Real estate: Buy or rent? Invest or occupy? Here's how you can decide

Despite a surge in property prices and interest rates, housing loans and property sales have increased in India post the pandemic. According to the RBI data, the all-India house price index (HPI) recorded its highest increase over the last seventeen quarters (4.6 per cent, y-o-y) in the fourth quarter of 2022-23, and quality-conscious millennials prefer A-grade builders delivering projects priced in the Rs 1-2 crore range, shows data analysed by Bankbazaar.

The share of residential housing loans in total loans has increased over the last eleven years to 14.2 per cent in March 2023 from 8.6 per cent in March 2012. Total exposure of the banking system to real estate stood at 16.5 per cent of total loans in March 2023.

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Buy or rent? When are you ready? 

Adhil Shetty, CEO, BankBazaar.com lays down the five basic rules to evaluate whether you are ready to buy a home or not

1. Having about 30% cash for a down payment indicates financial readiness for homeownership. Having the minimum cash allows you to borrow the rest. The out-of-pocket costs are either up-front or staggered.

2. A credit score above 750 apart from a stable income and a long working life makes you an attractive borrower to lenders and qualifies you for lower interest rates. Ideally, target a score of 800 before you borrow.

3. Committing to homeownership means you’re prepared to invest both financially and emotionally in a property as opposed to treating it as a short-term investment. The financial math works in your favour in the long-term.

4. When you have researched the housing market in your desired location, ensuring that it aligns with your lifestyle and financial objectives. It’s hard to get the perfect option. 

5. Ensure what you’re buying has the necessary legal clearances, clear titles, and is not under dispute. Engage a property lawyer to vet the papers. It’s an additional cost but provides you peace of mind. 

How to save for your home: 

1. How much do you need to save? A loan may cover 75-90% of the sum of the base price, GST, amenities and utilities . The rest—i.e., 10-45%— comes out of pocket. Large costs such as registration and stamp duty and furnishing will typically not be covered and must come out of the buyer’s saving.

The closer a buyer is to retirement, the shorter their loan tenors will be. Older buyers are also likely to have saved up. Hence, the upfront payment needed may be much more than 10-45%. It can be saved with long-term investment options. A home loan can cover the rest basis the borrower’s eligibility.

2. FD or recurring FD:  An FD or a recurring deposit with a commercial bank or post office are safe options for protecting your savings and getting moderate returns. They can be liquidated instantly. AAA-rated company deposits are also useful. But check the lock-ins.

3. Use a liquid MF: Short-duration mutual funds such as overnight funds and liquid funds invest in money market instruments. They are low-risk and better for short-term savings than equity funds which can be volatile. Risks apply. Unlike FDs, they don’t advertise forward returns.

4. Equity is best for long-term saving: Equity has delivered high real returns in the long term. Hence it is ideal for long-term goals such as retirement planning. If you are delaying your home-buying plans, have

equity in your money mix for better returns. You must also systematically shift to debt as you approach your target for capital protection.

5. Your PF can help: Long-term debt savings such as Employees Provident Funds are meant for retirement planning but can also help with home-buying. Eligible subscribers can withdraw up to 90% of their savings for home construction or purchase. 

"In the short term, ensure the investment is not subject to market volatility. Stable assets like arbitrage funds or FDs work. For the longer term, invest in equity funds as per your risk profile. Reduce the equity exposure when near the goal," said Lovaii Navlakhi, CEO, of International Money Matters.

Invest or Occupy? 

When buying a house for self-occupation, returns are a secondary concern. The primary concern is whether the house meets your family’s immediate needs, said Shetty.  But when buying a house purely for investment purposes, returns are of prime importance. From housing, returns can be via market appreciation as well as rental income. Data from the House Price Index by the Reserve Bank of India shows that over the last 10 years, returns from house prices are comparable to a fixed deposit account.

Various industry sources cite net rental yields (rental income as a percentage of the house price) to be 3% or less in many Indian markets. Net rental yields (yield after maintenance costs, taxes, and loan interest) are often negative in the short-term.

The returns from housing would vary from one market to another, and from one investor to another. Hence the ideal use of a house is self-occupation. Wealth creation can also happen via equities, debt, and gold holdings.

The 10-year returns from 10 major markets covered by the RBI’s House Price Index show that real estate returns don’t compare favourably with other forms of investment. Price returns and rental yields before maintenance costs, taxes, and loan interest have been negative in the short-term. 

‘Real’ returns, i.e., are returns after inflation, are negative in many cases, assuming an inflation rate of 6 per cent. Housing is a cost-intensive investment which can shock a household’s finances and savings

in the short-term. Housing is also an illiquid investment as it cannot be liquidated easily. Financial investments such as ,mutual funds or fixed deposits do much better in this regard.

And since the costs are high, housing becomes the primary form of savings for many households which may not experience rapid wealth growth.

"Given the glut of housing inventory—both constructed and under construction, these trends are not expected to change and returns from housing will continue to come in stops and starts. Therefore, for retail investors, housing becomes a risky proposition on several fronts, and only long-term holding may lead to positive rental yields," said Shetty.

The  ideal use of housing purchase narrows down to self-occupation for most investors who can create wealth much more easily through investments in mutual funds, provident fund, debt, and equity.