When did your dad buy his first (and, in most cases, only) house? Perhaps mid 40s. But you want to buy your first house in early 30s. The reason you buy a house at this early age today is very different from why your dad bought his house during his mid 40s. He wanted to secure a roof over his head post retirement but you want to get a good return on your investment. Even if you can't afford a house large enough to live in, you feel a tacit pressure to buy a smaller one somewhere on the outskirts as an investment, just to sell off at the right time. But is it a wise investment option?
A detailed analysis proves that unless you pick up stake just when a city is taking off (like Gurgaon in mid 2000s or may be the new capital of Telangana now), a house investment isn't a good investment at all. In fact, even a FD gives you higher and safer return.
Let's do some simple maths to understand better:
Assumptions:
Let's assume that you are a salaried employee with all white money so you're interested in an all white deal (this analysis will not be applicable to those with black money support because they can't invest that money elsewhere legitimately so whatever return they get on property is better than an otherwise no return). Let's also assume that you are married and want to buy in a joint ownership so that you maximize your loan eligibility and tax benefits.
Suppose you are interested in buying a two plus study house in Gurgaon for about Rs.1.4 Cr. (typically a Sohna road location). You want to finance Rs.25 lac from your savings, Rs.10 lac from your PF and the rest Rs.1.05 Cr. from a bank loan (you can avail a loan of up to 85% of Rs.1.4 Cr which is Rs.1.19 Cr so you are able to afford this house). And suppose you are paying a rate of Rs.9000 per sq ft (typical fully loaded cost of a Sohna road property if you've cracked a good deal), which means your house area will be 1.4 Cr/9000 = 1556 Sq ft.
Let's take two cases one by one:
Case I: You will self occupy the house.
Case II: You will rent the house to a tenant and keep living in a rented house yourself.
Now let's see if the house purchase makes you richer or poorer over 5 years.
Case I: You will self occupy the house.
Annual cash outflow:
Total annual cash outflow = Rs.10.66 + Rs.1.53 + Rs.0.85 = Rs.13.04 L
Annual cash inflow/benefit:
Total annual cash benefit = Rs.0.9 + Rs.3.24 = Rs.4.14 L
Net annual cash outflow = Total cash outflow - Total cash benefit = Rs.13.04 L - Rs.4.14 L = Rs.8.9 L
Resale value and the rate of return:
Suppose after 5 years you have a better job, higher salary, or higher savings (say, you are an IT employee and you went onsite and saved some money) and want to upgrade your house, i.e., sell this one off and buy a bigger one. In 5 years, you would have incurred a cash expense of Rs.8.9 L x 5 = Rs.44.5 L on this house. Besides all this, if you anyway planned to sell this house after 5 years then essentially the 6% registry charges that you paid also ends up being a sunk cost. Let's assume the circle rate for this property is Rs.5000 per sq ft so you paid 6% x 5000 x 1556 = Rs.4.67 L for registry. So your total expenses on this property in 5 years are Rs.49.2 L. Also sunk is the 1% that you paid to a broker both at the time of buying and selling (=Rs.1.4 Cr. x 1% + Rs.1.4 Cr. x 1%) = ~Rs.3 L.
With all these expenses, just to break even after 5 years you would want to net off Rs.52.2 L on your property. But selling after 5 years will also attract a long term capital gain tax of 20% so actually you want to sell at an appreciation of 52.2/80% = Rs.65.3 L. This means after 5 years, the value of your 1556 sq ft house should be Rs.2.05 Cr. (at a whopping Rs.13,174 per sq ft). On a per sq ft basis, we are talking about an annual appreciation of 65.3/5/1556 = Rs.840 per sq ft every year. And these numbers while look big, are just a modest 7.9% compounded annual rate of return (CAGR) pre-tax ((2.05/1.4)^(1/5)-1 = 7.9%).
