Factors to consider in buying vs. renting a home

There is an adage which goes something like this: “Foolish people build homes for wise men to live in”. In other words, it is wiser to rent a home rather than invest large sums of money in owning a home. It is true that after you invest, say around ₹40 to 50 lakhs all inclusive in a middle class apartment, you may end up with say around ₹1.8 to 2.4 lakhs rental income per annum. If this capital was kept invested in a super safe asset class like a Bank FD, you would have earned say around ₹3.6 to 4.5 lakhs per annum at current long term bank deposit interest rates less TDS.  Your post tax return will depend on which tax slab you are in, whether it is rental or interest income. The property also requires money to be spent on its maintenance such as repairs and repainting, and annual property taxes etc. affecting the net return on investment. If you are unlucky, you may also end up with a difficult tenant.

Hence, purely from a return on investment angle, without taking in to account capital appreciation, it may be a better idea to stay in a rented house and pay 1.8 to 2.4 lakhs rent per annum, and deploy your capital based on your risk profile in different asset class and get a return of more than 9% per annum. This way you end up with a surplus even after paying the rent for the house you live in and surpluses can also be deployed to get a compounded ROI. You also remain liquid, since real estate investment is least liquid, after Gold. The long term investments in equity and equity mutual funds are tax free. This helps in your tax planning.

The above scenario is on the assumption that one has large sums of money of their own and wants to invest it in an asset class like real estate. From time immemorial, ownership of a property has been the ultimate goal of every individual. It is not only the investment rationale that drives the real estate market, but the sentiment attached to ownership of a property. The sense of security provided by ownership of a house cannot be compared to any other asset class. God has stopped creating land, and demand outstrips available land. This has resulted in huge premiums on land banks. The more one delays buying a house, the more premium one ends up paying. The increase in housing prices is not only on account of land prices but also on account of ever increasing prices of all the inputs like steel, cement, paint, labour etc. Inflation affects all asset class including real estate. Hence, you always find a gap between what one can afford to invest and what a property costs. Such individuals invest in shares, mutual funds etc. with a view to beat the price gap and ultimately invest in a house by unwinding these investments at an opportune time. Unfortunately real estate prices would have also gone up and the gap would have only widened. Most of the speculative gains in share bazaar ultimately gets invested in real estate, and gives a price push. Hence, in the current scenario of a strong bull market in equities, a decision on buying a house is now, and not tomorrow.

Most of us do not have large sums of money of our own for taking investment decisions in property investments. Therefore, we need to make leveraged investments by going in for a housing loan. Leveraging also helps you in tax planning in view of tax reliefs available to you u/s 80c for principal up to rupees 1 lakh and up to Rupees 1.5 lakhs towards interest component u/s 24 from the EMI payable. This gives a tax relief of Rs 25750 at 10% slab. This relief can be claimed as loss on house property if one stays in the house instead of renting it out. If one rents out the property, then the rental income can be set off against rebate provided u/s 80c and 24 up to Rs 1 lac and 1.5 lakhs respectively.

With a downturn in credit demand from commercial and industrial sector, and rising NPAs in this sector, Banks are competing in providing housing loans on attractive terms. This is the right time to invest in a property by taking a housing loan.

Staying in a rented house throughout your working life is not an option at all. Such a scenario may have several implications:

  • One will never have that sense of security in owning the roof over one’s head. One will always feel insecure compared to the peers who own their residences.
  • One need not relocate every now and then to get over the annual escalation clause in lease agreements and/or landlord trouble.
  • One will realize over a period of time that instead of paying monthly rent, one could have very well paid EMI on a housing loan and become owner of a house property.
  • Similarly huge advance rents paid, by whatever name called, could very well have served as margin on a housing loan.
  • When one gets older, a property investment would be a best bet as an investment vehicle. Property investments give a steady appreciation, and long term capital gains tax can be minimized through indexation benefits. One can also go in for a reverse mortgage if the other sources of income have eroded due to inflation, and maintaining the lifestyle becomes difficult, along with rising medical bills due to old age ailments.
  • Over a period of time the property you own, if selected properly when initially buying it, will become a coveted property due to location and command a premium. But one may need to downscale and relocate to cheaper locations if the property is rented. Cheaper locations will obviously have several drawbacks including safety.
  • One can buy a property and then make additions and alterations and earn rental income by renting out the additional structure. This way one can have the cake and eat it too. One gentleman I know acquired a property in a fantastic location and pays his housing loan installments out of his rental income and also lives in the ground floor of same property, paying no rent!

I have given below a scenario demonstrating why taking a housing loan and investing in a house property is a good idea, since many people are averse to taking on the burden of a huge liability.

A senior citizen approached me for advice on a situation he faced. His son earns around ₹5 lakhs per annum salary income. He has bought a ready to occupy apartment costing ₹17 lakhs all inclusive and taken housing loan of ₹12 lakhs @ 10.25% interest repayable in 20 years. Margin of ₹5 lakhs has been contributed by the senior citizen by breaking some fixed deposits. The EMI works out to ₹11,780. EMI payable from July 2014. The senior citizen has some more Bank FDs aggregating to ₹10 lakhs on which he is earning interest @ 9.5% per annum. The tenure of the FDs is 10 years with residual maturity of 5 years. Bank does not deduct TDS as it is a 15H case. He earns interest income of ₹95,000 per annum. He wanted to know whether it would be advisable to break the FD and partially clear his son’s loan to the extent of ₹10 lakhs.

Apart from an old man liquidating his life savings of ₹10 lakhs and being entirely at his son’s mercy, I had to show him the economics of the proposal from current year.

His son’s gross pay₹5,00,000
Less basic exemption₹2,00,000
Less individual rebate₹2,000
Less section 80c₹14,250
Less section 24b₹91,770
Taxable income₹1,91,980
Tax Payable₹19,774

By prepaying the housing loan of his son he will lose interest income of ₹95,000 per annum on his FD, and his son will lose tax rebate of nearly ₹11,000. This rebate will go up next year as full effect of amortization kicks in. Hence, I advised him to hold on to his fixed deposit.

People who intend to foreclose their housing loans need to weigh the cost benefit of it before taking a decision. At this time one also needs to calculate the ROI on the amount kept for foreclosure by deploying in different asset class plus the IT benefit. In the ensuing budget there is a bright possibility of section-24 reliefs being increased to ₹2,00,000, as Government is keen on housing for all.  This will be a big boon for salaried class. It will be worthwhile buying a house rather than renting a house, and the old adage can be turned on its head!

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