Homebuying For Self Use Or Investment? The Rules Of The Game Are Different

Most Indians buy homes not so much for investment, but rather for self-use, which incidentally should not be seen from the prism of investment. So, before you put your money in real estate, ask whether it is better to stay on rent or buy a home for yourself. And should you decide to invest in property, compare it with other options, such as fixed deposits, gold, bonds, and equity

Real estate holds a unique allure for Indians, and Bollywood has portrayed this well. Over decades, cinematic narratives have woven tales of families clinging on to their ancestral lands, starry-eyed individuals chasing the elusive dream of homeownership, and the gritty battles waged against unscrupulous builders and land mafias. Films like Do Bigha Zamin, Gharaonda, Khosla Ka Ghosla, Love Per Square Foot, and Gulabo Sitabo are some of the movies that serve as a testament to the enduring relevance of real estate in our collective consciousness.

Whether it’s residential properties, commercial spaces, or land parcels ripe for development, the realm of real estate beckons investors with promises of long-term growth and diversification.

But should you invest in real estate? To answer that question, you would need to answer another one: Are you looking at this asset for self-use or purely for investment? A survey by FICCI-Anarock released in March 2024 found that 64 per cent of the 5,000 parcipants across 14 cities had bought real estate for personal use.

The survey also revealed that real estate is the most favoured asset class for investment, with 57 per cent preferring to invest in it. So, let’s delve deeper into both scenarios—buying for personal use or buying for investment purpose.

End Use

You would need to evaluate if renting a house is a better option than buying one. However, the choice hinges on several personal and financial factors and not mere calculations (see Buy Vs Rent).

Renting offers flexibility, minimal maintenance responsibilities, and the freedom to move without the burden of having to sell a property or be worried about some tenant occupying it. It’s often suitable for individuals in the transitional life stages or those who prefer to avoid dealing with the upkeep and additional costs associated with home ownership. It is also preferred by those who want multiple career opportunities at various locations.

On the other hand, buying a home is seen as a long-term investment that can build equity and provide stability. It’s generally recommended when you plan to stay in one place for a significant amount of time, typically 10 years or more. Home ownership allows for personalisation and also income tax benefits, but it also comes with additional costs, such as property taxes, insurance, and maintenance.

It is also crucial to assess your financial readiness. For instance, a higher downpayment will ease your loan burden while a stable job will allow you to pay your equated monthly instalments (EMIs) regularly through the loan tenure.

Says Shashank Pal, chief business officer, PL Wealth Management, Prabhudas Lilladher: “Striving for an EMI-to-income ratio of around 50 per cent is often considered ideal. In simpler terms, this means that your total monthly EMI payments shouldn’t surpass half of your total monthly income. While this guideline serves as a helpful rule of thumb, it’s important to recognise that individual circumstances can vary significantly.”

For those who prefer to base their decision on concrete calculations, understanding the concept of rental yield is a good starting point. Rental yield is calculated as the total annual rent paid divided by the property’s purchase cost.

Salma Sony, an investment advisor registered with the Securities and Exchange Board of India (Sebi RIA), after examining rental yields across different cities in India, found that rental yield varies based on the city. For instance, in Bengaluru, the rental yields typically range from 2-4.5 per cent, while in the suburbs and downtown of Mumbai, it is typically 1-2.5 per cent.

She adds: “As a general rule, if the rental yield is below 2 per cent, it’s usually more economical to rent rather than buy. If the yield falls between 2 per cent and 4 per cent, the decision becomes less straightforward, and opinions on the matter can vary. For someone looking to buy a property in the retirement phase, they must expect a minimum 4 per cent rental yield.”

The alternative approach would be a detailed evaluation. We are assuming you will take a loan to buy the house (see Steps To Detailed Evaluation). You can also refer to detailed calculations Outlook Money did on Buy Vs Rent in its November 2022 issue (bit.ly/493MTEp).

M.S. Shabbir, a Hyderabad-based Sebi RIA, advocates that individuals should prefer renting instead of buying a property on loan. The impact of compounding is better when investing in a long-term goal, such as buying a home.

He says: “Buying a house can limit your investment opportunities too. It also reduces your risk appetite. So, you may end up missing out on a possibly great career opportunity. Also, if you decide to move out of India, there is no assurance that your money will grow due to the depreciation of the currency. Add to it, there will be limitations of liquidity, maintenance, and inheritance distribution when you are older.”

He cites a personal experience. He had bought four properties of similar value in different parts of Hyderabad after looking at possible developments in 2006-07. Of the four, only one delivered good returns, while two did not even outpace inflation, and one has not moved much.

Sony advises her clients to invest in residential property only for self use once they know the city they wish to settle in. She says: “People in the utilisation or retirement phase can consider residential property for rental yield once they have saved enough to buy a property for regular income. But it may not be right for people in the accumulation and/or saving phase unless they are sure about the city. If the clients want to buy the property for their personal use, they should do so with a minimum downpayment of 50 per cent to make the house purchase borrowing less expensive.”

Investment

Buying real estate for investment requires a different mindset.

Remember that financial planners do not consider the house you are living in as an investment. When you are looking at a house for investment, you have to compare all possible avenues, such as mutual funds, direct equities, corporate deposits and others.

Within real estate, there are options such as real estate investment trusts (Reits), private investments, among others.

For investing in real estate through a portfolio management service (PMS), the minimum investment requirement is Rs 50 lakh, and one cannot borrow. Meanwhile, the minimum requirement for alternative investment funds (AIFs) is to be an accredited investor.

On March 8, 2024, Sebi amended the Reits regulation. Now there are two types of Reits available for investors: small and medium (SM) Reits and traditional Reits.

Shiv Parekh, founder and CEO, hBits, a real estate platform, explains, “SM Reits primarily target affordable and high-quality commercial properties, whereas traditional Reits focus on larger office buildings. SM Reits typically invest in assets with long-term value and stability, featuring ticket sizes as low as Rs 10 lakh, and are thus appealing to retail investors.”

Reits need to distribute nearly 90 per cent of earnings as dividends to investors annually, thereby ensuring a higher income ratio for investors.

What Should You Do?

Investment in real estate, on an appreciation basis, is a laggard (see Compare Returns). Some pockets of real estate may deliver high returns through capital appreciation, but that’s usually not the norm. While the rental yield may add more to the returns, it may not tilt the scale significantly, as the returns will be close to that on fixed deposits (FDs).

Says Mahesh Patil, senior group vice-president of property advisory at Motilal Oswal Private Wealth: “When it comes to real estate, it’s essential to distinguish between home buying and investment for end use. Mixing the two can lead to confusion and suboptimal decisions. Notional appreciation may seem attractive, but it holds little practical value in the long run.”

He adds:“For investors focusing on rental yield, commercial properties would make more sense. With infrastructure development underway, the demand for commercial space is expected to rise steadily. Thus, it’s crucial to keep an eye on the infrastructure market, particularly in emerging areas, to capitalise on potential opportunities. Additionally, it is important to ensure that the quality of the asset remains paramount for sustainable returns and long-term growth.”

Investors have multiple options within the real estate industry to invest, and each option has its own set of requirements. For investing in physical real estate, go to a competent legal expert as they are better informed about local documents to be checked (see Know Your Documents). In some states, it is better to check the land ownership documents for 30-50 years.

Understanding your needs and the ways to purchase real estate, and the investment strategies can provide clarity and confidence in navigating this complex process.

The author is a Sebi-registered research analyst and financial writer