Think of these numbers in following four ways:
So in case I (self occupied house), should one not purchase a house at all? Yes, buying purely for financial gain doesn't make sense (compare a modest 7.9% CAGR that looks too huge to realistically achieve in property with a FD that gives you 8.75% CAGR without risk easily). But you should consider buying a house if:
Case II: You will rent the house to a tenant:
Annual cash outflow:
Total annual cash outflow as calculated in case I = Rs.13.04 L
Annual cash inflow/benefit:
Total annual cash benefit = Rs.5.63 L
Net annual cash outflow = Total cash outflow - Total cash benefit = 13.04 L - 5.63 L = Rs.7.41 L
Resale value and the rate of return:
In 5 years, you would have incurred a cash expense of 7.41 L x 5 = Rs.37 L on this house. Add the 6% registry charges on circle rate of Rs. 5000 per sq ft = 6% x 5000 x 1556 = Rs.4.67 L. So your total expenses on this property in 5 years are Rs.41.7 L. Also add the 1% brokerage at the time of buying and selling = ~Rs.3 L (as calculated in case I).
This time just to break even you would want to net off Rs.44.7 L on your property. Accounting for a long term capital gain tax of 20% so actually you want to sell at an appreciation of 44.7/80% = Rs.55.8 L. This means after 5 years, the value of your 1556 sq ft house should be Rs.1.96 Cr. (at Rs.12,586 per sq ft). On a per sq ft basis, now we are talking about an annual appreciation of 55.8/5/1556 = Rs.717 per sq ft every year. And this is again just a modest 6.9% compounded annual rate of return (CAGR) pre-tax ((1.96/1.4)^(1/5)-1 = 6.9%).
Now again think of these numbers in following four ways:
So, if your objective was only investment, then this house is hardly going to give you a 6.9% CAGR pre-tax and there is too much risk of uncertainty even on getting this much from your house in 5 years. Compare that with a 8.75% CAGR pre-tax that a FD gives you risk free.
Another way of looking at this investment:
And in case II, just theoretically, if we agree that the going rate of this house will be Rs.11,000 per sq ft then you only made (11000-9000) x 1556 = Rs.31.1 L from capital gain. The balance of 55.8 - 31.1 = Rs.24.7 L over 5 years or Rs.4.94 L per year should come from rental income. This takes your required rental income to a whopping Rs.2.57 L (rental income that we calculated for case II) + Rs. 4.94 L (gap needed to bridge to break even on your investment) = Rs.7.51 L per annum. Reverse adjusting for all the factors considered in point 2 of income in case II, this comes to a required monthly rental of Rs.84100, which is definitely not happening.
In this case the ratio of your purchase value of your house to the average 5 year monthly rental comes out to be 14000000/84100 = 166. It can be shown roughly that factoring for annual rental increase, around this house price, the ratio of house value to the monthly rental at the time of purchase should be anywhere less than 200 if your investment has to give you positive 5 year return (The calculation isn't different for 10 year, 15 year returns either).
At current Gurgaon prices, this ratio realistically is more around 14000000/30000 = 467 which makes a house a bad investment option in Gurgaon. This is why I believe we're in a property bubble and should keep distance from it. While this calculation has been done for Gurgaon, in general, a residential house purchase turns out not a good investment option in any city unless you pick up medium term stake in a city that is just taking off.
Philosophically thinking:
All the above calculations were financial and they proved that house purchase is not a good investment option. But there are other associated costs as well.
In your early 30s, you are newly married and may be will soon have a baby. This is a great time to see the world together and fall in lifelong love with each other. Once the baby grows up into a teenager, you will anyway have all sorts of practical pressures of life. But this time will not come back. Do you want to get into a Rs.1 Cr+ loan, get tied to a monthly EMI of Rs.1 lac+ at this stage and not have any spare money to go on that expensive Saturday night dinner date with your young partner or go on that summer vacation to Europe with your love and your still able parents?
Chances are that you will do well in life and will have good money in your mid 40s (better than your dad in the then coveted government service) to buy a house and handle growing pressures of a family. Do think about retirement fund now, don't touch your PF, get an insurance term plan for about 6-8x your annual CTC, save 30% of your take home salary and put it in a balanced portfolio (FD, mutual funds, metal, stocks) but don't fret about a house yet. It's sunny out there, take your partner on a date today!
A detailed analysis proves that unless you pick up stake just when a city is taking off (like Gurgaon in mid 2000s or may be the new capital of Telangana now), a house investment isn't a good investment at all. In fact, even a FD gives you higher and safer return.
