Should you buy or rent? That depends

Representative image.
Representative image.

Summary

Financial influencers on Twitter would like you to rent a house. Their arguments are simplistic

Where were you?" he asked.

“Oh, mummy ji had called," she replied. “The signal here was weak, so I stepped outside to talk to her."

“An early morning call from her is never good news. What did she say?"

“Well, she was saying that we should buy a flat. This living on rent was a waste."

“Ah, the usual."

“Not really," she replied.

“Why?"

“Because this time she offered what she thought was financial logic."

“When emotion stops working," he said. “So, what was this logic?"

“It seems the rent that we pay every month is going waste, given that we are not using that money to create an asset out of it. On the other hand, if we pay an EMI towards a home loan, we will end up owning a flat and create an asset."

“I had never thought about the issue in this way," he said. “Guess for once she makes sense."

“She doesn’t."

“Doesn’t?"

The math

“Take this flat that we live in. We pay a rent of 20,000 per month or 2.4 lakh a year. The market price of the flat is around a crore. If we were to buy it, we would also have to pay a stamp duty of 6%, which means a price of around 1.06 crore."

“Ah, maths early in the morning," he said.

“So, we pay 2.4 lakh to live in a flat that would cost at least 1.06 crore. This means the rental yield is 2.3% ( 2.4 lakh divided by 1.06 crore expressed as a percentage)."

“Where are you going with this?"

“Now, let’s say we decide to buy this flat and take on a home loan of 80 lakh. Further, we offer 20 lakh as a downpayment and 6 lakh as stamp duty. So, we need to pay 26 lakh from our savings. There is a cost attached to all this."

“Of course, an EMI will have to be paid."

“Let’s say we pay an interest of 9% per year for a home loan to be repaid over 20 years. The EMI on this works out to around 72,000 per month, or around 8.64 lakh per year. Also, there is an opportunity cost of making the down payment and paying the stamp duty."

“What opportunity cost?" he asked.

“That amount of 6 lakh could otherwise continue to remain invested and thus earn a rate of return. If we were to invest it in a fixed deposit at the rate of 7% per year, we will earn an interest of 1.82 lakh on it. We add this to the 8.64 lakh EMI and the total amounts to 10.46 lakh."

“I can see where this is going now."

“So, we pay 2.4 lakh to live in this flat right now. In order to own it, we will end up paying 10.46 lakh. Of course, the interest of up to 2 lakh paid on the home loan can be deducted while calculating the taxable income. That should bring down the cost of owning this flat to slightly less than 10 lakh for a while. Further, we will no longer have to pay rent."

“Which is why the idea that we aren’t creating an asset out of paying rent basically doesn’t make any sense," he said. “So, this means that it doesn’t make any sense to buy a flat?"

Representative image
View Full Image
Representative image

Nine reasons to buy

Now when did I say that?" she responded.

“You just did."

“Not at all. I was just trying to show that mummy ji’s theory doesn’t work."

“So, does it make sense to buy a flat or not?"

“It depends."

“On whom?"

“The family buying it."

“Like how?"

“Well, there are quite a few advantages if one is buying a flat to live in it."

“Tell me."

“First, one does not have to live in the insecurity of having to vacate when the rental agreement runs out."

“Yes," he replied. “Thankfully, this time around, we managed to sign a three-year agreement."

“Second, families with children need some stability. Children need to continue going to the same school. Have a set of friends. And so on."

“Makes sense."

“Third, the same applies to retired parents, if they live with the family. They also need their stability, a set of friends, a family doctor they can visit on a regular basis, and so on."

“Yes. And the feeling that their children are settled in life."

“Fourth, every time you change a flat, the address proofs need to be updated. And that can be a real pain."

“I haven’t forgotten the last time; you totally dumped it on me."

“Fifth, in a rental flat, one has to live with the idiosyncrasies of the landlord and many societies treat tenants as second-class citizens."

“Oh yes. Every Saturday the landlord turns up and he wants stock tips."

“Sixth, single people have a really tough time looking for a flat."

“Don’t remind me of that. I have some real horror stories. Once, a landlord asked me what do I do with chicken bones that remain after eating. "

“Seventh, every time you rent a flat you need to go through an agent. That means paying a commission. Now with the internet there is some chance of dealing directly with the landlord. Nonetheless, the best flats are still with agents."

“That’s so true."

“Eight, during the process of searching for a new flat, you have to go through a set of prospective landlords, who may judge you for everything, from your eating habits to your religion."

“Indeed."

“Ninth, so many landlords expect a portion of the rent to be paid in cash. In the process, our hard-earned money gets converted into black money."

“Now I almost feel like buying a flat," he said. “Your arguments are spot on."

Five reasons to rent

Hold on dear," she said. “I have counterarguments to these arguments."

“So, bring it on."

“First, as I have already explained, there is an opportunity cost to buying a flat."

“That you have."

