Should you rent or buy?

16 comments Written on July 16th, 2006 by
Categories: RealEstate
The question one often asks when one gets to a comfortable state of personal affairs is: Should I rent a house or buy one?

All your friends are buying houses, or at least have "booked" them. There are good sentimental reasons to do so - owning a house ensures a tiny element of piece of mind - you can change things you don't like, like the drawers in your kitchen cabinet, or the paint on the walls, or add wooden flooring or a bathtub and such. But does it make financial sense to do this?

There are some advantages of each, but I shall take the Indian perspective. Here's where we are with Renting:

  • Renting in India typically costs less than 3% of a house value. Meaning, if a house's market value is Rs. 50 lakhs, the rental will be around Rs. 15,000 per month.
  • Tax breaks are available: Around 40% of your basic salary (or the rent, whichever is lower) is deductible from your taxable income.
But there are tax advantages for buying too. Here's where we are:
  • Payments on Interest upto Rs. 150,000 per year is tax deductible.
  • Principal repayments are tax free upto Rs. 100,000 per year. (Section 80C)
Let's see the comparison for a Rs. 50 Lakh house. I'm assuming that if you were to buy this house you will have a certain amount as "down payment" and pay a much higher EMI per month than the corresponding rent (Rs. 41,000 EMI, vs. Rs. 15,000 rent). If you rented, the extra money goes into the bank as a saving, and so does the down payment.

The return analysis on this, is in an excel sheet I have built, but here's the summary:

Key points to note:

  • Cash flow wise, Renting is better for the first 8 years.
  • After 8 years, buying is better, and after twenty years, the bought house is better by Rs. 1.4 crores!
  • The equation is skewed to some extent because of the limits on the tax saving. The limit of Rs. 150,000 on the interest is too low - for the first 15 years, you pay more than 150,000 interest per year.
  • Even the principal paid is more than 100,000 per year, so the tax saving there is limited too.
(Download the real estate calculator excel sheet)

If you're in for the long term you should buy, but remember this: If you think the prices will stabilize or come down in the next eight years, delay your decision to buy. After all, renting is far more cheaper and you will have much more money saved up in the longer term.

Also, be more aggressive in your investments to give you a better return, and therefore a better down payment.

Finally, remember that owning your house is important for sentimental and personal reasons too. The happiness you can derive from having an own house perhaps outweighs financial reasons.

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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@capitalmind.in.

16 comments “Should you rent or buy?”

>Hey… thnx a lot for posting such an exhaustive analysis… I was really contemplating on when to buy a house and then I come across ur piece of info which really served as a source of enlightment to me… GOOD ANALYSIS.. I must say
Cheers
Anshuman Kashyap

>hi,

can you please comment on AVIVA life insurance – save guard policy

>The rent vs buy question usually seems to result in ‘rent’ for most of us mobile professionals as we’re never quite sure where we’ll be tomorrow.

Given this situation and the returns possible from real estate, I did an analysis assuming it is a ‘buy’ and then seeing how much return one should get out of real estate in order to make it worthwhile (after considering the down payment, EMI, interest etc.). Check it out and let me know what you think!

>Hey Deepak – thanks a lot, great tips and simple explanations.

Can you please handle another blog “foreclose loan or invest in MFs?” I pay my regular EMIs, but cant figure out whether i should pay a part of my principle every year to foreclose my loan or to completely invest it in MFs. (with inflation, tax benefits, returns) the picture gets very complicated for me.

I would really appreciate if you can put a blog on these lines :)

>Ron: Good idea. I shall analyse and perhaps have a blog entry for you soon. Holiday season is around so I’m bound to be lethargic…

>Hi Deepak,
Your blog is very insightful. Can you add a script to make your posts “Printer friendly”. Since i would prefer reading things on paper :) (I am sure it will be a useful feature to many people)

Thanks
Govind

>Hi Deepak,
This is a very useful analysis. I have a doubt on real-estate investment in smaller cities which grow at a slower pace than bangalore.

The differences i have noted is

Capital appreciation in Bangalore = 10%
Capital appreciation in “Small towns” = 5-7%
Cashflow (rent) in Bangalore = 3%
Cashflow (rent) in “Small towns” = 5%

I have sufficient data to prove the figues i have quoted for the “Small towns” part.

My question to you is “if i wanted to invest in real-estate, would it make sense to invest in bangalore or in smaller towns”. Another point to be noted in terms of risk is that in bangalore there are too many fraud cases where property deals are concerned whereas it is almost non-existent in smaller towns.

Thanks
Vinayaka CA

>Vinayaka: Nice points. I think with 5% you will have a much better deal with rental returns – is the cash flow any better , using hte excel sheet? I have no idea what a house in the smaller cities cost and how much rent etc.

>excellent analysis. But I would say one big element which resulted in such a big difference (over 1 crore) was the fact that the capital appriciation assumed was 10% per year. I doubt that the assumptions remains valid after 5 years if you buy an apartment.

>Sachin: I’m not sure if you mean 10% is too little or too much. Yes, if you change the parameters you’ll see a difference in the results. I’ve noticed over the last 10 years that apartments make about 10-15% a year averaged. At this point, the values are actually coming down, so buying now may not result in much of an increase over time.

Overall, appreciation is a good thing, but cash flow wise, renting is far superior in the short and medium term.

>Hi,

I have a house that I bought for 50 lakhs in Mumbai in 2005. It has since appreciated to 90 lakhs. I am paying an EMI of 48,000. I had to move out of Mumbai when I changed my job and now renting in Bangalore at 16,000 per month. My question is: Should I keep house in mumbai (it can fetch a rent of 25,000 per month) or sell it and buy another house in B’lore? Or buy another house in B’lore keeping the house in mumbai? There is a tax benefit if you have both house where the WHOLE interest paid on non-self occupied house is fully deductible from income? Does buying two houses in my case is better or not?

-Thanks

>Well, don’t sell the mumbai house until you have finished three years (AFTER possession) because otherwise you lose 33% of your gains as short term capital gains tax.

Interest paid is deductible ONLY when you give your house on rent, and only to the extent of amount of rent received.

If you think the price in Mumbai will appreciate more, keep it for longer, otherwise sell when you have finished three years of possession.

Buying another house with so much negative cash flow (48K EMI, 16 current rent and you haven’t yet got rent on the other house) is very lopsided, I woudl not recommend it.

>Hi Deepak,

Thanks for such a quick reply.

Regarding whole of interest from EMI being tax deductible, i think it is possible to show loss for “Income from house property” if [Rent received - 30% of Rent (maintenance deductible) - Interest component of EMI] is negative. This can be offset with salary and other income.
http://www.incometaxindia.gov.in/publications/5_House_Property/5_House_Property.asp#AnnualValueofletoutproperty

Hi,

I saw your this article today.
Out of curiosity have you factored changing interest rate when buying a house?
I think that will change the 8 year factory of owing a home

Thanks..!

Good analysis and I tend to agree with you on most points you mentioned.

P.S. Sorry for being picky but 1,50,000 is how we Indians write it. I hate it when it is written as 150,000.

I’m as Indian as they get but I switch between the two formats :) My excel is configured to do the lakhs and crores thing.