Can I afford a house at current prices?

By
Hemant Beniwal
58

Last week I wrote “Indian Real Estate bubble – will it ever burst?” – People shared a common view that properties are unaffordable for common man & even prices are not going to come down.  Sunil summed it very well “It is quite sad and sickening that real estate prices have literally gone through the roof. A common man who wishes to have a roof over his head finds his dreams shattered. In the past three years, prices have shot up to the extent that a common man cannot even buy a small shelter even in far flung suburbs because of astronomical price. For all this mess, the government is to be blamed, which has done precious little to make housing affordable.”

In this real estate series this is my second post & will talk about “How much house I can afford?”.

Why it is important that affordability should be measured?

There can be two purpose to buy real estate – either for self-occupying or investment purpose. In first case it is goal & in second case it is a means to achieve some goal. When we are talking about affordability we are talking about self-occupying and that too first property.

It is important to know this number because it will have significant impact on other goals – for example:

  • If you have locked big amount in home then lesser amount will be available for other goals.
  • You will be asset rich but cash poor.
  • If EMIs are on higher side how you will save for other goals which are even more important.
  • If you need decent income after retirement will you be prepared to sell your house & move to a small apartment? It will be tough to change as the lifestyle at that point of time will make this compromise tough. Also will your family support this kind of decision?

So now you understand that buying house is an important decision and should not be taken in haste.

Indicator of Real Estate Affordability

There are a couple of indicators but the simplest & which is most commonly used across the globe is “price to income ratio” – property prices are compared to after tax income.

In India we don’t have any accurate statistical data – anyways, we have this Australian data of last 5 decades.

Real Estate Affordability

Few important points that it throws:

  • Properties can stay unaffordable for fairly long period 🙁
  • Interest rates & government policy towards housing sector plays a  significant role in real estate prices.
  • Affordability is related to income – property price can be called cheap if EMI is less than 37% of income & affordable if it’s under 50% (these are Australian standards & can be different from India)

Australian numbers are scary for any person who doesn’t own property – let’s check Indian numbers.

Indian real estate affordability Index

Indian Government does not provide any long term statistics – couple of years back national housing bank started providing some data but that is not sufficient to reach any conclusion. Best data available to check affordability is from HDFC Ltd – leader in Home Loans – I am not sure about the reliability but will still consider the same as something is better than nothing. This data can be found on their website – investor presentations.

House Affordability India

Myth Busted: Property price don’t correct/crash

Above image clearly shows that property price correct & even it can have deep correction of 50%. This data shows that if property was priced Rs 26 Lakh in 1996 the same property was available for Rs 13 Lakh in 1999. Prices remained flat from 1999 to 2004 & starting 2005 it is in bull phase. So please stop predicting that prices will never correct.

Few more points – assuming this data is reliable:

  • Property prices not even doubled in last 16 years – this means rate less than 4.5% which is much lower than even FD rates.
  • Prices tripled in last 8 years which is clearly a bull run – which means 15% CAGR.  Last equity bull run started in 2002 & ended in 2008 beginning – in 6 years Sensex went up by 7 times or 38% CAGR.
  • Affordability number is more or less flat in last 12 years – which is close to 5 times.
  • If we assume 1995 was peak of last Bull Run – but that matured when affordability hit 22 so what are we heading towards??

I know you have lot of interesting points to share on the above data & my analysis – feel free to add that in comment section 😉

Can I afford a house at current prices??

Question is not about current prices but it is the number that should not impact complete financial life – negatively. Some time back I wrote “Financial Planning Thumb Rules” where we talked about this magic number but for most of readers it was unacceptable number. Rule is…..

“The value of house should be equal to 2-3 times of your family annual income. So if you & your spouse are earning total Rs 20 lakh – you should buy a house in Range of Rs 40-60 Lakh.”

And if we stick with this – normal person can’t buy property in Australia or India. HDFC Ld shows average price is 5 times of income in last 12 years so should we put this as Indian Standard??

Another rule that should be followed while purchasing property is Home EMIs should not be more than 28-30% of net income & total EMIs should not be more than 36%.

