Million Rupee question “Should I buy or rent a house?” because in most of metro cities you can’t buy a decent flat which is under Rs 50 Lakh. In Real Estate series we have already covered “Indian Real Estate Bubble” & “Real Estate Affordability”. Today we are touching yet another sensitive issue or “Oh My God!” thing. If you have not seen movie OMG – let me share that people don’t appreciate & even stand against person who give different views than normal belief. Buying house is as sacred as praying to God in India & there must be lot of pressure if you don’t own one.

Disclaimer: I own a decent house & I am biased towards buying a house before retirement – 100% of my clients who don’t own a house are having this as a goal. But few questions are buying today or after few years – buying in heart of city or suburbs – buying in city where you are currently working or buying at native place or the place where finally you would like to live after retirement.

When buying a house is no brainer

• When house price are low
• Expected appreciation in property is high
• When interest rate is less
• When rents are high

We can’t quantify the numbers for above points but still most of the indicators are not in favor of home buyers. So it’s not a cake walk & you have to be much more prudent and do your calculation than people who bought properties in last 5-6 years.

House is a liability – Robert Kiyosaki

Robert Kiyosaki is a big fan of property investment but surprisingly he calls House a liability. Why – check this Video. You may not agree with his definition of asset & liabilities in this specific case but we can add another angle which will draw a line between house is an Asset or Liability or Need. Check this image & tell me who is wealthy.

The House which looks like a house from a fairy tale was owned by Michael Jackson, the second one which looks like an average house belongs to Warren Buffet.

• Michael Jackson was bankrupt as he bought a house which was a ranch and then made a zoo and an amusement park inside. His house was his biggest liability due to EMI &maintenance cost.
• While, Warren Buffet is still one of the wealthiest person in the world.

So you should know your limits – you should not overspend in buying house. House is not a show off thing. Make it comfortable to stay and not unaffordable to maintain.

Buying Vs Renting House

Coming back to our core agenda of today – let’s evaluate which makes more sense right now. Answer can be different for everyone so do your calculation or talk to your financial planner before taking final call.

I did some calculation using MSN Calculator – you can find calculator link after the screen shots. (ignore $ signs)

My Example

I have assumed rate of flat price increase at 5% – because I thought let’s not take it negative and scare the readers who are reading this. 🙂 You can take your own assumptions but if its higher than 8-10% – go & check HDFC chart here 1995 to 2012 (rate less than 5%). But if price double by next year don’t come running to me.

I have assumed both husband & wife are working and will be able to get maximum benefit by paying interest on home loan (section 24) – which is Rs 150000 each or Rs 300000 combined.  (In US 100% interest is allowed to be reduced from income for tax calculation purpose)

Comparison

Above calculation show that I am having marginal benefit in renting a house rather than buying. You can share your views in comment section.

Detailed Calculation

Buying Vs Renting Calculators

You can do your own calculations with MSN Calculator (ignore dollar sign) – You can also try The Wealth Wishers calculator – its excel based & Indianised – click here  (make sure to add ZERO in total amount of deduction for principal payment as we have n number of options for availing 80C benefit).

Views from Other People

Khan Academy who are pioneer in Online Education are having 2 videos on Rent Vs Buying

• Video 1
• Video 2 You can easily learn the things & apply on your situation.

Economic Times wrote

The case against buying becomes even more compelling if you are an investor, not an end user. The rental yield, which is the annual rent of a property as a percentage of its market price, has steadily dipped in urban areas. In overheated markets, it works out to merely 1-1.25%. In other words, a Rs 1 crore property will fetch a monthly rent of only Rs 8,000-10,000. Experts say that if the rental yield is below 4%, the investment is not worthwhile. This is especially true if the cost of capital is high. What you pay as interest on the loan will neutralize any gain from the property.

Srivatsan who added “Fools buy houses… Wise men live in them” comment on last post shared these calculations:

If house price is over 25 times the current annual rent you are paying, postpone buying the house!!!

For example, let rent paid = 9000 pm = 1.08lacsp.a
If cost of house = 30lacs, ratio = 30/1.08 > 25!!!

If buying a house for 30lacs @11% home loan rate and letting it for rent, then minimum rent should be 12500 pm!

Max 2.5 times your income should be overall debt to buy a home. If you are taking 30 lakh loan, your annual income must be atleast 12 lakhs!

Your total housing payment should not exceed 30% of your net income. To afford EMI of 30k pm, your net income should be atleast 100k pm!

