Get Rich by staying in a rented house !

I was reading Ranjan’s post and it got me thinking again about the real returns of real estate and the arguments against owning a house. I have been not in favour of buying a house and my opinion is still the same.
The problem with real-estate investment is that there are multitude of factors like notional gains, emotional trauma, significant risk exposure and various hidden costs that clouds the real picture, causing the confusion about returns. One of the points that I liked from Ranjan’s post is
If you calculate the IRR for an investment in property, you also need to factor in the maintenance costs and the rent you receive. Often a 3 times increase turns out to be a 6% return on investments.
This is significant to note since most of the times, the friends and family that boast of exceptional earnings on investing in real-estate, is just notional.

In the current scenario, I feel that real-estate is definitely not a good investment and a person can become more rich if he stays in a rented house.
  • A person buys a house depending upon the level of his income. A person earning higher amount tends to buy a higher priced house and vice versa. Hence there is some correlation between the increase in income levels and the increase in house prices. This also implies that house prices are definitely not going to increase all the time, since incomes are not going to increase all the time. But there are various reasons that house prices can go down even when demand is high. Also there are articles which provide an indication that real-estate prices can drop. If we look at rental prices, they have not gone up proportional to the house prices and hence owning a house is getting costlier every year but not renting the house.
  • When one considers the ratio of EMI/Rent for a similar house, it is very clear that  the minimum ration could be still 4:1 while in some cases it could be as high as 100:1 depending on the location and the built up of the house. This implies that EMIs are always significantly higher than rents. If the remaining amount (EMI-rent) that is saved on EMI (by renting the house) is put into conservative bonds/stocks/gold, they can give significant returns compared to owning the house. So renting could make you richer if the surplus amount is invested in other asset classes which have given better returns than real estate over long period.
  • When renting a house a low maintenance charges needs to be given to the house owner apart from rent, but when you own a house, a person’s outgo is not only EMI but other expenses like taxes, insurance, maintenance etc and if this can also be invested in other asset class, wealth can be grown many fold over longer durations.
  • When the interest rates rises or real estate prices come down, the EMI seldom comes down (it rather increases) but rents will definitely come down. If you own a house, the outgo remains high in all real-estate cycles. Also the EMI pinches the most since majority of the portion is towards the payment of interest component of home loan, whereas a person living on rent can again invest the additional surplus if the rent decreases.
  • A home loan increases the risk appetite of a person tremendously and hence restricts the person to pursue options to increase his income. I know of many friends who could not move to another city, take up another job or start their business simply because of the home-loan EMI. But a person living in rented house can simply move to a better job in another city or move to a smaller rented house before starting a business.
  • If a person buys a house, the choice of house/neighbourhood will depend on his income level, but when a person rents a house, at a much lower outgo, he/she can stay in a much better house with better quality of life. This is especially true in metro locations where better locality commands a huge price of house but the rents are still affordable. For example, in Bangalore if your EMI is around 20K per month [house ~ 25L], the only house you could buy is in a lower-middle class locality (or far away places from city), whereas with a rent of 20K you can take up a house in the really posh locality. 
  • There are other factors which are never accounted like emotional trauma in purchasing a house (most of the builders are not keeping their promises). The house possession is being delayed, the quality of construction is not up to the mark and in certain cases their is a straight cheating by builders who simply run-away taking the money. A person on rent simply changes the house if he/she doesn't like the current place.
Although government is doing its bit by planning to have a real-estate regulator but I do not think that it can change the real-estate landscape significantly in coming years. It is important to invest in real-estate as a means to diversifying your risk but don’t follow the herd. It is very important to set out priorities and understand your risk appetite. It is a myth that if you don’t buy today, you will miss out on the game and hence don’t fall for it. Only buy when you really need it and buy only, what you can afford without compromising your lifestyle or other priorities in life. I have not invested in real-estate and do not intend to do in next ten years.
Read out this interesting blog post by Manish as well.

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