Housing market: to rent or to buy?

Last year discussions with friends centered around the rent versus buy decision. This year, hopes are fueled with conversations about purchasing that house given even lower prices. Has a drop in property prices made buying more lucrative than renting? Does economic logic today support buying rather than renting?

I stress on the term economic logic because reasoning based on personal preference has unmatched support in the society for buying property. Owning a property is etched in our tradition and possibly in many others. Personal preferences aside, whether you make an outright purchase or take a home loan, the economic logic does not support the buy option even today.

Do the math. Say you have just enough to buy a 3-BHK apartment. To the property price, add costs like stamp duty, registration and municipal taxes—an increase of about 8-10% to the total cost. Then, the cost of doing up interiors—it can be as little or as much as you like. In building complexes, there will be recurring monthly maintenance—more the amenities, higher the charges. If you opt to build your house, there are costs for the upkeep.

Now assess this against a rental property. Mumbai has a rental yield of 2.5-3%; your monthly rental comes to ₹ 20,000-25,000 for a property worth ₹ 1 crore. In Mumbai, the owner usually takes care of maintenance and structural repair costs. The lump sum you saved by not buying a house can be invested in equity mutual funds. Given an estimated annualized return of 12% (over periods of 10-20 years), at the end of 10 years even after deducting annual rentals (with an annual escalation of 7%) and, say, an initial deposit of ₹ 5 lakh, you will have around ₹ 2.6 crore. No taxes to pay, no interest repayment, no monthly maintenance. You get the drift.

Taking a loan? Consider this: for a 20-year housing loan for a ₹ 1 crore principal at 8.5% per annum, you pay interest of around ₹ 1.06 crore, more than the value of your loan. Plus, the costs and property taxes.

These figures are difficult to ignore. It’s low rental yields in large Indian cities compared to the rate of interest on loans that make renting economically more viable. Also, land prices have skyrocketed over the years, resulting in disproportionately higher cost per square feet in certain locations. Yes if you are an outright buyer (no loan), you are looking at gains from capital value. But if you are living in that house, you may never sell it. Plus, real estate is not a liquid asset. Lastly, we are having this conversation because the pot of money is limited and needs efficient allocation to create future wealth. If you have an uncountable surplus, there is little merit in such tedious assessments.

People have seen property value increasing 10-12 times in 15 years or so, thanks to the real estate boom cycle from the mid- 1990s or thereabouts. That is an annualized return of 17-18%. Truth is you would have made 20-21% average annualized tax-free return with an equity diversified fund for the same 15-year period. The 20-year average annualized return would be around 17%. We are not even touching upon lifestyle aspects of cutting back on expenses or being tied down to a job you don’t like just to pay interest; travelling long hours because you could only afford that house in that locality and so on.

There is pride in being an owner. Your own house will always come with a greater sense of achievement as compared to, say, your own mutual fund portfolio. But remove the rose-colored glasses and you will find it’s simply a triumph of emotional bias over pure economic logic, at least for now, till the equation turns.