Is it a good time to buy Real Estate?
Updated: Apr 6, 2021
I believe that investing in real estate can be a single source of wealth destruction in your life. But maybe that’s an emotional statement based on some past experience.
So, let me step back and analyze this better. I will try to park my biases for now and see it from a NO emotion sense. I hope the reader is able to think in an emotionless way too.
I don’t know about someone else’s context but here is my context. I was renting out a place in DLF Phase 4 Gurgaon (Regency Park 2) for Rs 40,000 per month. In February 2021, I shifted to DLF Phase 5 Gurgaon (DLF Park place) for a rent of Rs 65,000 per month.
The capital value of Regency Park 2 is Rs 1.75 Crores and DLF Park place is Rs 3.50 Crores. People who live in Gurgaon will have a good sense of what I am sharing.
A few days back, I asked my wife, do you think we should buy a second house (I have one in Delhi, the story to follow later). She unexcitedly said, sure “I have heard good stuff about DLF Camellias”. I may be managing other people’s money, but just like any other reasonable wife, my wife also knows how to ground her husband. (Outside Gurgaon region reader, DLF Camellias has a capital value of around Rs 25 crores).
When should you buy real estate for self-consumption?
You buy a property for self-consumption when mortgage rates are close to rental yields. The current mortgage rate is around 7%, probably the lowest we have seen. Let’s understand what rental yield is.
Rental Yield = Yearly Rent divided by Capital Value of the house
Regency Park 2 = (40000 X 12) divided by Capital Value (1,75,00,000) = 2.74%
DLF Park place = (65000 X 12) divided by Capital Value (3,50,00,000) = 2.23%
I always look for value deals, coming to DLF Park Place may have increased my rent but my rental yield actually reduced. Enough of my ego boast but the real question remains unanswered “Is it a good time to buy Real Estate?”.
You compare the rental yields with the mortgage rate.
7% vs 2.74%/2.23%, the test fails.
Have you ever seen a time when the mortgage rate was close to rental yield?
In the year 2005, mortgage rates were close to rental yields. The mortgage rate in 2005 was around 10%. I was staying with my parents in Dwarka (Delhi), the monthly rent was Rs 12,000 for a flat value of around Rs 15 lakhs. This is a rental yield of around 9.60%, close to the mortgage rate.
I validated this hypothesis with a CFO of a very large online brokerage firm. He agreed that 2005 was indeed a very good time for the same reason.
I got caught up in real estate investing during 2009 and 2011. Made some money from the first deal (out of luck, it was flat in Jaypee) but the second one got stuck. I negotiated hard to avoid a court battle with a builder company and did a side deal to get a flat in Dwarka. The idea was principal protection and not growth. I invested around Rs 1.05 Crore in that house, which has now a value of Rs 95 Lakhs. Had I just kept the money in a bank, maybe an FD, the money would have risen to Rs 1.6 crores in the last 10 years? And I still call myself a financial advisor :(
I paid a price for making an irrational decision at the wrong time.
A house is not just an investment asset, there are memories attached to that space. Is there a rational way to make this emotional decision?
Now, let's use a framework to make this emotional decision more rational.
I created a model that helps me understand the inflexion point when you would decide to rent or buy. This is based on a 10-year period. (The Excel Model is attached for your reference).
Assuming that instead of paying Rs 65,000 per month rent, I buy this apartment for Rs 3.50 crores, a down payment of 20% and a loan of 80%. I am ignoring any additional repair cost, registration cost etc.
In the case of Renting Out:
There is rent and that rent continues to increase, assuming 5% p.a. A total rent of around Rs 98 lakhs is paid over 10 years.
In the case of Buying Out:
The loan amount will attract interest payment and the total of that would be Rs 1.37 Crores over 10 years. Value of the house also increases by 5% p.a.
Now the implied benefit.
In the case of Renting Out:
Since you are not paying any down payment, the money can be invested and grown. 20% of Rs 3.5 Cr is Rs 70 lakhs and that can be invested. There are also some additional savings on registration cost, repair etc. but I have ignored them for simplicity.
How much you earn on this will define whether you should buy or rent. If I assume 12.5% p.a. I will break even.
In the case of Buying Out:
I have assumed an increase in home value at 5% p.a., this increase would be Rs 1.92 crores (Value of house will become Rs 5.42 crores in 10 years).
Now my final view, mortgage rate or rental increase may not have a huge impact on your decision.
Your critical piece of assumption would be the rate at which you expect your funds to grow and how much property price increase you expect.
You can change the assumptions in the excel file and see it for yourself if you are better off buying or renting out.
Note that earning an after-tax return of 10% plus may not be easy. Also, a house value increase beyond the inflation rate should be seen with suspicion.
(Investing in a piece of land may be a good investment decision. And in case, you plan to invest in an apartment, ensure it's delivered and ready to move.)
I apologize to readers who had to do some bit of maths in order to understand the analysis. The intent was not to complicate but take away the emotion from the decision making.