​​​
  1. Are renters better off than homeowners?

Are renters better off than homeowners?

Empirical research shows that if the savings due to renting are prudently invested, the long-term growth in a renter’s wealth will surpass a homeowner’s

By: | Published: September 14, 2016 6:08 AM
Empirical research shows that if the savings due to renting are prudently invested, the long-term growth in a renter’s wealth will surpass a homeowner’s Empirical research shows that if the savings due to renting are prudently invested, the long-term growth in a renter’s wealth will surpass a homeowner’s

HOME ownership is often associated with a sense of security, pride and entitlement. Communities with more homeowners tend to have deeper investment in socio-political infrastructure which enhances welfare. There are some disadvantages too: Restricted mobility of homeowners may interfere with career prospects. Issues related to risks in title, construction-delay by developers and fears of adverse possession may take their own psychological tolls. However, it is the financial motivation which poses a bigger question.

Consider a flat worth R1 crore, say, in Noida. Also, consider a 20% margin, 30-year loan which costs 10% interest rate. Including the annual EMI, property taxes, insurance, fees, etc., and adjusting the income-tax benefits, the annual cost of homeownership will be about R9 lakh. This means that in terms of cash flows, homeownership has a negative 9% yield initially. On the other hand, the after-tax rental income from such a flat (after adjusting for brokerage, maintenance, etc.) will hardly be R1.5 lakh. So, in the short run, the net-effect of homeownership is negative (-7.5%). A conventional hope is that whatever negative yield accumulates over the years will be “more than” compensated by real estate price appreciation.

However, Residex, the NHB’s residential real estate price index offers a reality check. Of the nearly 220 price indices tracked, most (120-odd) indices fail the investors, where year-on-year real estate price appreciation has been less than 7.5% in recent years. The price-appreciation averages at 5% ranging between -9% (Meerut) and 17% (Chennai). Of the 26 metros tracked, in nine the price appreciation is near-zero or subzero, in six, the prices appreciated at levels below 7.5% while only in 11 metros, the price appreciation was above 7.5%.

Some pockets of these metros which experienced high appreciations are, in fact, at the risk of bubble-building and are ripe for bursting. Interestingly, the 7.5% price appreciation benchmark only affords a homeowner to breakeven on the investment. It is the appreciation in excess of 7.5% which would mean growth in wealth. Even so, how many owners will actually sell their homes soon to capitalise on this gain?

The cash flows that appear so grim to the homeowners in the beginning years will, of course, improve in the long run. After all, the rental income will grow, but the mortgage payment may stay stable. Considering a 6% growth rate, the cash flows would still stay negative until the loan matures. If the home is sold at its market price (considering 6% to 10% annual appreciation) in the 30th year, a homeowner’s annual return would roughly be 5% to 11% which averages at 8%.

Similar returns may be generated from investing in bonds or fixed deposit bank accounts which are virtually risk-free and hassle-free. Even the optimistic real estate returns in the long run may be matched (or beaten) by mutual funds. Empirical research, too, supports this notion: if the savings (due to renting) are prudently invested, the long-term growth in a renter’s wealth will surpass a homeowner’s. Nevertheless, studies also caution that renters are too imprudent to capitalise on the opportunity.

The example cited here is typical to middle-class investment in multistorey flats; and may deviate from reality. For owner-occupied flats, the psychological perks of homeownership may outweigh all financial concerns. Also, investments targeted at parking cash in real assets or unleveraged investments in homes may offer a slightly different story. Nevertheless, despite India being among the lowest-ranked countries (among peers and developed nations) in terms of housing affordability, mortgage availability and per-capita income, our homeownership rates are among the highest globally. Is it time we rethought our obsession towards homebuying?

The writer is assistant professor of real estate finance, Ecole hoteliere de Lausanne, HES.SO, University of Applied Sciences, Western Switzerland

 