Next Post: In last 3 posts we talked mostly about buying first house – what about if we are talking about investment in real estate. It’s human nature to play safe and not to indulge in risky matters & people thing buying property is the safest thing. Investment in real estate sector has different parameters to consider but basic concepts of return and risk apply in this domain also. I will cover this in next post.

I believe you must be having some idea after reading this post & using calculators. Anyways, last suggestion “take cool headed decision”. Buying a property is a huge decision where you invest what you have; you build liability and pay a part of your future earnings to claim the clear title. So your decision has to be well thought and well believed.

Last week I wrote “Indian Real Estate bubble – will it ever burst?” – People shared a common view that properties are unaffordable for common man & even prices are not going to come down.  Sunil summed it very well “It is quite sad and sickening that real estate prices have literally gone through the roof. A common man who wishes to have a roof over his head finds his dreams shattered. In the past three years, prices have shot up to the extent that a common man cannot even buy a small shelter even in far flung suburbs because of astronomical price. For all this mess, the government is to be blamed, which has done precious little to make housing affordable.”

In this real estate series this is my second post & will talk about “How much house I can afford?”.

Why it is important that affordability should be measured?

There can be two purpose to buy real estate – either for self-occupying or investment purpose. In first case it is goal & in second case it is a means to achieve some goal. When we are talking about affordability we are talking about self-occupying and that too first property.

It is important to know this number because it will have significant impact on other goals – for example:

• If you have locked big amount in home then lesser amount will be available for other goals.
• You will be asset rich but cash poor.
• If EMIs are on higher side how you will save for other goals which are even more important.
• If you need decent income after retirement will you be prepared to sell your house & move to a small apartment? It will be tough to change as the lifestyle at that point of time will make this compromise tough. Also will your family support this kind of decision?

So now you understand that buying house is an important decision and should not be taken in haste.

Indicator of Real Estate Affordability

There are a couple of indicators but the simplest & which is most commonly used across the globe is “price to income ratio” – property prices are compared to after tax income.

In India we don’t have any accurate statistical data – anyways, we have this Australian data of last 5 decades.

Few important points that it throws:

• Properties can stay unaffordable for fairly long period 🙁
• Interest rates & government policy towards housing sector plays a  significant role in real estate prices.
• Affordability is related to income – property price can be called cheap if EMI is less than 37% of income & affordable if it’s under 50% (these are Australian standards & can be different from India)

Australian numbers are scary for any person who doesn’t own property – let’s check Indian numbers.

Indian real estate affordability Index

Indian Government does not provide any long term statistics – couple of years back national housing bank started providing some data but that is not sufficient to reach any conclusion. Best data available to check affordability is from HDFC Ltd – leader in Home Loans – I am not sure about the reliability but will still consider the same as something is better than nothing. This data can be found on their website – investor presentations.

Myth Busted: Property price don’t correct/crash

Above image clearly shows that property price correct & even it can have deep correction of 50%. This data shows that if property was priced Rs 26 Lakh in 1996 the same property was available for Rs 13 Lakh in 1999. Prices remained flat from 1999 to 2004 & starting 2005 it is in bull phase. So please stop predicting that prices will never correct.

Few more points – assuming this data is reliable:

• Property prices not even doubled in last 16 years – this means rate less than 4.5% which is much lower than even FD rates.
• Prices tripled in last 8 years which is clearly a bull run – which means 15% CAGR.  Last equity bull run started in 2002 & ended in 2008 beginning – in 6 years Sensex went up by 7 times or 38% CAGR.
• Affordability number is more or less flat in last 12 years – which is close to 5 times.
• If we assume 1995 was peak of last Bull Run – but that matured when affordability hit 22 so what are we heading towards??

I know you have lot of interesting points to share on the above data & my analysis – feel free to add that in comment section 😉

Can I afford a house at current prices??

Question is not about current prices but it is the number that should not impact complete financial life – negatively. Some time back I wrote “Financial Planning Thumb Rules” where we talked about this magic number but for most of readers it was unacceptable number. Rule is…..

“The value of house should be equal to 2-3 times of your family annual income. So if you & your spouse are earning total Rs 20 lakh – you should buy a house in Range of Rs 40-60 Lakh.”

And if we stick with this – normal person can’t buy property in Australia or India. HDFC Ld shows average price is 5 times of income in last 12 years so should we put this as Indian Standard??

Another rule that should be followed while purchasing property is Home EMIs should not be more than 28-30% of net income & total EMIs should not be more than 36%.

Let’s see one Example:

But don’t take this rule as final verdict – go here  and read points shared by Mudit & Rohan Doshi.

Is buying a house the only choice – we will check this in next post.

If you have any questions & suggestion – add them in comments & I will try to cover that in next posts.

