated on this round. In fact, it gets downright scary. Let’s say you believe that your assessments are going to go up because of inflation – maybe 3% per year on average. Wellllllll….now that’s equivalent to paying an extra \$160,000 (1200/(.0375 – .03)!

OK. You’re not going to believe that and, while it’s accurate, it’s not totally correct so I better explain. The formula I used above is for what’s called a perpetuity. In other words, it assumes you are going to live there forever. Of course, that’s not true. In fact, you will either die (sorry, but it’s true unless you are a teenager in which case you believe you are immortal) or move before perpetuity comes. So what you really need to do is factor in the increases that will occur while you are living there using a technique called discounted cash flow, which is too complicated for me to get into right now but, in a simplified form, it’s actually the basis for all the formulas I’ve been kicking around here. Basically, it averages out the increases you are likely to experience while living in this place and it comes up with a number far closer to \$32,000 than \$160,000.

But here’s the point: an extra \$100/month really adds up over time and the longer you live there the more of a burden it’s going to become. So think twice about buying a place with a higher assessment unless it’s a lot cheaper.

Gary Lucido