Let's do some simple maths to understand better:
Assumptions:
Let's assume that you are a salaried employee with all white money so you're interested in an all white deal (this analysis will not be applicable to those with black money support because they can't invest that money elsewhere legitimately so whatever return they get on property is better than an otherwise no return). Let's also assume that you are married and want to buy in a joint ownership so that you maximize your loan eligibility and tax benefits.
Suppose you are interested in buying a two plus study house in Gurgaon for about Rs.1.4 Cr. (typically a Sohna road location). You want to finance Rs.25 lac from your savings, Rs.10 lac from your PF and the rest Rs.1.05 Cr. from a bank loan (you can avail a loan of up to 85% of Rs.1.4 Cr which is Rs.1.19 Cr so you are able to afford this house). And suppose you are paying a rate of Rs.9000 per sq ft (typical fully loaded cost of a Sohna road property if you've cracked a good deal), which means your house area will be 1.4 Cr/9000 = 1556 Sq ft.
Let's take two cases one by one:
Case I: You will self occupy the house.
Case II: You will rent the house to a tenant and keep living in a rented house yourself.
Now let's see if the house purchase makes you richer or poorer over 5 years.
Case I: You will self occupy the house.
Annual cash outflow:
- Interest on bank loan = 10.15% x Rs.1.05 Cr. = Rs.10.66 L
- Opportunity cost of your savings (had you kept this money in a FD, it would have grown by 8.75% FD rate and attracted a 30% income tax, thus returning you an annual 6.13% return) = 6.13% x Rs.25 L = Rs.1.53 L
- Opportunity cost of your PF (earns about 8.5% with no income tax) = 8.5% x Rs.10 L = Rs.0.85 L
Total annual cash outflow = Rs.10.66 + Rs.1.53 + Rs.0.85 = Rs.13.04 L
Annual cash inflow/benefit:
- Income tax rebate under section 24 (Rs.1.5 L of income is deductible from taxable income for both owners) = Rs.1.5 L x 30% + Rs.1.5 L x 30% = Rs.0.9 L
- Saving of house rent that you would have otherwise paid (assuming you pay a rent of Rs.30,000 per month including society maintenance of Rs.3,000. With your own house you will still pay society maintenance but will save rest of the Rs.27,000 rent) = Rs.27,000 per month x 12 months = Rs.3.24 L
Total annual cash benefit = Rs.0.9 + Rs.3.24 = Rs.4.14 L
Net annual cash outflow = Total cash outflow - Total cash benefit = Rs.13.04 L - Rs.4.14 L = Rs.8.9 L
Resale value and the rate of return:
Suppose after 5 years you have a better job, higher salary, or higher savings (say, you are an IT employee and you went onsite and saved some money) and want to upgrade your house, i.e., sell this one off and buy a bigger one. In 5 years, you would have incurred a cash expense of Rs.8.9 L x 5 = Rs.44.5 L on this house. Besides all this, if you anyway planned to sell this house after 5 years then essentially the 6% registry charges that you paid also ends up being a sunk cost. Let's assume the circle rate for this property is Rs.5000 per sq ft so you paid 6% x 5000 x 1556 = Rs.4.67 L for registry. So your total expenses on this property in 5 years are Rs.49.2 L. Also sunk is the 1% that you paid to a broker both at the time of buying and selling (=Rs.1.4 Cr. x 1% + Rs.1.4 Cr. x 1%) = ~Rs.3 L.
With all these expenses, just to break even after 5 years you would want to net off Rs.52.2 L on your property. But selling after 5 years will also attract a long term capital gain tax of 20% so actually you want to sell at an appreciation of 52.2/80% = Rs.65.3 L. This means after 5 years, the value of your 1556 sq ft house should be Rs.2.05 Cr. (at a whopping Rs.13,174 per sq ft). On a per sq ft basis, we are talking about an annual appreciation of 65.3/5/1556 = Rs.840 per sq ft every year. And these numbers while look big, are just a modest 7.9% compounded annual rate of return (CAGR) pre-tax ((2.05/1.4)^(1/5)-1 = 7.9%).