Let’s see one Example:

Thumb Rule 3 Times 5 Times
After Tax Income

100000

100000

 Monthly
After Tax Income

1200000

1200000

 Annual
Value of House

3600000

6000000
Down Payment

720000

1200000

20%
Loan

2880000

4800000

80%
Loan Tenure

15

15

 Years
Interest

10.50%

10.50%

 Fixed
EMI

31835

53059
EMI Vs Income

32%

53%

But don’t take this rule as final verdict – go here  and read points shared by Mudit & Rohan Doshi.

Is buying a house the only choice – we will check this in next post.

If you have any questions & suggestion – add them in comments & I will try to cover that in next posts.

Previous articleIndian Real Estate Bubble – Will it ever burst?
Next articleShould I buy or rent a house?
Hemant Beniwal
Hemant Beniwal is a CERTIFIED FINANCIAL PLANNER and his Company Ark Primary Advisors Pvt Ltd is registered as an Investment Adviser with SEBI. Hemant is also a member of the Financial Planning Association, U.S.A and registered as a life planner with Kinder Institute of Life Planning, U.S.A. He started his Financial Planning Practice & TFL Guide Blog in 2009. "The Financial Literates" is a dream & mission to make Indians Financial Literate.

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58 COMMENTS

  1. Awesome awesome post. Should be any eyeopener for 20-s somethings who take on a large EMI without thinking of other goals.

    ‘Asset rich cash poor’ . Terrific quote. I can find many people who fit into this category.
    Cant wait for the next in the series as I can probably never afford a house !

  2. Hi Hemant
    I have gone through the two posts on Housing bubble and affordability of House.
    Besides Property how else do you think one can invest a large amount of say upto 2 lac per month for about a year.

    I see a house as obvious choice, wouldn’t you agree?

      • What is the return in FD? Hardly enough to beat inflation while Property will give u rent and at the same time capital appreciation. I dont know if Hemant has done any Statistical study on this.

    • Doesn’t matter whether one has 2 lacs or 2 crores to invest per month. Since your time frame is one year .. you have no better option than Debt. You may choose between Debt funds or RDs.

        • Hi Hemant
          Thanx for the link, though I was conscious of it already. What I am hinting at, is not a short term investment. I am saying the best form of investment for large amount of personal saving as in present case (2 lacs) would probably be real estate for a 10-15 yrs horizon. What is your opinion/advice?

  4. A series worth reading. Hope the common man finds a way out of this UNAFFORDABLE situation. All eyes on your next post.

  5. Excellent. It would be wonderful to read the full series. I ma from Mumbai and the rate which I purchased in thane in 2006 is not even available in Virar/Badlapur – very far flung places.
    From the above it clear that stay in rental and be “cash rich and asset poor”

    After this series would like to know your comments on Gold and Gold ETF as an investment option.

  7. It depends on what one has goals in mind..one should always keep affordability in mind.
    Only for people having extra cash & looking for investment:
    Property data shown above is average of all data..however in certain cases you can generate very high returns by carefully selecting a property (do only if you can handle it) which will outrun any other investment vehicle. However, property is a physical thing same like having money in your hand…it may slip out because of natural calamities, forgery & you know sad state of law in our country…better keep a good ratio in MF/FD/PPF which no one can rob from you.
    For normal person working in 10-6 shift should not compete with anyone who is full time engaged in property transactions or have good contacts….I feel mostly people get influenced & loose theri hard earned money.

    • Hi Pratap,
      I was expecting this from someone “Property data shown above is average of all data” – good that highlighted this. In case if we are talking about particular property – we should talk about individual stocks & not indexes. I hope you understand what I am hinting – will cover more in next post.

  8. Hi Hemant,

    Excellent and interesting article! Deep correction of 50% is not possible in case of apartments. Probably these data of HDFC might be based on land cost. In 1996, apartments were not common in NCR. Since the construction cost is increasing day by day due to increase in material and labour cost, the possibility of correction is in land cost. What’s your opinion?

    • Hi Umesh,
      I believe even price of apartments can correct by 50% because if we are talking about luxury apartments cost of construction in some cases will be just 25% of the value of land.

