Buy v Rent. Part 1: Cost

Since a roof over the head is a basic need, most adults will have to pay for their home at some point. One can buy and own a home, or simply rent it. In this two-part series, we explain which option is better for your wealth. You can read the second part here.

What this article isn't about.

We will not explain where, what kind, or how spacious your house should be. Likewise, we won’t consider the emotional aspects or non-financial benefits of owning versus renting. Instead, we will try to answer which option will help you make more money in the long run. While this article is primarily for those looking to live in the property, it is also applicable for those buying a home purely as an investment.

But isn't "owning" always better?

Traditionally, we have had great faith in house or land as an asset (next only to gold). 

As we will explain, neither buying or renting itself is a guarantee of a wise financial decision. To determine whether a decision makes financial sense, we need to know the investment, i.e. cost, and the total return on investment. The first part will deal with how much you will totally pay, i.e. cost, while the second part looks into how much you can expect to earn, i.e. ROI.

We will consider 5 properties across the country (see list below) to illustrate each point.

Cost of owning vs Cost of renting

You can live in a property after - 

Option 1) Owning it by paying the entire amount in one go, i.e. outright purchase. 

Option 2) Renting it and paying a rent that increases by 5% every year. 

Option 3) Owning it by paying only 20% as down-payment and repaying the remaining 80% as EMIs at 9% interest for the tenure. We will consider the tenure to be 20 years.

In Table 2, Columns 1, 2, and 3 respectively mention the cost of living for each property.

The property price (Column 1) in this table also includes additional 6% for stamp duty and registration.

Observations

1. For property A, renting is cheaper than outright purchase and far cheaper than paying EMIs. As highlighted, one should rent this property instead of buying it.
2. For property B, the cost of renting is almost equal to EMIs and downpayment. For the long-term, one should own the property.
   
   

Real estate prices of some areas in Mumbai are comparable to that of Manhattan, New York.

To a great extent, the decision to buy or rent depends on the difference between renting and EMIs. The last column in Table 3 (see below) expresses it in the EMI: Rent ratio.

Table 3

Observations

1. Lower the ratio, greater the reason to buy. Ideally, the ratio shouldn’t exceed 1.6.
2. More importantly, the EMIs shouldn’t exceed 35% of take-home salary.

Stamp duty and registration

Depending on the location, buyer’s gender, sale amount, and other factors, the buyer has to pay 4% to 7% of the sale amount for stamp duty and registration of the property. Therefore, the cost of buying the property should be inclusive of this amount.

Brokerage, pending dues, and renovation costs

If the sale was done with the help of a broker, the charges could typically vary from 0.75 to 1%. The cost of buying the house should also include any tax and maintenance charges that are due on the property. The biggest cost, especially while buying old properties, can be around renovating it. All of the above should be included to arrive at the total cost of the property.

What is the cost of living?

The cost of living for different locations in the city -- sometimes for two properties on the same street -- could be entirely different. Typically, the cost of electricity, water, maintenance, and property tax are the components that get added to your monthly outgo. While rent usually includes maintenance and property tax, none of these four are included in the EMI.

For example, in Bangalore, this amount for a 2BHK apartment in a gated community could be as high as Rs. 4,500 per month, depending on the amenities available, water consumption, and water source. In contrast, for an independent house in the same neighbourhood, it may not even exceed Rs. 1000.

If one were to take the example of Mumbai, the property tax for an old apartment in the heart of the city could be lower than a new one in the suburbs, even if the rent and price is many times more. 

If you have school-going kids, the amount spent on their education could also greatly depend on the location you choose. 

The hidden cost of commuting

Given the state of India’s congested roads, the time spent in commuting is a high cost many fail to consider. 

Let us consider someone drawing a monthly salary of Rs. 1 lakh. If he spends 20 hours and Rs. 2,000 every week navigating traffic jams, it costs him 20% of his waking hours and 8% of his salary. A lower EMI for a home in the far suburbs isn’t always worth this sacrifice. In Bangalore, it is not uncommon for people to rent a house near their workplace even though they might own a house elsewhere in the city.

In the second and final part of this series, we look at what impacts returns and how much you should expect.