Think of these numbers in following four ways:
- Do you think a 1556 sq ft house that you bought today at effectively Rs.9000/sq ft rate will go at the rate of Rs.13174 per sq ft in 5 years? (To put it in context, 13000 is the rate at the most prime locations in Gurgaon today, e.g., MG Road and Gold Course Road and 9000 is the effective rate on Sohna road after including all hidden charges if you cracked a good deal. My guess is as good as yours but I would bet my money on Rs.11,000 per sq ft max after 5 years for similar locality under similar circumstances. MG Road and Golf course road rates did grow from Rs.5,000 in 2005 to Rs.13,000 in 2014 but at that time Gurgaon and the property bubble in Gurgaon was picking up. It's beneficial to invest at that stage. These rates in all Gurgaon locations have been constant or gone down a bit over the last 2 years as the property bubble became unsustainable during economic downturn. Also the rates tend to peak out as people find the rate of return in those areas small so take their money elsewhere. This in turn makes the area unattractive for future speculative buyers. Sohna road seems to have realized much of it's potential for a few years because it's already expensive and a lot of new inventory is coming up around golf course extension road and southern periphery road so people have many alternative options. But investment even in this new inventory isn't attractive because it can be shown through similar analysis that even that under-construction or just announced inventory is over priced to yield a good rate of return over 5-10 years).
- Do you think prices will increase by Rs. 840 per sq ft every year? (Again to put it in context, prices have not increases at all in the last 2 years and most of these areas are already overpriced).
- Do you think the value of your Rs.1.4 Cr. house will increase by Rs.13 L every year? (Think Sohna road to put it in context).
- Do you think a 1.4 Cr two plus study will get 2.05 Cr in 5 years? (Who will be the buyer? A typical salaried, middle class family with an annual 10-14% salary increment and 1-2 kids gathers around Rs.1.0-1.6 Cr for a small house)
So in case I (self occupied house), should one not purchase a house at all? Yes, buying purely for financial gain doesn't make sense (compare a modest 7.9% CAGR that looks too huge to realistically achieve in property with a FD that gives you 8.75% CAGR without risk easily). But you should consider buying a house if:
- A rented accommodation doesn't give you all the facilities you want (e.g., you like stylish bathrooms and rented houses all use cheap fittings).
- The particular house that you're interested in has sentimental value for you (e.g., you grew up playing in that house or you really like this location but the availability of house here is very rare).
Case II: You will rent the house to a tenant:
Annual cash outflow:
Total annual cash outflow as calculated in case I = Rs.13.04 L
Annual cash inflow/benefit:
- Income tax rebate under section 24 (as calculated in case I) = Rs.0.9 L
- Rental income (assuming you will get Rs.35,000 per month including Rs.3,000 maintenance for this house) = 12 x 32000 = Rs.3.84 L (I have assumed a rent on the higher side but because rent will slightly increase year on year, I am taking a constant average amount which is a bit higher today). You're allowed an income tax deductible of 30% towards general house maintenance which means you pay tax only on 70% of your rental income, which comes to an income tax of 3.84 x 70% x 30% (slab rate) = Rs.0.81 L. And if you rotate your tenant every 18 months and pay a brokerage of 15 days (Rs.15,000 every time), this also comes to an annual expense of Rs.10,000. Also, when you rotate the tenant, your house may be vacant for approximately a month every 18 months so a loss of Rs.32,000 every 18 months coming to annual loss of Rs.21,300. Plus your house will really need some miscellaneous expenses (e.g., seepage repair, paint) so let's deduct another Rs.15,000 per year. So you net rental income is 3.84 - 0.81 - 0.1 - 0.213 - 0.15 L = Rs.2.57 L.
- Because you consider your house an investment vehicle in this case, you should calculate net gain/loss on this investment and claim tax benefit. This means if your net cash inflow from the house is 2.57 L + 0.9 L = Rs.3.47 L and your interest payout is Rs.10.66 L, you're incurring an annual loss of 10.66 - 3.47 = Rs.7.19 L. On this you claim tax rebate = 30% x 7.19 L = Rs.2.16 L (This option isn't available in case of a self occupied property, that's why we didn't consider it in case I).
Total annual cash benefit = Rs.5.63 L
Net annual cash outflow = Total cash outflow - Total cash benefit = 13.04 L - 5.63 L = Rs.7.41 L
Resale value and the rate of return:
In 5 years, you would have incurred a cash expense of 7.41 L x 5 = Rs.37 L on this house. Add the 6% registry charges on circle rate of Rs. 5000 per sq ft = 6% x 5000 x 1556 = Rs.4.67 L. So your total expenses on this property in 5 years are Rs.41.7 L. Also add the 1% brokerage at the time of buying and selling = ~Rs.3 L (as calculated in case I).
