Is Buying a House a Good Investment?
The decision to purchase a house is one of the most significant financial commitments most people will ever make. While homeownership is often viewed as a sound investment, this perception is worth deeper scrutiny.
Why People View a House as an Investment?
1) Potential for Appreciation: Property values tend to increase over time, creating the opportunity for capital gains.
2) Collateral for Loans: Homeowners can use their property as security to access credit. Houses are tangible, stocks are not. A home has real worth and that value is readily apparent to everyone. Stocks, on the other hand, are merely paper representing a claim of ownership in a business. This feels too abstract for some, and downright scary for others.
3) Cultural Norms and Aspirations: There is a common belief that owning property is a key milestone of financial success.
4) Perceived Financial Prudence: Renting is often described as “throwing money away,” whereas buying a home is seen as building equity. Additionally, the type of home we want, in the area we want to live, simply is not available as a long-term rental.
5) Stability: A home provides a stable environment, offering a “home base” for family life. Homeownership carries significant emotional and social benefits.
6) Volatility: Housing prices are less volatile than stocks. Stock market declines are more frequent, more severe, and more publicised than those of housing. The relative short-term stability of housing often convinces people that it is a better investment, without consideration of the long-term trade-off of lost returns.
7) Personal experiences are limited and anomalous. Many of us have direct personal experience with housing values only over the last 15 to 20 years. Housing values have increased significantly over this time frame, but the results are anomalous when compared to any longer period.
The Flaws in Viewing a Home as an Investment
It is fascinating to hear our old relatives bragging about how their real estate investment decision turned profitable as they invested Rs 20 lakhs and the current property value has become Rs 1 cr. But do we consider the time horizon here? If you calculate the real returns considering the investment horizon and other factors, the returns could be average or even less than that. The main objective behind any investment is to create wealth. However, the purpose of creating wealth may differ from person to person, one might want to build a retirement fund, and the other might want to generate enough funds for their child’s education. But in the end, we all aim to generate maximum returns on our investments based on our risk appetite. There are numerous options one can choose to invest in, such as equity, mutual funds, fixed deposits, real estate, gold, etc. Out of which, real estate and gold are the oldest asset classes. Owning real estate could be a huge step towards financial independence for many Indians. But to consider it a better investment than putting money in the financial markets may be short-sighted. The income generating property narrative starts to make sense when many investors end up renting their house instead of selling it, i.e. purchasing an income property to imitate their parent’s past decisions, or buying a rental unit because they weren’t sure what else to do with their money.
1 High Initial and Ongoing Costs: Purchasing property involves significant upfront expenses:
a. Stamp duty, registration charges, brokerage fees, and other taxes.
b. Renovation and interior decoration costs.
c. Ongoing maintenance, repairs, insurance, and property taxes.
The middle class cannot afford to buy a decent property in an urban area without financial help from a bank or NBFC.
2. Opportunity Cost of Capital: Money spent on a down payment and mortgage payments could generate higher returns if invested in financial markets. For instance, investing the same amount in equity mutual funds often yields better long-term results.
3. Inflation-Adjusted Returns: The increase in home price is easy to calculate and remember. We all have loved ones who can recite both the purchase and sale price of a particular house, leaving the impression of substantial gains: “My parents bought their house for Rs 500000 in 1970 and sold it for Rs 5,00,00,000 in 2024!” Of course, you will never hear the comparative return of that capital if invested in stocks over that same time frame, or the housing-related costs (commissions, taxes, maintenance costs, etc.) that were incurred over the years. People underestimate the long-term impact of inflation. In the above example, the Rs 500000 paid in 1970 is the equivalent (after inflation) of Rs 2,50,00,000. In other words, the majority of the increase in value is simply the result of inflation. Just because the magnitude of the impact of inflation is not intuitive, it is often underestimated.
4. Underperforming Asset– Real estate investments often yield returns similar to fixed deposits over 30 years. Rental income ranges from 2% to 5% of the asset’s value, which is usually lower than fixed deposit returns and less than the EMI payments on loans. For example, renting an apartment for Rs 50,000 per month might seem affordable compared to buying a house worth Rs 1.5 crore.
If you make a down payment of Rs 30 lakh (20%) and take a loan for Rs 1.2 crore at 8% interest, your EMI would be Rs 1,03,000- double the rent. Over 20 years, you would pay Rs 2.41 crore to the bank, far exceeding the original loan amount. In contrast, investing this money in financial markets could yield better returns, without additional costs like property tax, maintenance, insurance, or sale commissions. If we had invested the same amount of money in equities, the amount would have grown to 10 crores after 20 years, even after deducting the rent cost.
5. Low Liquidity: For example, if you invest in gold, you can sell your investments during an emergency to take care of unexpected expenses. Similarly, you can redeem your equity investments anytime. However, a real asset can face many liquidity challenges. It can be difficult to find a buyer if it is a buyer’s market. Furthermore, even if you find the buyer, they should be ready to pay you the expected price during times of need. Besides, you cannot divide the investment or liquidate a part of it if you only need a part of your investment, which is possible in the case of most other investment options.
6. Lack of Diversification- Portfolio diversification is crucial to meet financial goals with limited risk. Unlike financial investments, real estate does not offer various types of opportunities based on investment objectives and risk appetite of an investor. It is impossible to diversify with real estate and the main reason behind this flaw is the heavy capital requirement to begin with. A general thumb rule is that the value of your home should be around 25-40% of your overall net worth.
Practical Tips To Buy A House
– Assess how long you plan to live in a house; short-term ownership can be expensive due to closing costs and commissions.
– Keep an eye on your local housing and rental markets to decide which offers better financial value.
– Consider your lifestyle and non-financial reasons (stability, family needs) alongside financial ones.
Should You Buy A Home?
Like many things in life, there’s no single answer for everyone. Not everyone should buy a home and not everyone should rent. The answer to this question comes down to intention and personal choice. One of the things you might not hear about home ownership is that it’s not for everyone.
If you’re buying a personal residence because you think it’s going to be a good investment, there’s also an argument that the money could be better invested elsewhere like the stock market. But if you’re looking for a roof over your head, have sufficient income to cover the expenses associated with homeownership, and like the potential of future gains, then buying that house might be a good idea.
A house is not an income-generating asset, and the timing of buying a home plays a crucial role. Purchasing a house too early can lock you into 20 years of EMI payments, limiting your financial flexibility and opportunities for other investments. There are many good reasons to own your home. Just be mindful: if you decide to buy a house, you should be doing it because it is life-optimising, not returns-optimizing.