The trouble with rent vs. buy calculations

‘Should I buy a house/apartment now’ or ‘should I continue to stay in a rented accommodation?’  I am sure you would agree that this is a common dilemma faced by many youngsters.

In fact, although there are several decent ‘rent’ vs. ‘buy’ calculators available, I continue to receive requests to make one.  For a variety of reasons, I am not motivated to make one although from a mathematical point of view it is reasonably interesting.

In this post, I would like to jot down the reasons for my lack of enthusiasm for making one and why in general ‘rent’ vs. ‘buy’ calculators may not be as useful as other calculators.

  • ‘rent’ vs. ‘buy’ calculations need to take into account several inputs: rent paid, annual increase in rent, cost of house, annual increase in property prices, tax deductions on renting, tax deductions on buying, maintenance charges etc. and arrive at a table or graph which tells the user when it is beneficial to ‘buy’ – right now or a few years later
  • This is definitely a challenge and many people have successfully tacked this.  Although this – the fact that I will have to reinvent the wheel to a large extent – is enough to dissuade me from making one, I am disturbed by the fact that, although there are several inputs, a single input dominates the entire calculation. To makes things worse, there is no proper method available to even reasonably estimate that input!
  • I am talking about the rate at which property price increases.  Take any rent vs. buy calculator and change this input randomly.  You will immediately notice that the results change dramatically.
  • If property prices are increasing at a rate much higher than renting costs, then buying asap is always better.  Do you really need a calculator to determine this?
  • Well, if you don’t have a property of your own and feel desperate to get one for a host or emotional and psychological reasons, the answer to rent or buy is naturally buy. The question is of course, when.
  • Buy asap is one answer. Buy after 3/4/ years as these calculators cough up is another answer. The question is, are these calculators and the typical reasoning associated with this issue adequate to arrive at the answer to when to buy a property?
  • Easy enough to guess my answer: No (why else would I write this post?!). No, because most people are swayed by the increase in property prices whether they use such calculator or not. They look at the high returns from real estate and believe that it is best to buy asap as postponing can make buying unaffordable.
  • While this is indeed true, a more considered decision is necessary. Here is a list of factors one should take into account before buying a house. I am convinced that many of these factors cannot be taken into account in rent vs. buy calculations.
  1. Have I planned for retirement?  Most people take a home loan in the hope that they would pay it off asap and then focus on retirement planning. This is dangerous in more ways than one. A person must recognise the investment needed (immediate and rate at which it should grow) for retirement. I think one must consider buying a house only after at least 60% of the investment needed for retirement is in place and will not be affected by the purchase and subsequent home loan EMI.
  2. This implies postponing the purchase for at least 3-5 years. As Ashal Jauhari points out, postponing can be beneficial is other ways too: "At the start of a career if one can prolong his/her house buying, more money can be there in the pocket to pay as a down payment. More than the money, in next few years in the career, there’ll be more clarity on where I want to settle for a house, city as well as area in that city".
  3. These are key points. One factor that is most crucial is in which city should I buy?  Most people who migrate because of work, plan to buy a house in their native town/city if you ask them immediately after they start work. After a few years they change their mind because they become used to life in the new city. So waiting a while can prove beneficial.
  4. Another key factor: The area of purchase. A rented accommodation in the heart of the city cannot/should not be compared  with a house in the suburbs. Most of us can afford to buy only in the suburbs of a major city today. Therefore, relocating to a very different milieu can be painful and expensive in terms of transport. It can also affect the personality of children.  Logistics, proximity of shops, hospitals, hygiene (open sewers), adequate clean water etc. should be considered before you buy.
  5. Emotional factors. There is a lot of emotional baggage attached with rent vs. buy! A  calculation which says, ‘buy after 7 years’, can never understand the difficulties associated with renting – lack of freedom, difficult landlords, frequent shifting etc. Therefore, most people decide to get their own place and handle other issues ‘later’.  Fair enough. A calculation cannot help much in such circumstances. I am sure this point will find universal acceptance!
Do rent vs. buy calculators make sense only when an identical property is involved?! Photo Credit (Phil Sexton; Flickr)
Do rent vs. buy calculations make sense only when an identical property is involved?! Photo Credit (Phil Sexton; Flickr)
  • What if I can never afford a house?  Yes this is indeed a major factor to consider. However, more importantly, one should also consider the following: It is all well to own a house, however if I do so,
    • Can I still manage to invest enough for retirement?
    • Can I afford to pay for my children’s education and not burden them with an education loan?
    • What if I face the danger of becoming asset-rich, but cash-poor?
  • Reverse mortgage is a load of crap Many think that a self-occupied property is valuable in retirement as it can reversed mortgaged to fund retirement. This is true only when the property is purchased only if the property is purchased in ones middle-age (45-50) and not ones 30s – the property would become too old to be worth anything.
  • Invest for a retirement home  Why not buy a retirement home (when eligible) and relocate there when convenient. This is not only a cheaper option but also a prudent one in many ways.  Most importantly, it allows your children to do what they without having to tend to you.

