House investment: Is there a business case?

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:

1. Interest on bank loan = 10.15% x Rs.1.05 Cr. = Rs.10.66 L
2. 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
3. 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:

1. 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
2. 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:

1. 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).
2. 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).
3. 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).
4. 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:

1. 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).
2. 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:

1. Income tax rebate under section 24 (as calculated in case I) = Rs.0.9 L
2. 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.
3. 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:

1. 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).
2. 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).
3. Do you think the selling price of your house will increase by Rs.11.16 L every year?
4. 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!

Badlo usey, na jaane kisey...Hoga aise, na jaane kaise!

It was inhuman - the brutal torture and rape of a girl in a Delhi bus. We were disgusted by what we have made of our society. And so many of us started hoping, instead of dreading, that the world would end on 21st December 2012 as predicted by Mayans. The prevailing sense was captured best by a post doing rounds on facebook - 'I am not scared the world would end on 21st, I am scared that it will continue as it is'. But the world didn't end. It went on and it went on unchanged. So some of us, in fact, many of us got out of our homes and started demonstrations at India gate for something that needs to happen somehow. The only things unclear were what and how!

1. We have gathered at India gate to demonstrate without a clear leader. When a group of people from among us demonstrators came out after meeting some officials in the Rashtrapati Bhawan, the crowd questioned the legitimacy of their representation and refused to listen to them.
2. We do not seem to have a clear demand. Some of us want capital punishment for rape in rare of the rarest cases, some want capital punishment for rape in all cases, some want a special session of parliament to bring this amendment to the law, some want the guilty in this specific case be lynched, some want the resignation of Home Minister, some want the suspension of Delhi police commissioner, etc. What seems to doom our demonstrations is the absence of a comprehensive set of structural fixes in our demands.
3. I heard a politician ask "if capital punishment hasn't deterred criminals from murdering people, will it deter criminals from resorting to this crime?" and found myself unsure.
4. Five policemen found in dereliction of duty will be suspended. But that's routine. Things will be forgotten in 2 months and those guys would be back in service. We are anyways short of staff in police. And the broader point is the state of our police staff. They are 'on duty' for long hours and sometimes 7 days a week, are paid peanuts in salaries, take bath in open outside the police stations (read their office), dry their laundry in the police station (read their office), can't easily touch most serious criminals due to their political connections (read do not perform their duty because their bosses do not allow them to do), etc. If you and me worked under such conditions, what would be our quality of work! Despite those work conditions, because all of us have to feed our families, someone might supervise us into working from time to time by brandishing the stick of suspension but in absence of the underlying motivation, we would revert to our shoddy self as soon as the supervision fades.
5. Many of our political leaders are 70+ years of age. At our home, we do not expect family members of this age to be 'able' to take care of us youngsters. They speak feebly and walk with support. We urge them to take more rest, eat carefully and lead a retired life. I feel terrible then when people of this age have to run this entire country. Not that they are stronger of the lot, even they are speaking feebly and many of them walking with support.
6. It's heartening to see that High court has taken suo moto cognizance of this unfortunate incident and set up fast track courts to hear rape cases. But a villager whose land was snatched by local influential people wants a fast track hearing equally badly because he can't feed his family without that land.

Thoughts will keep coming and I will keep updating this post, but the underlying questions will remain -

1. Should we not demand judicial reforms, police reforms, and political reforms?
2. Can those reforms not happen in parallel with economic reforms?
3. Given the number of inconclusive public demonstrations on various issues lately, is it time that we make our demonstrations more effective by taking lessons from our rich pre-independence history (on proper public discourse to come up with a blue print of popular ideal state while agitating for change)?

And a personal question to myself, should I not stop writing but do something about it?

Bachpan ki woh ameeri..

बचपन की वो अमीरी ना जाने कहाँ खो गयी...
जब बारिश के पानी में हमारे भी जहाज चला करते थे.
                            
                                                     - गुमनाम

Rest in peace JEE...you will be missed!

Yesterday marked the day when JEE was killed. I am extremely distressed at the disconnect politicians and bureaucrats have from the masses. I have done well as an IITian but had the system been so in my times, I would never have been an IITian.


A comment from Chairman of the Central Board of Secondary Education (CBSE), Vineet Jain, - "This will bring about a big change in the teaching-learning in the classroom" makes me wonder how this will happen. Will the quality of our secondary school teachers change over the next 10 years Mr. Jain? Have you even met tier 2/3 school class 12 teacher in the last few years Mr. Jain or are you only meeting the principals and directors of public schools in Delhi? Do you seriously believe a typical tier 3 city student has a chance of competing with a tier 1 city student in class 12. The only way the playing field can be leveled is if the poor tier 3 city kid spends a large amount of money to stay in hostel in a tier 1 city himself to study at the same quality place. Where a kid used to do so for only 1 year of JEE preparation so far, he would perhaps do so for 2 years of inter college too now.


This will just make small town students miserable. Even pandering to the wishes of unethical teachers who want to teach only at private tuition at home wouldn't help poor kids score in board exams because most of these small town school teachers anyways don't have their fundamentals in place. And if kids don't pander to their wishes, they are screwed in even bigger ways. My geography teacher in 10th didn't tell me in school that board exam has a 10 mark question on maps. He told so to his students at his private tuition classes and asked them to be quiet about it at school. I figured this only a day before the final board exam, tried desperately to understand maps at the last minute but ultimately lost on all 10 marks. Result - I scored just 63 marks in Geography, substandard looking at my larger academic record.


