Buy or rent a flat- What makes financial sense?
Buying a home is often an emotional decision. Who can argue with a desire to have a roof over your head without having to think about paying the rent every month? However, paying EMI is equally big headache. Especially in current environment where job security is a thing of past. If one is a buying a flat for living in it, then one must do it after careful consideration. This article is not to dissuade you from buying your first flat but to just give an idea about its financial merit.
Real-estate as an investment option
Increasingly, younger people are buying flats purely from an investment perspective. If you have already bought a property for your residential purpose and thinking about buying a second flat for investment purpose, this article is for you. Most people think that real estate prices never fall. They always have an example where prices went through the roof as soon as their friend or relative bought it. Let me share my personal experience with you:
- The price of the flat I bought in NCR area is stagnant since 2012.
- The previous flat that I was renting in Bangalore, despite offering a very reasonable rate, the owner has not been able to find a buyer for more than a year.
- In Bangalore, the prices have not gone up in last 3-4 years in many areas.
- From my personal experience, I can say that builders rarely deliver what they promise, rarely deliver at the time they promise and rarely deliver at the price they promised.
- In past, the rapid rise in home prices, to some extent, was due to black money flowing into real estate. The crackdown on black money, implementation of GST will lead to reduced pace of black money generation. This will have significant impact on investor demand for real estate and its prices going forward.
While there are many problem with real-estate but the main problem is difficulty in selling your flat/home when you want to sell it at the market price. There is oversupply in most major cities and buyers prefer to deal with builders directly instead of buying from secondary market.
Hence, buying a flat is no-longer a no brainer.
Buying vs renting- What makes financial sense?
In the example below, we have two options.
Option 1 is to buy a flat. We pay 20% as down payment and remaining is financed through home loan at 8.5%. Now we also have scenarios where flat is ready to move in or possession will be given in 1,2 or 3 years. During the period possession is not given, we pay only the interest component of the home loan. Once the flat is ready to move in, it earns a rent every month. Rental yield has been taken at 2%, 3% and 4% of the price and then assumed to rise at 6% every year. We have also assumed a registration charge and other initial transaction charges as 6% of the property value.
Option 2 is to invest the same cash flow as above in equity mutual funds. We take three return scenarios of 12%, 14% and 16% from the equity mutual funds.
Finally, we look at the initial price of flat and calculate at what annualized rate it should rise to have a value that is equal to our mutual fund portfolio.
We have made some simplifying assumptions
We have assumed that the flat earns rent every month after it is handed over. We have ignored cost of furnishing, maintenance etc from our calculations. We have also ignored tax impact as largely the tax benefit on interest payment will be partly negated by HRA deduction for rented apartment.. Furthermore, buying a house just because of tax benefit is not a solid reason to buy a house. We have also assumed that interest rate on home loan remains 8.5% for the duration of home loan. We have also ignored the tax on selling the flat as this can be avoided by using the investment option or investing the proceeds in another real estate property.
In most scenarios, it appears that renting a flat is far better option than buying a flat as just to break-even, the flat price needs to rise by 10% or more. Such rise in real estate price is difficult over medium to long-term
Buying Vs Renting- What makes financial sense?
What rise in flat prices is needed to justify buying a flat?
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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