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Should you Buy a House as an Investment? A Critical Review

April 21, 2023

Table of Contents

    Table of Contents

      If you're on the fence about buying a new home as a good investment, we've broken down the basics, so you understand whether it's future-proof or not!

      When you reach a certain age, one of the first things that constantly crosses your mind is investments and whether you should consider buying house as an investment. They are your ticket to a secure future and living a life that's devoid of any financial problems and hiccups.

      An investment's primary purpose is to produce income or capital appreciation. Additionally, a smart investment returns more money than it costs, and that's a no-brainer!

      However, do homes meet such criteria? That's debatable.

      Real estate or homes are among the most important investments your family and friends constantly parade upon. Let's explore the scope of investing in homes, and whether or not you need to purchase one for the future.

      Is buying a new house a good investment? 

      As an investment, a home could make sense under certain circumstances. And in certain places, the return on investment may be far lower than the purchase price. 

      You might know the drill since buying a home is one of the most common discussions with parents in an Indian household. For most Indian parents, owning a property is the primary security that is unparalleled to any other investment in the market. 

      Most often than not, the top reasons for buying the home rest on statements like "it's a good investment for the future" or "think about the money you'll achieve for this property 10 years down the line!". However, not everything that rises in value is a good investment.

      Over the past decade, the All-India House Price Index has increased by 10.4% per year due to inflation.

      Some factors to consider 

      In certain areas, the demand for houses outpaced the supply, leading to a price increase exacerbated by the high costs of land, labor, and materials (not to mention the profit builders made on the project). Increases in the double digits have been witnessed in Tier 1 cities like Delhi, Bengaluru, and Chennai, whereas tier 2 cities like Jaipur and Lucknow have grown barely 5% each year.

      Consequently, the inflation rate in the area where the property is located is a major factor in determining whether or not the price of homes in that area will increase.

      Don't forget to consider the tax factor 

      Three years after the date of purchase, the capital gain tax rate is 20% after adjusting for inflation. Following the preceding logic, the property's indexed purchase cost is calculated to be 80 million. For this reason, a sale for Rs 1.1 crore would result in a capital gain of Rs 30 lakh. If you've made a significant profit, a 20% tax will cost you Rs 6 lakh.

      When additional costs, like brokerage and legal fees, are disregarded, the after-tax return on the sale of real estate amounts to 2.7% each year. Rent income boosts the yearly rate to 4.3%.

      To defer paying taxes on capital gains, you can invest the proceeds in yet another property or a capital gains bond. Post-tax returns average 3-4% each year on the latter, but it's not tax-free.

      It is an investment, but not the best one  

      If you can't profit from the equity in your home, it's not an investment, and for most home-buyers, the real-estate property stands a low chance of reaping great benefits. 

      It's possible to rationalize the purchase of a primary dwelling as an investment. Because its value will rise over time, you may cash in on that rise later.

      For the sake of argument, let's assume that it does ten years from now. So you sell it, and what do you do with the funds? Put them toward something else, like maybe a larger home.

      Having your money stuck in an asset like a home reduces its value as an investment. That's not to say that having a house of one's own is inherently negative. Housing is essential. But because you can't immediately cash in on the rewards, your property isn't an investment in most situations.

      When will you see a profit? 

      A home purchased in Mumbai for Rs 50 lakh 10 years ago should now be worth Rs 1.22 crore, assuming yearly returns of 9.4 percent.

      First, of the Rs, 50 lakh, around Rs 5 lakh is used to pay stamp taxes, registration, parking, and brokerage fees. There is no way to recover these expenses. Only the remaining 45 lakh rupees are subject to returns. Consequently, based on the aforementioned appreciation rate, the home should sell for around Rs 1.10 crore, or around 8.2% p.a.

      Second, the renovation costs of a home are very high. Modular kitchens, marble floors, security systems, and fancy furnishings are among the first things a new homeowner will invest in. In addition, ongoing expenses crop up every month, such as cleaning, fixing, and daily maintenance.

      A monthly outlay of Rs. 10,000 for such objectives would amount to Rs. 12 lakh after ten years. Another Rs 18 lakh is lost to interest over a 10-year mortgage.

      Add them to the initial Rs 50 lakh price tag, and you're looking at a total of Rs 80 lakh (12+18). Your investment's effective CAGR has dropped to 3.2% at this point. If you successfully rent the property, though, you stand to earn Rs 15 lakh (at 2% of market value) over the decade.

      Timing the market is tricky

      There is a widespread belief that buying a home is a wise investment since property prices will eventually reach their peak and continue to rise. And that is true in a healthy economy with robust consumer demand.

      However, selling a property at the optimal moment to generate profit is challenging. A "buyer's market," with more sellers than buyers, is necessary for this strategy to function.

      Prices tend to drop when the market favors buyers and bargaining power increases. On the other hand, you should try to sell your house when there are more sellers than buyers.

      A seller's market is one in which the asking price of a house is greater than the average price of homes on the market. However, striking a balance between the two is notoriously tricky. Many individuals make the mistake of selling either too soon or waiting too long.

      When can it be a good investment? 

      Before you end up purchasing a home, make sure that you do all your calculations beforehand. One of the primary reasons for owning a home for most home buyers is to have their own space to say. However, if you're buying a home purely as an investment in the future, you must be smart with your decision.

      Ensure you don't pool all your money into a new home without keeping some for emergency funds or savings. Another crucial aspect to remember is to time your investment right and do all the due diligence required before making the final decision to buy a home. Once you do so, only then will you be able to gauge whether it's genuinely a good investment or not!

      To conclude:

      The idea that buying a home is the finest investment you can make is often used to persuade individuals to become homeowners. Truthfully, a home is not an investment unless it serves as a monthly revenue source in the form of a rental.

      There are still plenty of folks for whom buying a house is the best financial move. Owning a home may be a fantastic investment since it can provide you with a stable income, freedom to make choices, and a significant return on your money.

      You are the greatest judge of your financial status now that you have heard all sides of the argument. You should buy a property for investment purposes if you can afford to do so. For those who want to delay the home-buying process, the option to rent a home is always open. 

      Good luck!