INVESTMENT-WISE: IS THE PURCHASE OF HOUSE WISE?

There is a school of thought that believes it is better to stay on rent than buy a house. The logic is that purely from an investment point of view, a house purchase is a loss-making proposition and it is profitable to stay on rent. NAMRATA KOHLI writes


Who is wiser — the guy who bought the house he liked, or the guy who decided to take up on rent, the house he loved! From an investment point of view, a house purchase is not the best thing to do, or so believes one set of people.

The argument that supports renting accommodation treats a house as a liability and attributes several cost heads under the 'real' cost of housing like initial down payment, closing costs, initial upgrade costs, furnishing costs and upkeep, mortgage payments — principle, mortgage payments — interest, property taxes, insurance and maintenance plus brokerage at the time of sale. The cash flow in includes house price appreciation and the tax deductions. The returns are proven to be any day better, when you put the same amount in other financial instruments.

Dinesh Jain, an investor, says, "If you parked the same amount in other financial instrument, you would get far greater returns. But in reality, who cares about real estate market? Bull, bear or bubble?

When it comes to housing, we need it so badly and we base our decisions on pure emotions rather than rationality. Most of the time, we are told by media, books and friends, that buying a house is a great deal and renting is throwing the money 'down the drain'. But in fact, renting is a wiser thing to do from a return on investment point of view."

Krishnan Srinivasan, Infrastructure consultant, does a mathematical analysis of investment in a house worth Rs 1 crore. He says that one needs to compute the cost of the house at buying time, holding period and selling time. If you have plans to sell the house and there is an exit time for this project. Also there is a cost associated with it.

Krishnan, says: "If we do the calculation for a house worth Rs 1 crore and consider down payment as 20%, 5% as closing costs, 5% as upgrade costs, the loan amount would come to Rs 85 lakh. Assuming the maintenance at the rate of 0.25%/year, insurance at the rate of 0.25%/year, prop tax: 2%, brokerage at end of 30 years — 2% on sale value of house, upfront payment - Rs 25 lakh (Rs 20 lakh down payment plus Rs 5 lakh closing costs), rental income Rs 40,000/year with increment of 10% every

2 years and interest rate 9%.

"Assume that the house is not sold in between mortgage period; the house then would have to appreciate at least 9 times in 30 years for the houseowner to make Rs 1 crore in profit from this investment. If you invest the same in stocks and even get a return of 9% per year for 30 years (which is very conservative considering the economy rate of 9% now), you would make around Rs 13 crore! To get the same return from house purchase, the property would have to go up 24 times!

This is only possible if the house is bought at a very low rate and the area is developing rapidly (rule of thumb for such cases is property doubling in value roughly every 5 years). Now, when a little more finessing is done with 4% inflation, 30% tax rate, one finds that the house would have to appreciate 58 times to get the same post-tax return as a Rs 1 crore investment with a 5% real rate of return (about Rs 2.86 crore) and 30% tax rate. Rule of thumb says house prices double every 5 years — so, a house would go up by 64 times by end of 30 years theoretically. But this is rarely possible and depends on a number of factors."

In Delhi, and a majority of the cities in India, rental yields are less than 2-3%. Sharad Duggal , a Gurgaon-based professional, says: "Developed markets have rental yields of almost 5%, way higher than India and also 2% higher than inflation. Indian rental yields are just too low. With even fixed deposits promising 9%, financially rental is a far superior investment unless you firmly believe that the capital value will skyrocket soon, since demand is way less than the supply."

The primary reason for low rental yields may be that the capital value is in
a bubble, if we assume rental to be a true indicator of demand and supply. The big question is - will prices actually keep doubling? Can they? In the US, this myth was broken rather painfully, as reality struck realty. So, renting is definitely better than buying a property if looking at it as purely an investment.

But that is one side of the argument. The other is that capital values appreciate in India at a rate, like they do nowhere else in the world. Ashok Mehta, who stays in Dwarka, says: "I bought my house in 2005 for Rs 30 lakh and in six years the value has increased to Rs 1.25 crore. The rental value today that my house fetches is Rs 20,000, which is over 8% of the initial capital investment. If you were to factor in the rate of interest of home loan which I paid over last six years at 10% per annum, then it sums up to approximately Rs 11 lakh, still the capital value appreciation has been four times over."

In short, the capital value appreciation typical to Indian real estate market, is what bails out the homebuyer; the rider is that one should have a longterm horizon, a minimum 5-10 years!

Also, if you choose to invest in markets which are relatively new, the gains are many times over.

In India people do not buy for rental returns as that is minuscule at the rate of 2-4% — they buy for the capital value appreciation. Besides, there are intangibles associated with home ownership — security, stability and pride — which play an important role as well and which cannot be quantified.

QUICK BITES

DEVELOPED MARKETS HAVE RENTAL YIELDS OF ALMOST 5%, WAY HIGHER THAN INDIA AND ALSO 2% HIGHER THAN INFLATION. INDIAN RENTAL YIELDS ARE JUST TOO LOW. WITH EVEN FIXED DEPOSITS PROMISING 9%, FINANCIALLY, RENTAL IS A FAR SUPERIOR INVESTMENT UNLESS YOU FIRMLY BELIEVE THAT THE CAPITAL VALUE WILL SKYROCKET SOON, SINCE DEMAND IS WAY LESS THAN SUPPLY

IN INDIA PEOPLE DO NOT BUY FOR RENTAL RETURNS AS THAT IS MINUSCULE AT THE RATE OF 2-4% — THEY BUY FOR THE CAPITAL VALUE APPRECIATION. BESIDES, THERE ARE INTANGIBLES ASSOCIATED WITH HOME OWNERSHIP — SECURITY, STABILITY AND PRIDE — WHICH PLAY AN IMPORTANT ROLE AS WELL AND WHICH CANNOT REALLY BE QUANTIFIED
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