Should you rent or buy a house? Many young families face this decision when they move out of the joint family to be on their own or when they shift to a new city for work. Notice that this is not an invest-or-not question, to which the answer will be very different. This is a should-I-rent-a-house-that-I-will-live-in or should-I-buy-now question. For others already on rent, the family conversation about ‘rent or buy’ comes up each time the math is done on how much rent flows out of the family budget each month. “If we had bought our own house, we’d be owning it soon rather than all this money getting wasted in rent” is something most renting families stress over. I’ve had this conversation at home many years ago; especially when money is tight and the growing family’s needs are many, the rent vs buy decision seems even more crucial. Why not put money down for something you will own rather than down the drain in rent?
If real estate markets were efficient, there should be almost no arbitrage between the decision to rent a house or buy it. The rent and the equated monthly instalment (EMI) would be not all that far away and you would be able to stretch just a bit to compensate for the mortgage cost to turn the rent into an EMI. But real estate markets in India are far from this utopia and follow no rational rules for valuations for residential real estate. At current market prices where the rental yields (annual rent divided by value of property, or the return you get from the asset if you were to rent it out in percentage terms) are just 1-2%, renting is clearly better than buying. Look at it this way— what you can rent for Rs25,000 a month will cost you at least Rs1.2 lakh in EMI in Delhi and Mumbai.
Around this time every year, for the last few years, Mint does a special edition tracking the uber rich in India. Conceptualised and edited by my colleague Vivina Vishwanathan, the edition looks at the lives of the super rich Indians through the lens of money. Economic liberalisation allowed new categories of people an entrance into the uber rich club. Doctors, lawyers, professionals, first-generation entrepreneurs, actors and sportsmen joined the high table of the super rich where the already rich through inheritance sat.
Year 2014 kicked off the edition idea with an issue that mapped the new Indian rich. You can read the edition here: bit.ly/2xsiOjF. Year 2015 mapped the Rich Professional. You can read the edition here: bit.ly/2wAF1be. In 2016, Mint Rich Stars mapped the money lives of India’s movie and sports stars. You can see the edition here: bit.ly/2hapZaf. We found behind the glitter and the high living was an uncertain future, sporadic income and a short tinsel earnings lifespan. This year, we mapped the lives of the young inheritors of some of the biggest business houses in India. You can read the edition here: bit.ly/2xfj6tY.
The reactions to the editions have always been a mirror to our difficulty in dealing with money. The basic question asked is: why do we map the lives of the rich? Why feature their lives in a poor country? I can only answer with a counter-question: why not? Mint aims to be an unbiased and clear-minded chronicler of the Indian dream. A lot of young Indians dream to be rich. Surely it is better to dream to be rich than dream to be poor. Chronicling the lives of the rich in one edition a year doesn’t make Mint an apologist for the rich.
The stories you hear are romantic only in hindsight. A young man starting with just Rs50 in his pocket sets out into the world. Thirty years later, he is the king of a large multinational empire. The stories of deprivation and lack of food in the early years make for good copy today, but only somebody who has been through it can even begin to imagine what it was like.
When you are struggling to get out of a bad place, you don’t know how it will end. Whether you will break through or get sucked in. In that struggle, however, comes the transformation. It is that fire in the belly to change, to transform, to win that pushes some people to do superhuman things. And once you make the breakthrough, it is a very human desire to promise that your children will never go through the bleak and seemingly bottomless darkness you have lived through.
You remember what the cold felt like without the money for an overcoat. Or the smell of hot food when all you had was a hole in the pocket. Not your children. Never.
I have a friend who lives well when she earns more and gets into a frugal mode when business is bad. An artist, her income fluctuates, so does her lifestyle. Up when there is more and down when there is less. Her mood, though, is quite delinked from her financial status—always up. Last year, she said she wanted to start systematic investment plans (SIPs). Why? Because everybody around her was starting SIPs, and it seemed a cool thing to do—getting financial security is good, no? Yes, sure, but it has taken her the first 40 something years to get to even talk about financial security. Better late and all that. The first thing I asked her to do was to put down a number that she needed each month to live. It’s very difficult to pin down an average monthly expense for a person who matches expenses to earnings every few months. But the budgeting exercise, which is the building block for most plans, takes on much bigger importance for people with fluctuating incomes. Without knowing what you spend each month, there is no financial plan.
Why Indian households remain in financial behaviour that is ‘regressive’ is a question that has wrinkled the brows of many a policy maker. ‘Regressive’ behaviour is the over-exposure of Indian households to cash, gold and real estate instead of financial assets. This behaviour includes a reliance on the moneylender for debt, rather than the formal financial system, and the use of ex-post borrowings to deal with medical and other emergencies rather than purchasing an insurance contract. With the mandate of the Reserve Bank of India (RBI), the Tarun Ramadorai committee set out to find answers to some of these questions in 2016. While other committees have looked at the same issue of the strange behaviour of Indian households from the supply side and found serious problems in the way formal markets have been set up, the Ramadorai Committee was asked to look at the problem from the demand side and provide solutions to it. In short, the committee found (read the report here: bit.ly/2iC3GKU) that Indian households are indeed globally unique in their financial behaviour. Not only do they rely heavily on gold and real estate, they are under-insured, have very little pension corpus build-up, take home mortgages much later in life than their mature-market counterparts, and walk into retirement still carrying the burden of debt on their heads.
How do we know when a market is overvalued? The equity market looks at price: earning (P-E) ratios, book value, price earning to growth (PEG) ratios and valuations to see if stocks, or entire markets, are overpriced or underpriced. Is there a similar metric for real estate, a rule of thumb that tells you when a property, or the whole real estate market, is overpriced or underpriced? Mature markets use some rough rules of thumb to decide over- or under-pricing in real estate. The first is the ‘gross rent ratio’. Divide the sale price of a property with the gross annual rent it will get. Gross rent does not account for costs of the loan, maintenance or society fees. If a flat sells for Rs1 crore and can be rented for Rs50,000 a month, or Rs6 lakh a year, the gross rent ratio is 16.6. Real estate investors use a rough rule of thumb that says: buy at 10 and sell at 20. Buy when the rent ratio is 10 and sell when it touches 20 because the property is overvalued. The second metric is the yield which just switches the two numbers. Divide the gross annual rent by the sale value of the property. The annual rent of Rs6 lakh divided by a capital value of Rs1 crore gives a yield of 6%. Mature market thumb rules say buy at a yield of 5% and sell at 10%.
If in the 1950s somebody wrote a future finance story about India, they may not have predicted the market that faces a retail consumer today. Till the 1990s, your savings and investing decisions were dependent on the government. No wonder Indian households chose gold and real estate as saving sumps. The financial sector was a reflection of the overall direction of the economy. Costs were high, service poor in state-owned and run finance. But post 1991, change came suddenly to finance and this column maps some of those changes as India celebrates 70 years of political and 26 years of economic freedom.