In this article, we will discuss housing as an investment option. Whether you should invest in the real estate for creating wealth or not? And if at all you want to invest, then at what price should you buy? Investing in housing is an obsession among Indians. We Indians are mad about real estate. We think that the price of the real estate will go up quickly, but in reality, it is not true.
We should look at what we are getting against what we are paying for real estate. You should be more conscious about what you are getting against what you are paying. In this article, we will discuss housing as an investment option and figure out whether the house you are buying is a good investment or bad.
Most importantly, we will discuss how to check the value of the real estate?
You will learn about the RIGHT price at which you should buy the house for an investment. Always remember there is two aspect of Investing. Buy a good thing and secondly buying a good thing at greate valuation. There is a trend that if something is good then you should buy it at any price.
If you are buying a stock of the good company whose price will go up in the future, but at what price will you purchase it will matter a lot. There must be a correlation between the price and the company’s ability to earn.
Let me clarify that I am not against the investment in housing. Housing is a great investment, the only thing is at what price should you buy? The stock market is a great investment but that does not mean that you buy the Nifty at the PE ratio of 100. Same way housing is a great investment if it is bought at the right price.
How about investing in Housing?
In India, housing is a big obsession that people are willing to pay a very high premium on it. Everyone in the family will think that you should have at least one house. I fail to understand why you need to have at least one house? People are saying it is just for a sense of security and so on. Some are buying a home to show that they are rich and have enough money to buy a home.
There is a general belief that having your own house means you are wealthy. People are ready to pay an enormous amount just to prove that they can afford it.
Secondly, housing is a way for converting your black money into white. You buy a house let say for Rs. 1 crore using all white money. After some years you want to sell that house let say for 2 crores. There are many people who will tell you that we will buy the house half in white and half in black money. So you have given out all your white money for purchasing the house and when you will sell it you will get half black money.
But at all, if you want to buy the house, go for it. Make sure you are paying the right price for the house. So how do we know the right value of the house? For this, we will calculate the PE ratio of the house.
P = Price of the House
E = Earning from the House
Let’s assume that the house you have is priced at 2 crores.
Now, how will you earn from the house? There are two ways, one is you rent out the property and earn rent. Second, you use it for your own consumption and save on rent you would have to pay if you are staying on rental property.
For making it simple, we will assume that we are consuming the house for our own use. So saving on rent is an income for me.
Let’s assume that I am paying Rs. 30000 rent per month. So for the year, it comes to 3.6 lakhs. So my earning from this property is Rs. 3.6 lakhs/year.
Hence, 2 crores/3.6 lakhs = 55
Means, people are spending Rs. 55 to earn Rs. 1 rent from the property.
Now let’s compare it with the bank FD rate which is around 6% per annum. So you will earn Rs. 1 as an interest on an investment of Rs. 16 in a bank FD. While in the house you will have to spend Rs. 55 to earn Rs. 1. Shocking no???
Let’s look in the other way, Rs. 55 you are paying for the house – Rs. 16 for bank FD = Rs. 39 is the premium you are paying for the house. Why are we paying so much of premium for buying the house?
There could be two reasons, one, you think the rent will increase very fast in the future. Second, for your status in the society
So it is clear that paying rent is cheaper than buying a property at a high premium.
Do you think that you should pay Rs. 2 crores for getting only Rs. 3.6 lakhs? You must be thinking that there will be rent increment in the future. But at what rate rentals are increasing? usually at around 10%/annum. Why I am saying 10% is because the salary is also increasing at around 10%. If rent is increasing more than the salary increment, then there will a situation where people will not have a capacity of paying rent. Which is not going to be the case.
On the other hand, the price of the property will also increase at the same rate at which the economy is growing. So the price will also increase at 10%/annum. In the stock market, the earning will increase at the rate of 15% so Sensex will also increase at 15%.
In a long run, Sensex will always beat real estate. Let’s check how?
Let’s assume that a businessman has bought a land to build a factory. So if the return from the factory is lesser than the return from the land, why would a businessman be interested in building a factory? A wise businessman will then not build any factory and keep on buying land only.
The land is the raw material for the industry. So the price of the raw material will always increase lesser than the business return. If the price of the land will increase at a higher rate, then there will be a time when no one will do business.
In India, last ten years have seen a major shift in housing pricing. There are instances where the price of the house has increased by 10 times in 10 years. (this is possible at the 26% CAGR rate) but if you check the trend of the rent in that 10 years, it has not increased at the same pace. How is this possible? This is because of the sentiment of the people. Earnings have not increased but sentiment(PE ratio) has increased and so the price of the house.
This ten times in ten years will not continue forever. The gap between earnings and price will be narrowed down at some point in time. Same way as the Sensex is going up and down. Either the price has to come down or earnings have to go up.
Now let’s check what is the best time to buy the house for investment. In the below table I have mentioned the value of the house and its corresponding rent. If you check the PE ratio for the year 2018, it is 50 which is very high as compared to the year 2006 or 2008. So here you can clearly see the gap between value and earning of the house.
|Period||Value of house||Rent of house||PE Ratio|
Buying a property at PE ratio 11 is far better than buying it at 50 PE. At that time the bank was also giving a same kind of returns. So if you have bought the house in the year 2006 at PE ratio of 11 then it would be your productive asset which will give you good returns. So before 12 years buying a house was a good investment option as compared to 2018 at the PE ratio of 50.
There is another benefit of buying a house at a lower PE ratio. Imagine you want to buy a house in the year 2006 at 31 lacs but you don’t have enough money. You would take a home loan. Assume that you take a full loan of Rs. 31 Lacs.
The EMI of your loan would be around 31k/month. As you can see that the house of 31 lacs has the ability to generate 24k/month rent. So you just have to shell out Rs. 7k/month to buy the house which has an ability to generate good rental income + valuation.
Buying a house as an investment option is good only if it is bought at the right price. The earning from the house will not be going to increase very quickly. The price of the property will also not going to increase very quickly. So do your math before making any property buying decision.