So you finally have around Re 30L that you can now invest, after having slaved for a good part of your youth. It is at this stage that the magic question often comes up to young people. Should I put this as down payment and buy myself a nice apartment? Or should I just invest it somewhere and stay on rent?
This is where our society kicks in with its platitudes. Over the years, we have got used to statements such as “real estate never fails”, “a home is the best investment”, “there will always be a shortage of space in this country” etc. This pushes many of us to rush out and take that home loan and buy a nice (one crore) apartment, using the 30L as down payment. In the process, we create this constant liability of a home loan EMI over our heads. Having to pay out around a Lac every month generates quite bit of stress. Many families cannot afford to have even one parent taking time off to attend to a loved one’s illness or to give time to their kids because the EMI payments will become impossible. But does the math behind this hoopla really work out? Well, the answer really depends on the rate at which the real estate market is growing, independent of speculators. Over the last 5 years, it appears this has really not been very high in most urban markets in India. And the next 5 years don’t look that bright either. I would argue that now it is much better to invest one’s money in flexible instruments and live stress free on rent. Let’s see why.
To start, let us consider the Bangalore market for apartments, which is considered more stable and less speculator driven than say Gurgaon etc. Let’s look at both the cost and earnings side of the equation.
First, the earnings calculation.
- In the last 5 years, an apartment from a good builder in Bangalore would have gained in average value by about 8% per year in compounded interest at best. This means that a property that was purchased for 1 crore in 2010, would be worth at best about 1.47 crores in 2015. Fair? That should check out with the experience that most of you have had. In fact, my own experience suggests an even slower rate of appreciation but let’s err on the higher side. Long term capital gains of 20% applies on earning from properties. So that’s a net gain of 38L in 5 years.
- The rental one would have otherwise paid, can be taken as savings as well. However, rent is tax deductible. Assuming a 1 crore house would cost about 35- 40 K per month to live in, the deductible part is at least 25-30 K in most cases. So the balance savings would be about 10K per month over 5 years. A saving of 6 L
- Then there are savings from the tax break that we get on the interest part of the home loan. The government currently caps this at 2 Lacs per annum. So over 5 years, one could save up to 10L in tax breaks.
Hence the total gain in 5 years = 38L + 6L + 10L = Re 54L
Now let us ask ourselves what is the cost of money that we are deploying, based on the assumption that the 1 Cr home is on a 70% home loan.
- Our own money here is 30L. If we consider an absolutely conservative investor who just parks his money in a fixed deposit at 9% per annum, this would earn 16L over 5 yrs in compounded interest terms. Less tax that would be 11L.
- The interest cost on a 70L loan would work out to about 34L over 5 years
Expense in 5 Years = 11L + 34 = 45L
* We have not factored in the delay between payment and possession of the apartment, Pre EMI etc, which could make this picture worse
Overall difference = 54 – 45 = Rs 9L over 5 years on a 1 crore investment
Apparently, there isn’t much difference between just putting your money in a fixed deposit and staying on rent! Now if you were a smart investor and could do better than a fixed deposit rate of return, then it really starts make no financial sense to buy the apartment.
Of course, this does not take into account the emotional value and sense of security that comes from owning a home. But then, neither does it factor in the stress of having to cough up an EMI every month, as opposed to being liability free. And the fact that a 30L investment is always available to you, while the home is difficult to liquidate in an emergency situation, without affecting the value again.
The moot point of course, is whether an apartment will only deliver 8% pa appreciation over the next 5 years. I believe this is the best case scenario. The fact that there may be a spike later on is balanced by the fact that apartment values also taper as they grow older.
On the other hand, equity markets have the reputation of delivering well over 15-20% pa in the long run for those who have the courage to stay invested and the ability to pick the right stocks. And the sweetener here is that earnings from stocks are tax free when held for over a year!
Equity is deservedly considered riskier, but right now we have seen years of irrational value growth in certain pockets of real estate and we are coming out of years of painful fall in the stock market. Given the up-down cycles that naturally follow, logic points to the fact that for the next 5 years or so, real estate growth may be muted while the stock market may outperform. So my current advice to prospective home buyers would be, invest smartly into equities through a good fund manager and stay on rent. You’ll make more money and remain stress free in the bargain. Maybe 5 years later the trend will turn and you can pull your money out of financial instruments and invest into an apartment then!
*Note : This article has some detailed figures for those interested
*Disclaimer : This does not apply to 2nd homes. There is a complex taxation loophole there that makes it a whole different ballgame. But that’s another topic.