I have a wonderful question! We won the housing lottery in New York City (focused on keeping middle income people in the City) and pay $2,500 per mo (which we can afford) for a large apartment that fits (and will always fit) our family. The market rate for this apartment is $5,000 (which we could not afford). We would love to stay for the long term, but I worry that we are not investing in property and will not realize the gains that come from a real estate investment over the long term. Question: How should I think about the economics of this situation?

*Disclaimer. The following is not intended as investment advice. You should consult a financial advisor who knows the tax and real estate issues related to New York City as there are likely many factors to consider. *

First, congratulations on winning the NYC housing lottery. This is actually a bit of a tough one, because the one number we do not know is what the larger house is worth to you. Usually a “rent vs. own” question is comparing similar housing units where you consider renting (where all of your rental check goes to the landlord) versus a mortgage where part of your monthly check goes to the bank (interest) but the other part stays with you as equity in the house. In your case, though, you are paying half the rent on a larger unit than you otherwise could afford.

Let’s consider purchasing first. You say you cannot afford $5,000/month. You do not say what you could afford. But, if you cannot afford the rent, you couldn’t afford a $5000/month mortgage either. So, assuming that you could afford a $2500/month mortgage (same as your rent), here is what I calculated, with lots of assumptions so please seek a financial advisor who knows the particulars of the NYC housing market.

My assumptions.

Roughly $2500/month in mortgage. 30-year mortgage with a 7.1% rate (roughly the average national rate I found on several web sites for 9/11/2023). $7,000 in closing costs (national average, again based on my personal searches of lender averages). 20% down. I also considered $0 down, the results below are about the midpoint. This would get you roughly a $400,000 to $450,000 home in NYC.

That’s a small home in the NYC market–and likely an older one in need of repairs. But, what would you have at the end of 30 years? With no change in home prices, you would have $400,000 once the loan is paid off. However, it is more likely your home price will increase. Here are more assumptions I made:

The 10-year average, annual return on housing in NYC according to the Case-Shiller price index is 5.4% (https://fred.stlouisfed.org/series/NYXRSA. I used compound, not simple interest). So, let’s assume the $400,000 home increases in value by 5.4% a year for the next 30 years. Next, I will use the common rule-of-thumb that annual repairs are roughly 1% of the initial home price or $4,000 and I am letting them grow by 2% per year for inflation (the Federal Reserve’s inflation target rate, NYC may be higher than this, but probably not lower). Importantly, I did not include deductions for large repairs (new roof, leaking windows, new furnace, etc.) since I have no way of predicting that (but it is a cost that should nag you somewhat and over 30 years is very likely to happen). Mortgage Interest can be deducted from income taxes, but this varies by every tax filer’s particulars, so I assumed a simple 2 percentage point deduction in your mortgage rate: making your real rate 5.1% instead of 7.1%. This assumption has a lot of other fuzzy assumptions behind it, including whether you itemize your deductions and what your tax rate is. Using these and the mortgage assumptions previously, my forecasted price of the home after the loan has been paid off in 30 years and taking all of the other costs into consideration is roughly $1.8 million, *if none of my assumptions change*! If house prices go down, or a hurricane takes off the roof and you aren’t fully insured, or the neighborhood is not attractive to new buyers, the price could easily be less than that. It could be more, too.

That’s the easy part. The hard part to consider is what *utility* you are getting from living in a $5,000/month large apartment for half the rent? If you would pay $5 for a loaf of bread that only cost you $3, then you benefited by $2. If you go to a Taylor Swift concert and pay $200 for a ticket but for which you would have gladly paid $400, you benefited by $200. True, those benefits don’t go into your bank account, but they are real. Just because I tell you your smaller apartment might be worth $1.8 million 30 years from now, doesn’t make that real either. It is in your distant future, not in your current bank account. And, you have to sell the home to get its equity. Your larger apartment is likewise benefiting you in ways that are hard to account. But, do not neglect that. Put a price on it if it helps. Is it worth it to you to live in a smaller unit that you are buying just so in 30 years you might have $1.8 million? Using the calculations above, you will be giving up at least $2500 a month in better apartment living but probably you are giving up even more because the larger apartment is likely worth more to you than the actual payment–just like the loaf of bread or Taylor Swift ticket is worth more than its price. What is it worth in terms of nearby schools? Parks? Swimming pools? Transportation? Shopping? Nearness to work? Dog walking? Happier kids? Which apartment is best and what would I pay for these things? Think of all of those things and ask yourself, “What is that worth to me each month?”

But, I get it, the equity from owning is tempting. Mortgages build wealth, rent doesn’t.

You say you cannot afford $5,000/month for a unit of that size without the lottery. You say you can afford $2500. Could you afford $3,000/month? $4,000/month? If you can, then look at it this way. You could consider the money you could have put toward a mortgage, subtract off your rent, and invest the remainder elsewhere. Then you will grow equity you can see in your bank account while enjoying the benefits of the larger place. You might not be building property wealth, but you would still be building wealth.

Your question is tougher than the typical “rent vs. own” question because of the lottery. In the typical case, you are deciding on renting or paying a mortgage of approximately the same amount. Often (not always!) because of tax considerations and equity building, the owning pays off. However, you are getting half of your rent paid due to a lottery or, looked at differently, you are getting a much larger property and different amenities than you ordinarily could afford, at least twice as large in fact. Your choice is really do live in a small home that builds equity or a large home that doesn’t?

We all want to build equity. Property is only one of many forms of equity. I know I didn’t answer the question you came here with, but it really all depends on what that larger apartment is worth to you. There is no calculator for that.