This time just to break even you would want to net off Rs.44.7 L on your property. Accounting for a long term capital gain tax of 20% so actually you want to sell at an appreciation of 44.7/80% = Rs.55.8 L. This means after 5 years, the value of your 1556 sq ft house should be Rs.1.96 Cr. (at Rs.12,586 per sq ft). On a per sq ft basis, now we are talking about an annual appreciation of 55.8/5/1556 = Rs.717 per sq ft every year. And this is again just a modest 6.9% compounded annual rate of return (CAGR) pre-tax ((1.96/1.4)^(1/5)-1 = 6.9%).
Now again think of these numbers in following four ways:
- Do you think a 1556 sq ft house that you bought today at effectively Rs. 9000/sq ft rate will go at the rate of Rs. 12,586 per sq ft in 5 years? (As I said my guess is as good as yours but I would bet my money on 11,000 per sq ft max after 5 years for similar locality under similar circumstances).
- Do you think prices will increase by Rs.717 per sq ft every year? (Again to put it in context, prices have not increases at all in the last 2 years and most areas are already over priced).
- Do you think the selling price of your house will increase by Rs.11.16 L every year?
- Do you think a Rs.1.4 Cr two plus study house will get Rs.1.96 Cr in 5 years? (Again, to put it in context, think of your average middle class salaried buyer who gets an annual raise of 10-14% and can perhaps gather up to 1.6 Cr of funds for a small house purchase in their early 30s).
So, if your objective was only investment, then this house is hardly going to give you a 6.9% CAGR pre-tax and there is too much risk of uncertainty even on getting this much from your house in 5 years. Compare that with a 8.75% CAGR pre-tax that a FD gives you risk free.
Another way of looking at this investment:
And in case II, just theoretically, if we agree that the going rate of this house will be Rs.11,000 per sq ft then you only made (11000-9000) x 1556 = Rs.31.1 L from capital gain. The balance of 55.8 - 31.1 = Rs.24.7 L over 5 years or Rs.4.94 L per year should come from rental income. This takes your required rental income to a whopping Rs.2.57 L (rental income that we calculated for case II) + Rs. 4.94 L (gap needed to bridge to break even on your investment) = Rs.7.51 L per annum. Reverse adjusting for all the factors considered in point 2 of income in case II, this comes to a required monthly rental of Rs.84100, which is definitely not happening.
In this case the ratio of your purchase value of your house to the average 5 year monthly rental comes out to be 14000000/84100 = 166. It can be shown roughly that factoring for annual rental increase, around this house price, the ratio of house value to the monthly rental at the time of purchase should be anywhere less than 200 if your investment has to give you positive 5 year return (The calculation isn't different for 10 year, 15 year returns either).
At current Gurgaon prices, this ratio realistically is more around 14000000/30000 = 467 which makes a house a bad investment option in Gurgaon. This is why I believe we're in a property bubble and should keep distance from it. While this calculation has been done for Gurgaon, in general, a residential house purchase turns out not a good investment option in any city unless you pick up medium term stake in a city that is just taking off.
Philosophically thinking:
All the above calculations were financial and they proved that house purchase is not a good investment option. But there are other associated costs as well.
In your early 30s, you are newly married and may be will soon have a baby. This is a great time to see the world together and fall in lifelong love with each other. Once the baby grows up into a teenager, you will anyway have all sorts of practical pressures of life. But this time will not come back. Do you want to get into a Rs.1 Cr+ loan, get tied to a monthly EMI of Rs.1 lac+ at this stage and not have any spare money to go on that expensive Saturday night dinner date with your young partner or go on that summer vacation to Europe with your love and your still able parents?
Chances are that you will do well in life and will have good money in your mid 40s (better than your dad in the then coveted government service) to buy a house and handle growing pressures of a family. Do think about retirement fund now, don't touch your PF, get an insurance term plan for about 6-8x your annual CTC, save 30% of your take home salary and put it in a balanced portfolio (FD, mutual funds, metal, stocks) but don't fret about a house yet. It's sunny out there, take your partner on a date today!
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