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

  1. A
    Ajeet
    Sep 15, 2016 at 10:52 pm
    Great analysis. But, I don't get the paradox that all the rich people I have seen are invested too heavily ( not the uber rich, but the upper middle cl). How can we explain this scenario if investing in the stocks/bonds/gold is going to yield better result?
    Reply
    1. P
      Prashant
      Apr 12, 2017 at 5:06 pm
      Dear Ajeet: Thanks. "Paradox", indeed, is the best way to explain the phenomenon. Sometimes, the excessive investment in residential ets may be driven by irrational expectations, sometimes to ensure the security of illegitimate wealth. Of course, sometimes it does make some economic sense as well.
      Reply
    2. A
      Amar Bishram
      Sep 14, 2016 at 2:15 pm
      well Mr. Das, as this study focuses on Indian context, the observation appears to be wisely considered. A middle cl citizen is following the old age "security" pattern in terms of finance as well as realty estate,. However the present generation might deviate from it and start taking risk of investing in promisung return n maturity plans since the investment sector is also evolving. For example, with NPS(New/National Pension System) in force quite a good amount of capital is aculating in individuals' account which is never accepted by the old thought I am referring to. The same change of pattern is rather being obsereved in today's earning generation who bothers less on houwnership but due to movable job nature pays rent at his place of duty. On the other hand thought on prudent investment or saving has to be suggested as noted in the article. I expect that this opinion will be widely accepted.
      Reply
      1. P
        Prashant
        Apr 12, 2017 at 5:10 pm
        Dear Mr. Bishram: Thanks. Could not agree more. For some households, home-ownership may be a genuine need. For many others, it just appears to be a fad. You make a very good point that "housing" and "home-ownership" are not the same. Here is a follow up article you will enjoy reading: : www.firstpost /business/budget-2017-with-demonetisation-hitting-homebuyers-rental-housing-needs-to-be-promoted-3239492
        Reply
      2. L
        Lalu Prajapati
        Sep 15, 2016 at 6:40 am
        Dear Prashant,Very good analysis, A bigger proportion of flat buyers(or say, potential buyers) face mobility issue. Some of them may end up settling in abroad too. A period of 25-30 years is quite long, and we are not sure if those flats will be ever used as a residence by homeowners. Also, there is no certainty that it can be sold easily after the end of loan tenure.
        Reply
        1. P
          Prashant
          Apr 12, 2017 at 5:13 pm
          Dear Lalu: Thanks. Indeed, our socio-economic structure is drastically changing. We must think of alternate ways of maximizing the quality of life. In a lot of places, the wealth invested in an owned home with a low probability of owner-occupancy does seem to make a lot of economic sense nowadays.
          Reply
        2. N
          Nachiketa Tuteja
          Oct 4, 2016 at 9:01 am
          Dear Mr. Prashant,I believe, that the key reason for fast growth of real estate prices in earlier years was parking of black money which used to be in abundance in Indian economy. Going forward influence of black money in relative terms is likely to be reduced. As such real estate as an investment avenue will not be as lucrative as in past and investment in equity markets relatively will be more attractive. Real Estate investment for self use (first house) still makes sense but not purely for investment of surplus funds.And yes, in recent years the phenomenon described is correct. However in 1970s, 80s, 90s and early years of 21st century, real estate in India gave stupendous returns. That is the reason people still keep hope that sooner or later this stagnation or negative returns cycle will reverse. This may be false hope for 1 to 3 years time frame and may turn out to be true if Indian economic growth accelerates to above 9% per annum for few years.
          Reply
          1. P
            Prashant
            Apr 12, 2017 at 5:14 pm
            Dear Mr. Tuteja: Thanks. Yes, black money only exacerbate the affordability problem. However, it is only a part of the problem. You will enjoy reading this follow-up article on these lines: : www.firstpost /business/budget-2017-with-demonetisation-hitting-homebuyers-rental-housing-needs-to-be-promoted-3239492
            Reply
          2. N
            Nachiketa Tuteja
            Sep 19, 2016 at 6:35 pm
            Dear Dr. Prashant,I feel that yes, in recent years the phenomenon described is correct. However in 1970s, 80s, 90s and early years of 21st century, real estate in India gave stupendous returns. That is the reason people still keep hope that sooner or later this stagnation or negative returns cycle will reverse. This may be false hope for a 1 to 3 years time frame and may turn out to be true if Indian economic growth accelerates to above 9% per annum for few years. Key reason for fast growth of real estate prices in earlier years was parking of black money which used to be in abundance in Indian economy. Going forward influence of black money in relative terms is likely to be reduced. As such real estate as an investment avenue will not be as lucrative as it was in the past and investment in equity markets relatively will be more attractive. Real Estate investment for self use (first house) still makes sense but not purely for investment of surplus funds.
            Reply
            1. M
              Murty
              Sep 14, 2016 at 3:37 am
              Dear Proffessor,Just tell me one thing! Who will buy a 30 year Old Flat???
              Reply
              1. P
                Prashant
                Apr 12, 2017 at 5:16 pm
                Dear Mr. Murty: Absolutely! That further supports the central argument of this article. What is the use if it takes us decades to breakeven.
                Reply
              2. P
                Parimal
                Sep 14, 2016 at 1:40 pm
                The loss in taxes is another loss which is not taken into consideration while buying.Eg. Stamp duty, VAT etc. needs to be paid during purchase of flat but it is not refunded when flat is sold. This money too is wasted & so return on this money should also be calculated accordingly when it is invested, thus increasing overall returns for those who rent.At current high prices, it is best to stay on rent.
                Reply
                1. P
                  Prashant
                  Apr 12, 2017 at 5:18 pm
                  Dear Parimal: Thanks. Well said. This is also a major impediment in the development of REITs in India. You will enjoy reading this article: : businessworld /article/Are-Managers-Ready-For-REITs-in-India-/09-11-2014-74601/
                  Reply
                2. T
                  Tripurari Kumar
                  Sep 15, 2016 at 4:26 am
                  Dear Prashant,Really a good article, currently I am also facing mobility issue. Also your calculations are mirror for cities having low appreciation.In my view before owning a house we must think as an investor i.e we should calculate appreciation rate of that locality.
                  Reply
                  1. P
                    Prashant
                    Apr 12, 2017 at 5:20 pm
                    Dear Tripurari: Thanks. Yes, mobility is clearly one of the perks of renting. Ideally, we only "worry" about the ets that we own.
                    Reply
                  2. Load More Comments

                  Go to Top