Most of the people are of the view that in India real estate prices will never come down due to a number of reasons including demography, the shift of population from villages to cites, increase in earnings, economy growth and the biggest reason that lot of black money that is generated through corruption is finding its way in Real Estate. So people who don’t own property are asking out of frustration that “will the Indian real estate bubble ever burst?” – “will we be ever able to afford a decent property for our family?”.  OR they should take a plunge at whatever rate they are getting? Let’s try to touch few related issues…

This is just the first in a series of articles – the next post will talk about the affordability of a property.

Check – Importance of Financial Planning in Your Life

My friend bought some plots in 2005 at Rs 1800 per square yard sold it in 2011 at Rs 13000 per square yard. From sale proceeds, he bought another plot at Rs 6000 per square yard & in less than 2 years price in that area is Rs 15000 per square yard. It means in 6-7 years his money has grown 16-17 times or 55-60% CAGR. Do you think he is a genius? YES, if I don’t share this story… One of my clients bought some property for Rs 25X & now it is valued 300X in around 3 years so 12 times or 120% CAGR. So do you think he is a genius? Yes if I don’t share this story… one of my relatives bought some agricultural land for 7X and now it is quoted at 100x in less than 2 years so 14 times or more than 250% CAGR.

Bull Market Vs Genius

You must be listening to similar stories from your friends, relatives & property experts on media. But the question still is – are they genius? Maybe…. It’s important to understand that everyone makes money in a bull run if he participates in that asset class – my neighbor told me that value of my house has tripped in the last 4 years. So one should remember that it’s because of the bull market they are making money & price increase should not make them insane. Something similar happened with equity investors in 2007.

But in all the above examples, people have started feeling that they know what will happen next & which makes me worried. A friend is saying soon one new road will be connected to that colony & price will be Rs 20000 per square yard, the client is saying when I can earn 100% from property why should I continue my business and relative has already converted all his financial savings in real estate & now planning to take a loan to buy more. Again the question is – are they genius? The answer is NO….

Predicting future price

Some Indian real estate reports recently said “The real estate sector will continue to remain an attractive investment destination with the possibility of prices in residential areas appreciating by 91 to 145 percent in select cities over the next five years.”

Their predictability of price reminds me of various reports published in Dec 2007 “close to budget SENSEX will be 25000”. OR dialogue from movie BORDER – Pakistani soldier after arrest “humain to yah bataya gaya tha subah ka nashta Jaisalmer main, lunch Jodhpur main & dinner Delhi main hoga” 🙂

Indian Real Estate Bubble

So should I want to say Real Estate price increase is actually a bubble? And if it’s a bubble – Warren Buffett said “For every bubble, a pin awaits”. No because I can’t predict anything & second is related to size of bubble which you can easily understand from Carl Richard’s image.

Read- 15 Ways To Save Money on Holidays

He said “The supposed ability to spot bubbles is just another way of talking about market timing. Market timing, while not impossible, has certainly proven to be highly improbable.

One of the big problems with some of the recent bubble spotting methods is that they work perfectly, just so long as you’re looking backwards. Many of these techniques are based on extensive research that relies heavily on back-tested models.”

But someone has tried to predict the Indian Property Bubble – from Wikipedia “Economists have expressed the opinion that the property market in Indian cities is in bubble-state and is expected to burst by November 2014.”

Another Story “India’s property prices- now falling, in real terms”

Recently, Indian property price increases have slowed sharply. Of the 15 major Indian cities covered by the NHB Residex, nominal house prices rose in 9 cities and fell in 6 cities during the year to end-June 2012. However, when adjusted for inflation, house prices fell in more cities (11 cities) than rose (4 cities).

This means that every property or real estate piece does not grow at the phenomenal rate, if you see in Mumbai & Bengaluru the prices have almost stabilized. And “stabilization” for real estate developer means a recession because he is not making more number of deals. Also an indicator to check is demand vs supply phenomenon in the city. If a city is already flooded with projects in city center vicinity, why will someone plan to live in suburbs? So if demand is met, the oversupply will crash the price. Just read somewhere that 65% of the properties in Delhi NCR & 35% properties in Mumbai are in hands of speculators. Does that indicate something – no because no one can predict size of bubble. (even if its there) Check real estate bubble 2021 burst of US & Japan.

Manshu shared his views on Onemint “Thoughts on Indian Real Estate Bubble”  – sometime back he also contributed a guest post on TFL “4 Lessons from real estate crash in US”

Big Myth: In India Property Price will never come down – will discuss this in next post.

If you have any questions or points add them in the comments – I will try to cover your points or concerns in the next post.