Friday, July 27, 2007

Home - Buy or Rent??

For every educated aspiring middle class Indian home ownership is all about the attached pride that comes with it. I can just imagine having a nice little spot that I can call my own and preen when others go all gaga over small little embellishments that you have made to your living room and your own personal garden (sigh!). But then soon as we remember the phrase "middle class", realization dawns upon us and we set out to slog the hours of youth away in saving up for that all important initial down payment for the loan.

With hope in my heart I searched on the net about such discussions. I came across a very good illustration on the topic on rediff money. Here's the gist of the calculations:
  • Property value (now): Rs. 25,00,000
  • Rental value (now): Rs. 13,500
  • Rate of inflation: 5%
  • Increase in rent on a yearly basis: 5%
  • Investment return: 8% (that seemed a little low!)
Additionally the author has considered property tax, and lots of small things. In the end the net outlay on rent is Rs. 46,19,303 while if a person were to buy the house it would cost him Rs. 74,29,300 over the 20 year period.

I just added a small little stuff to the above calculation. Effect of investment of the difference amount in a investment opportunity that will earn me an effective rate of return of 12% (the author assumes 8%). Also consider that the rent goes up as mentioned above, but the EMI on the house loan (calculated to Rs. 22,022) remains same. So in the first year, the monthly saving would be Rs. 8,522 (Rs. 22,022 - Rs. 13,500). In the
  • 2nd year - Rs. 7827
  • 3rd year - Rs. 7138 and so on...
  • ... and becomes negative in the later years as the EMI stays constant but the rent keeps on increasing.
So compound all the positive and negative cash flows over 20, 19, 18 ... years and so on. I ran the numbers in an excel sheet and I came up with an extra Rs. 32,00,000 (approx.) at the end of the 20 years. And I think that's cool change. So the total thing adds up to the same in terms of valuation. But consider that in the rental scenario, you also have Rs. 32,00,000 as liquid cash whereas in the home buy scenario you have a home to call your own.

And that is what it all boils down to in the end. Human emotions. When you buy a home you are not effected by external factors such as increase or decrease in real-estate prices or corresponding rental. Also it serves as an important strategy in your asset allocation. Plus you tend to take care about your home and feel more comfortable with investing in whatever embellishments you want. But be aware that you need to pay for the electrical and plumbing jobs all by yourself as also property tax and lots of small things will need to be done on a regular basis, like painting it, etc.

On the other hand if it doesn't matter to you where you live, you are probably better off renting a place to stay. In case you find that the locality is not suitable to your mental makeup you can go ahead and change whenever you want. If you suddenly don't like the paint work on the walls of the apartment that you are living in, you can change. And no maintenance headache. Add to it that if you shift your job in the next 4-5 years and the property market does not rise, you are doomed to a loss considering all the taxes that need to be paid. But given the current real-estate market in India, where property and rental values have gone up 5-10 times in the last 3 years, you can make a killing of an investment.

In the end, buy a home because you are reasonably sure that you want to live in it for your lifetime. But don't buy a home because it can appreciate in value (as your broker might tell you) because you are going to live in it, and any appreciation is immaterial for you (unless you sell it and make a move). And all said and done, I will buy a house given the opportunity and when the time for such a decision arises.

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Besides the above article from rediff money, I also found an article in MSN Money. There are lots of discussions in blogs about the same.
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