And why just go to a small town. I shifted to a mini metro city in 12th late in July, when 1st term exams were almost there. I scored 94 in those exams, thanks to a phenomenal tutor I had in my previous town. I used to study the legendary R.S. Agarwal book till that time in my own style. However, soon I figured that this maths teacher promoted a maths guide by a different author to the extent that he would beat us up physically if we were not showing hand-written solutions to the problems in that book. Now with my limited time, I had to give up my favourite R.S. Agarwal and switch to a different book just because this teacher was promoting it. It added one more adjustment to my already disturbed schedule (Remember, I had just joined this new school). Moreover, my freedom of solving the problems my way was lost. To me writing every line of solution in a notebook wasn't important but I had to do so to prove to this teacher that I was studying his 'favorite' book. All of this resulted in significant loss of time for me and I had 72 marks in my 2nd term.


Now, Mr. Sibal and Mr. Jain, I still made it to IIT because class 10 and class 12 DID NOT matter in my entry to IITs. Though my substandard knowledge from school education did put me a bit behind my metro public school counterparts but I made up for it through my hard work in the 1 year local JEE coaching. If you sit for an hour in a school's class 12 room and in a JEE coaching institute Mr. Sibal and Mr. Jain, you would figure out the difference in quality of education yourself. What we need Mr. Sibal and Mr. Jain is therefore not a change in entrance criteria for any exam but a change in the quality of our teachers. I am waiting for any such working plan from you Mr. Sibal and Mr. Jain.


Please forgive my language in this post Mr. Sibal and Mr. Jain but this is coming from the first hand experience of a person who seriously doesn't believe in your 12 year education system. Times change, systems change, why can you guys not be comfortable with the shift of importance from class 12 to engineering entrance? Has telecommunication not made India post irrelevant today, then why does our poor old class 12 have to remain relevant? Why can it not give in to evolution?!

12 years since school!

Man! Have I grown old or what? Just realized that thumb sucking babies who used to be in 1st when I passed 12th have themselves passed 12th today!

What's with this God?

I think this often -

We pray to God for more wealth, success in studies and business, but does God even understand these things? These things are part of the artificial web woven by human beings. We ourselves created this system and then are running madly to win in it. God only created nature. Human bodies are part of it. May be he can ease our physical pain out of some disease or old age. But does he understand money? Was he involved in creating our bad luck which led to some big loss in business? I mean the luck that he created may have given me fever sometimes but did that luck involve me losing an entrance exam?

And who created God? What is the origin of the ultimate?

Last weekend, I called security to send someone to clean the bathroom. Usually, it's a middle aged man who comes to clean the bathroom. He takes Rs.50 for each time he comes. But last weekend, a cute teen aged child knocked on my door. I wasn't sure what to do. I have had this debate within myself many times. As a principle, I decided long time ago that I will never employ children as domestic help. But at such times, when this kid is already cleaning 50 odd homes of society, would only me not letting him clean my bathroom help him go to school. One argument is that it has to start somewhere and I should contribute my bit. I don't disagree with this argument and this is why many times, I am the only one waiting behind the zebra line for traffic signal to turn green. But I also think that it's only a concerted effort on part of society that will help this cause. And given our society, only better law enforcement can bring that concerted effort. All of these thoughts crossed my mind in 10 seconds as I looked at that kid and I gave in. I get this nagging feeling that I was wrong and I should have done my bit. But this kid looked so cute and happy with where he was, I just gave in at that moment. I talked to him while he was cleaning, tried to understand him and tried to give him some feel of equality, love and respect. He supports his family financially along with his uncles, who don't earn much to provide for family. 


Seven days passed after that and came this weekend.


I called up security and asked him to send that same kid to my house. What happened to my principles? I don't know! He came in a very cheerful mood, started talking as soon as he came in and was very inquisitive. I switched the AC off with remote as I opened the balcony door. Apparently, he didn't know that an AC could be controlled by a remote and was excited to know this. He asked me if I wanted to engage him on a monthly basis. I asked him what the difference was, he could get his money every time he came in to clean. He told me his folks are planning to go to Vaishno Devi and he needs to save some money. If he gets paid for every time, he ends up spending it. The only way he can save is if he gets it in lump sum at the end of the month. Hearing his rationale, I agreed to have him clean my bathroom every weekend he can find me at home and take his dues at the end of the month. He agreed.
As he finished cleaning the bathroom, he noticed some namkeen lying in a corner. He asked me for a paper to throw it away. Man! wasn't it a lesson for me in customer delight and commitment towards your job! How many times we crib on getting that additional work from our customer! He also asked me to come and check the bathroom if everything was okay. Then he asked me to give his money for this time. I asked him what happened to his savings plan. He said last night he and his uncles didn't eat anything as there were no vegetables at home. With this money, he would go and buy vegetables. I was speechless. I have heard about world hunger, I have seen it in movies but this was the first time someone was telling me on face and that too a cute teenage kid! I felt stupid, gave him his money and couldn't think anything for the next few seconds. As I heard the sound of elevator doors closing, I thought I could have given him Rs.100 instead of Rs.50, I should have given him the Parle G biscuits from my cupboard, I could have even asked him to sit for a while and made him a Maggie! But I acted like a stupid there. Did I fail him!


Look at him, a kid with a lost childhood but still happy and dedicated to what he does! He dwarfs my problems.


As my head clears, I have decided to find him again today/tomorrow and ask him to come to me to take some money to buy food whenever this happens the next time. But what can we do as responsible people to help such children? Is there a way this kid can go to school?