  9. ‘Asset rich cash poor’ beautiful quote, more or less i am in this situation only.
    But for me i am lucky to own a house and got a very good deal last year.
    Last year May 2011, i booked a villa for Rs. 22lacs, now this aug 2012, same villa cost was 39lacs. I was amazed by the way it went up and now if i would have thought also i was not in a position to afford this.
    Very nice post, keep rocking Hemanth……

    • wow..you must be a genius..doubled your investment in 1 year!!!

      don’t sell it immediately ..it will reach 1 crore soon..
      actually, don’t sell it at all. you sit and watch as it really gains value so much you won’t believe it

  10. Hi Hemanth,
    these two are awsome…
    ■If you have locked big amount in home then lesser amount will be available for other goals. – absolutely true in my case…I am planning to buy a house, however income and other major goals arent supporting….
    ■You will be asset rich but cash poor. – this is absolutely true in my in-laws case…

    What should be the financial plan for buying a house, while keeping other goals in mind???

    • Hi Akodati,
      There can’t be a financial plan just for buying a house but if someone is going through the complete process he will know his limits.

  11. SIR NICE SESSION OF LECTURES GOING ON. kEEP IT UP. I AM IN LINE OF ASSET POOR AND CASH RICH LINE… SO WHAT IS UR OPINION FOR ME. SHOULD I REMAIN IN RENTAL HOUSE AND CASH RICH.. OR CHANGE IS REQUIRED.. THANKS

    • Hi Dilip,
      There is no simple yes/no answer to your situation – you have to do the calculations to justify your decisions.

  12. Rent v/s EMI is the most important deciding factor. Besides if planned to settle down in a particular city. It is better to buy than to wait for the pin for the bubble.

    • Hi Animesh,
      It looks you are talking about my next post 😉 but I may not agree with your second statement.

  13. Govt should do something abt it. maybe make a law that one person cannot own more than 2 houses in a city. Else rich will keep buying and making more money and poor will keep suffering. Unless that happens property prices will not decrease, because India has all of sudden started to get huge cash flows. Getting rich is easy nowadays. NRIs are investing in real estate just for its returns and since land cant be grown its prices will definitely keep increasing. MF/SIP/ULIP/Stocks are all nothing compared to investment in land.

  14. Hi Hemanth,

    Excellent post
    It would be great if you could cover Gold investments also after the real estate series.

  16. Hemant,
    Where is the chart that was displayed just above the “Myth Busted” showing the real increase and nominal increase ?

  18. The same financially literate moron that buys a house will not invest in a company’s stock if it is asset rich and cash poor.

    • Hi Moronbuffett,
      “asset rich and cash poor” is not invented by me this is a common saying in personal finance for people who are having big houses (self occupied) & low financial assets.
      Robert Kiyosaki is real estate fan but still he calls a house liability – not asset.

  19. Hemanth,
    While buying a property,can we have a thumb-rule to tell how much interest we have to pay to keep our deal as a worthy investment.
    For example : In 4 year of my investment in an apartment,I have paid an interest of approximately 16 lacs. And the property seems to have appreciated by similar or slightly lesser.So where is the appreciation.If I had bought that with complete cash,then appreciation would have made sense.
    Do we have any way to calculate this?Of course in my case,I have got a own house and have rented out this property meaning I have earned rental income.But still I feel real estate is not worth investing if entire amount (except 15% margin) is borrowed from loan.Am I correct in this analysis?

  20. Dear Hemant,
    Let me start my first by thanking you for making me so equipped with infomrtion. I do like all your post and this was too not an exception. ” Asset rich cash poor”, having cash for future achievements of goals. My thought process went on the similar lines when i decided to have a house of my own where i could live in. I started late but have to work for two months analysing my payouts for the last 5 years and then plan for the next 15 years.
    What i had was a secured job, a culture where i have the energy to work harder and harder with passing days and a determination for nothing less than second. With all these powers, my decision was to go for a house which was much more than i could have afforded when compared to the market situation. I did go for it and then chose a higher EMI to give myself the pressure to excel more and more.
    Life is not an usual story of “desires limitations”. I took a ready to move in house for an premium in a premium locality. My plan was to absorb the higher interest in he first three years by renting out and in turn live in a rental house for somtime, enjoying certain benifits.
    renting out took care my interest and i just had to pay the principal. Now with the time passing by, offers came in which i grabbed and offers comes only when the goals are focussedly determined. I took onsite oppertunities, and acumulated wealth. the people advised me to use the accumulated wealth to payoff my liabilities, but some how i could not get convinced and took up another property and invested in land. My decision was purely mine and i had to stand by it to make it success. Therefore my feeling is no decision is right or wrong, but once has to be cautious and have alternatives.
    Mine is just a normal story coming out of a middle class thought process that i thought of sharing with you.
    I am too anxious and waiting for your next article of alternatives to real estate.