To conclude, I strongly believe that instead of a rent vs. buy calculation, one should at least consider rent vs. buy vs. retire calculaton to understand the impact of buying or renting on ones retirement goal. One such illustration can be found here: Calculator: Prepay Home Loan or Invest?

However, I am still not convinced that it will improve anything. The rate of increase in real estate prices will still control everything.

So Why not use some thumb rules instead?

  • Well qualified individuals with a steady income (if not job!) could consider buying asap provided they focus on investments immediately after purchase and not after prepaying the loan!
  • Those staying in rent in a logistically well connected place with a decent landlord with whom they are likely to have a long term relationship, can afford to postpone buy until they fortify their cash flow and investments.
  • What about those in between?  Tough call! I think postponing until the fiscal ship is as steady as possible is a decent idea applicable to everyone.

Is buying overrated? So you got a house on your own. Congratulations! What of it? Means nothing if

  • you don’t have funds to meet your financial goals,
  • don’t control your expenses,
  • live a healthy and meaningful lifestyle.

At the same time, are the difficulties associated with renting often underrated? To stop living in rent may be the number one goal for a family. They choose that and wish to take a chance wrt financial independence in old age. Who are we to judge!

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What do you think?

When do you think about rent vs. buy calculations? Are useful?

What is your take on renting/buying?

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23 thoughts on “The trouble with rent vs. buy calculations

  1. Rama N

    Excellent article once again. Thanks.

    I'm not a youngster by any angle but rent-vs-buy dilemma used to hit me often (more rarely these days). From financial prudence point of view, I'm completely convinced that buying does not make sense at all, at least in Pune where I recently moved to. It took a while to help my better-half understand this point of view and now she is cool with my view too. What helps is that I did buy a house (when I was a youngster and had little money) in my native place which has been completely paid up for sometime now. Many times, only in hindsight we would know if we had missed on great opportunities to buy but when you add planning for retirement and children's goals into the mix, renting does get extra credibility.

    Reply
    1. pattu

      Thank you. I agree with you. However as you would no doubt agree buy/rent is an extremely personal decision and as long as a holistic view is taken, who are we to say anything?!

      Reply
  2. Rama N

    Excellent article once again. Thanks.

    I'm not a youngster by any angle but rent-vs-buy dilemma used to hit me often (more rarely these days). From financial prudence point of view, I'm completely convinced that buying does not make sense at all, at least in Pune where I recently moved to. It took a while to help my better-half understand this point of view and now she is cool with my view too. What helps is that I did buy a house (when I was a youngster and had little money) in my native place which has been completely paid up for sometime now. Many times, only in hindsight we would know if we had missed on great opportunities to buy but when you add planning for retirement and children's goals into the mix, renting does get extra credibility.

    Reply
    1. pattu

      Thank you. I agree with you. However as you would no doubt agree buy/rent is an extremely personal decision and as long as a holistic view is taken, who are we to say anything?!

      Reply
      1. B

        Holistic view...pattu...that's the whole point...it also includes the figures that your cacli churns out....so pls go ahead and prepare it...
        without these figures the only view is to go ahead and buy....not at all holistic...

        Reply
  3. Viren Phansalkar

    Hello Pattu,
    Nice post.... one of my very dear friend who already has 2 bhk (on loan, last year) aspires to buy 3 bhk (on additional loan)... now I tried reasoning with him saying that this upgrade will also increase property tax, cess, surcharge, maintenance, light bill, water bill (if not in maintenance) with sufficient ratio..... I know his family well... they do not need it.... however, I was argued with comments like 3bhk is helpful when you have functions at home, guests arrive, study room for children... and so on.... I had nothing to argue.... .. he may read this post and this comment, so I request you to mention your thoughts too.....

    Reply
    1. pattu

      Hi Viren,

      You friend is not not alone in this kind of thinking. Which by no means is wrong. If he can afford the EMI and still manage to invest enough for crucial long term goals, a second home loan can be accomodated. only question is, can he afford to do so, taking investments into account.

      Reply
  4. Viren Phansalkar

    Hello Pattu,
    Nice post.... one of my very dear friend who already has 2 bhk (on loan, last year) aspires to buy 3 bhk (on additional loan)... now I tried reasoning with him saying that this upgrade will also increase property tax, cess, surcharge, maintenance, light bill, water bill (if not in maintenance) with sufficient ratio..... I know his family well... they do not need it.... however, I was argued with comments like 3bhk is helpful when you have functions at home, guests arrive, study room for children... and so on.... I had nothing to argue.... .. he may read this post and this comment, so I request you to mention your thoughts too.....