“Second, clearly, our young and restless lives will come to an end."

“As in?"

“I mean, eating out every weekend will no longer be possible. Ordering dinner at the drop of a hat will have to stop. You will have to go slow on buying clothes. And me on buying books."

“Yes, because we will have to pay the EMI," he said.

“Third, if we want to buy this flat, we will have to really stretch ourselves financially. The other option is to buy something cheaper, but then that would mean moving away from this central locality which will lead to both of us having to travel longer to get to our workplaces."

“Now, I hadn’t thought of that," he said. “Basically, one can afford to live in a better locality on rent than one will be able to do while owning the flat because one can earn enough to pay rent but probably not earn enough to be able to pay the EMI."

“Fourth, as and when we buy a flat, then our families will want us to get to the next level of being settled in life."

“You mean have a baby?"

“Yes, and I am not ready for such a huge responsibility."

“Neither am I."

“Fifth, both of us have ambitions of doing a PhD in a few years. Hence, I think it makes sense for us to be physical asset light, until we figure out where we end up with our lives."

“But we can always sell the flat, if and when we decide to do a PhD," he said.

“Yes, we can. But selling a flat isn’t always easy. It takes time. Plus, by the time we get around to selling it, there will be an emotional baggage involved and two sets of parents who will be after our lives to not sell it," she explained.

“That makes sense."

“It has to. I have really thought through this."

Twitter debates

You know, I have been following this debate on Twitter where people are arguing about buying a flat versus renting it and investing money through a systematic investment plan (SIP) in equity mutual funds (MFs)."

“What about that?" she asked.

“It seems it makes more sense to rent a flat and invest the difference—between the prospective EMI if one decides to buy that flat and the rent of that flat—in equity MFs, through the SIP route."

“Hardly surprising. If you look at the RBI House Price Index, it has given a return of 9.6% per year from its inception in April to June 2010 to October to December 2022. Much of this return was until 2015. The return between December 2016 and December 2022 is just 3.9% per year. The return one could have earned by doing an SIP on equity MFs is considerably higher than this."

“Hmmm."

“Of course, the disclaimer here is that the all India real estate return is the average return of 10 cities, and returns vary across cities and across localities in cities. Nonetheless, unless one got a really cheap real estate deal, chances are one would have ended up better by investing in equity MFs."

“So, those on the side of renting are right" he asked.

“Not at all. It’s actually stupid to use math here. It’s the kind of argument you often see being made on social media. If you hadn’t bought vests but invested in the stock of a company making vests. If you hadn’t bought hawai chappals and invested in the stock of a company making them."

“And I thought you didn’t have a Twitter account."

“I don’t, but I do know," she said. “So, the point is one needs certain things at certain points of time in life."

“That’s true."

“So, if one feels the need to own a flat to have some stability in life and due to many of the other reasons I have already talked about, and one is financially in a position to make the down payment and has the ability to repay the home loan, one should go ahead and buy."

“Hmmm."

“In such a situation, the comparison with an SIP is basically being stupid. It fulfils the need of financial influencers to say simplistic things that can go viral and help them increase the number of followers on social media."

Risks and rewards

What about investing in a flat in our hometown?" he asked.

“Looks like you have got a call from your mummy ji."

“Yes," he said. “She called yesterday evening when you were out for a jog."

“I would rather invest in stocks, mutual funds, fixed deposits, gold, etc."

“Why?"

“First, the ticket size of a flat is very big in comparison to all other forms of investment."

“So?"

“If something goes wrong, the cost of that mistake will be very high."

“Like?"

“Well, builders have been known to disappear in the past. Projects can get endlessly delayed. "

“But one can then take the builder to court?"

“Yes, one can, but it’s a fight between David and Goliath. In most such fights, Goliaths ultimately win or they can manage to drag the case for years."

“How about buying a flat that is ready for possession and putting it on rent?" he asked.

“Rental yields largely vary between 2-3%. Why take so much risk for earning so little? Plus, we will have to take on a home loan to buy the flat. That means paying an interest of 9%. Then we need to pay an annual property tax, an annual maintenance charge to the society and so on. Plus, one will have to keep sorting out any issues that the tenant has."

“How about buying a flat and keeping it locked?" he asked. “We can sell it whenever it appreciates."

“I would hate doing anything like that," she almost burst out. “You end up wasting so many things. Money, sand, cement, steel and, most importantly, water… It pains my heart to see lakhs of flats across our cities which have been bought and locked up. If they were opened up, the quality of life in our cities would improve quite a lot."

“Calm down!"

“So, what else did my mother and your mummy ji have to say when she called?" she asked.

“Now that we have bought a car, we should buy a flat."

“There we go again," she said. “Their aspirations never end but it’s all about loving your parents."

(The example is hypothetical).

Vivek Kaul is the author of Bad Money.

Catch all the Industry News, Banking News and Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
more

topics

MINT SPECIALS