At current real estate prices, should you rent or buy?

Should you rent or buy a house? Many young families face this decision when they move out of the joint family to be on their own or when they shift to a new city for work. Notice that this is not an invest-or-not question, to which the answer will be very different. This is a should-I-rent-a-house-that-I-will-live-in or should-I-buy-now question. For others already on rent, the family conversation about ‘rent or buy’ comes up each time the math is done on how much rent flows out of the family budget each month. “If we had bought our own house, we’d be owning it soon rather than all this money getting wasted in rent” is something most renting families stress over. I’ve had this conversation at home many years ago; especially when money is tight and the growing family’s needs are many, the rent vs buy decision seems even more crucial. Why not put money down for something you will own rather than down the drain in rent?

If real estate markets were efficient, there should be almost no arbitrage between the decision to rent a house or buy it. The rent and the equated monthly instalment (EMI) would be not all that far away and you would be able to stretch just a bit to compensate for the mortgage cost to turn the rent into an EMI. But real estate markets in India are far from this utopia and follow no rational rules for valuations for residential real estate. At current market prices where the rental yields (annual rent divided by value of property, or the return you get from the asset if you were to rent it out in percentage terms) are just 1-2%, renting is clearly better than buying. Look at it this way— what you can rent for Rs25,000 a month will cost you at least Rs1.2 lakh in EMI in Delhi and Mumbai.

The need to buy a home rises from the need for stability, a permanent address, a roof over your head and ownership pride—the priceless joy of sticking a nail into any wall at any place you want. But don’t discount the joys of renting either. It costs a fraction of the EMI, you can uproot and move at short notice for work, due to a bad neighbourhood, bad neighbours, for the kids’ school, or to shift into a larger house.

Let’s work on some road rules for the buy vs rent decision. Buy the house today if you plan to live in it for at least 15 years. Look at this calculator to see when it makes sense to buy and when to rent. Many of our let’s-buy-real-estate calculations are made on the premise that real estate prices always rise. We take a 30-year absolute return—Rs20 lakh turned into Rs2 crore—and get really impressed, but forget that as an average annual return, this is a pre-cost and -tax 8% per year return. We forget that real estate prices typically move in 10-year cycles of bull and bear markets. Currently we are in a bear market cycle in real estate with an added price drag on the back of a structural change in the sector due to the setting up of a real estate regulator through the Real Estate (Regulation and Development) Act, 2016, the Benami Transactions Act, the anti black money focus of the government and the use of Aadhaar to go after assets that are disproportionate to income. Real estate as a sump of black money could sustain prices that were far ahead of their true valuations and it is unclear if residential real estate prices will recover even after the 10-year bear market cycle comes to a close in a few years. For people who buy hoping to flip the home for a profit, the numbers don’t add up for this strategy today.

Don’t buy a house but go on rent if you are planning to continue living on rent and then hoping that the rent from the bought house will cover part of the EMI. You do this because what you can afford to buy today and where you’d like to actually live are two different places in terms of price. But given that rents are about one quarter of the EMIs today, this strategy does not work out. The added cost of the stamp duty, broker's fee, building maintenance cost and the double burden of rent and EMI can be too heavy to bear. Also, you are exposing yourself to a financial disaster due to a job loss or illness to do this financial juggle. Remember that you should not be spending more than 30-40% of your monthly take-home as EMI. 

Don’t buy and stay on rent if the rent does not cover even 60% of the EMI. At current rents and EMI levels, rents are covering less than a quarter of the EMI in many locations. So either rents will go up or property prices will fall for the rent to EMI ratio to become better. Stay on rent and accumulate the down payment so that the EMI is lower when you decide to buy. How to do that? Live on rent, save a part of the money you’d have spent on an EMI and gather at least some of the down payment to reduce the EMI burden when you finally buy a house a few years down the line. Back of the envelope numbers say that if you rent for Rs30,000 and put another Rs30,000 a month in a balanced fund with a conservative return expectation of 8% a year, you will have around Rs22 lakh in five years. Renting will not seem like money down the drain if you have a larger plan in mind—that of buying the house you want to live in at a price that does not destroy your financial stability.

Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint and on the board of FPSB India. She can be reached at monika.h@livemint.com.