    Reply
    1. pattu

      Hi Viren,

      You friend is not not alone in this kind of thinking. Which by no means is wrong. If he can afford the EMI and still manage to invest enough for crucial long term goals, a second home loan can be accomodated. only question is, can he afford to do so, taking investments into account.

      Reply
  5. Viren Phansalkar

    Exactly Pattu....his major chunk of 'investment' is in LIC.. tried convincing him many times ...... finally I understood that Personal Finance is really personal and nothing else....

    Reply
  6. Viren Phansalkar

    Exactly Pattu....his major chunk of 'investment' is in LIC.. tried convincing him many times ...... finally I understood that Personal Finance is really personal and nothing else....

    Reply
  7. Rama N

    Agreed - buy/rent decision will, much more often than not, turn out to be a personal decision. In any case, we are no one to say anything - one is responsible for one's own life. But, there is responsibility on each one of us to spread awareness and knowledge and in this context, you have been doing a wonderful service to the world by way of your website/blog articles and calculators. Thanks for that.

    Reply
  8. Gopalakrishnan

    Dear Pattu,

    I have been reading about personal finance and learning a lot from your thoughts. Thanks for your free services. I live in Mumbai and is planning to buy a house for living (lived on rent for almost 9 years). I came across an interesting article "http://stockmusings.com/real-estate-bubble-burst-a-myth/", which is very true in the context of Mumbai RE prices and trends. Will be useful for fellow readers of your blog and hence sharing it here.

    Regards,
    Gopalakrishnan

    Reply
  9. anil suman

    Hi Pattu,

    Indeed, after subscribing to freefincal articles, my thought process has completely changed by reading these articles regularly.
    Literally i am so fond of this site, i became a free marketing agent of this site from last 6 months.
    Thanks for your posts/knowledge sharing pattu sir 🙂

    Reply
  10. lakshminarasimman

    sir lot of people forget there is one word called personal in personal finance. it is really that person's choice. what they do is right for that person and not for everybody else.

    if they can afford 2000 sqft house on loan and are happy putting retirement amount in post office there is nothing wrong.
    there is no point saying when you are 70 + put 90% of your money in share market after your 10th day ceremony

    nowadays i see lot of arrogance in people (old and young) saying this is the only way and correct way, i try to convince so and so he or she didnt listen

    there is a famous quotation worst vice in the world is advice. so i am stopping here

    Reply
  11. Anand Vaidya

    Sir, I think there are couple more variables in the Buy-vs-Rent dilemma.

    Tier-1 or Tier2/3 towns. The costs in T1 - just for a flat is atrocious whereas T2/3 towns - even a landed home is affordable enough to buy.

    Owning:
    Cost of owning also includes - regular repairs, maintenance, painting, home owners' Insurance, items misused/damaged by tenants, troublesome tenants etc.

    The 10 months advance can be invested in debt MF and earn some income

    With an own house, one can also rent out a portion (if feasible) and earn some money (That could pay for maintenance?)

    Reply
    1. Mukul Jaggi

      Some points that are missed out

      Why Property prices never fall drastically
      Max Black Money gets refined in Real Estate , Gold + now we observe Tax free agri income
      so any kind of xl sheet analysis would not work out.....

      Family Tradition is still alive in India - so Property price can not fall since property is so il-liquid that people continue to cling on to it

      Lack of social security - encourages people to cling on to property till last breath

      There is a huge pressure on land (in India) with a strong young work force

      Are things going to be different -
      Govts are going tough on Taxation - Things are coming in light at-least

      Places where real estate has exponentially appreciated - Provide Jobs, Mostly having some tax exemptions - IT / ITES / SEZ / STATE Capital
      + Salary Differential [$ v/s INR]

      In the same order - Salary Differential has narrowed down,
      Crumbling Infrastructure is hurting growth, Average 2 hours of travelling is becoming a norm, salaries are getting Normalized

      The Question is - Will these Job Powerhouses be able to re-define themselves ?

      Delhi - Yes will continue to have the advantage of being National Captial

      NCR - I do not know how they will manage "Water" requirements - for the affluent, Law and order is going to be challenge as constraint on resources increases

      Mumbai - Re-defines itself - From Mill Workers - TO BollyWood - To IT SEZ - ....... - Whats Next?....??

      GOA....- Prices are comparable to Suburban Mumbai Prices - Sustainability ????

      Pune - Should continue to enjoy Appreciation - considering Education Hub, Manufacturing Hub, Auto , Pharma, and Rich Agri Belt surrounding Pune ..... Water / Infra - God Knows .....

      All depends on - What Industry will be Outlining Next Bull Market

      Reply

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