  21. The one thing I dont like about Real Estate is that even if the prices come down, the sellers are not interested in selling the property at a lower rate…

    as a result of this, even when the prices decrease, their is no seller at the prevailing market price, as a result of which it becomes very difficult for the buyer to buy something at the current market price..

  22. Hi Hemant,
    Nice post and it contains a lot of data to take the decision if anyone is going to buy a new house.
    I think we should also consider few things along with the above data. If a family stays in rented house one an average we should pay 10-15K for a decent apartment in every major city, anyways one should end up with paying 15K per month, rather paying 15K per month as a rent, one can think that paying 25~30K to loan EMI is far better and some point of time that house will be yours!!.
    Isn’t it the great idea that paying 25 K to EMI rather than paying 10~15K for rent for many years?
    EMI rate considered here is just for example, rather we can even consider % of ones salary.
    Thanks,
    Siva.

    • This is the classic self fulfilling prophecy or the rationale given by home loan lenders, home loan takers for owning a home vs renting…this has been going on for 25+ years

      “…rather paying 15K per month as a rent, one can think that paying 25~30K to loan EMI is far better and some point of time that house will be yours!!….”

      LOL, at some point, when? 20 years from now? for a 30 lakh loan, you actually shell out 60 lakhs @ current interest rates. Every year, every bonus, every windfall, every onsite assignment you are going to obsess about repaying this loan….enjoy!!!!

  23. Loved the depiction of the Indian real estate affordability index. A very different point of view. True, property prices ever having a real significant correction has become a myth. In metro cities like Mumbai and Delhi, builders and real estate developers refuse to reduce their prices inspite of poor demand and unsold flats.. and people wait in hope.. of investing at the right time when prices come down.

  24. As far as teh classifications go, I am under the “Cash rich, Asset poor” category. However, the ‘Cash rich” scenario was facilitated by a house which I bought in Singapore (where I am currently based) in March 2009 (please note the month) and sold in April 2012. I saw capital appreciation of 40%, which was further sweetened in Rupee terms as INR had depreciated almost 30% vs Singapore dollar in the intervening period.

    I have the above calculation. What I do not have is this – what would have happened if I had invested in Equity Markets….considering that equity markets anywhere in the world were at their lowest after the financial crisis ?double ? more than double?

    So, was it good …..or not-so-good-afterall to have invested in the Real estate ?

    Affordability Chart – While it is good to have whatever data we have (something is better than nothing as Heamnt mentioned) , not sure if Annual income vs Property Prices comparison gives a complete picture. What about mortgage interest rates ? In Singapore mortgage rates have been between 0.8% to 1.2% in last four years so the EMIs (and the interest outgo) would be much lower. Even at the identical ‘Affordability Index”, the house, therefore, would be much more affordable in Singapore vs say, India, where the interest rates are 10 times more.

    Also, based on the commment of one of the participants above, If an EMI is 30k vs 15k rent, shouldn’t it be more proper to look at what is the principal repayment component from the 30k EMI ? In the initial years, depending upon the tenure and interest rates, interest component (an expense) can be 80-95%…

    A question I have is – is there a thumbrule as to at what ‘stage’ of the financial plan one should buy a house ? I am not talking about an extra-ordinary situation where one advances this ‘goal’ of buying a house if there is a major correction in the property prices…but just a guideline ?

    Finally, some pundits include Real Estate as one of the components of ‘diversification’. How does one achieve this, esp in India ? Owing physical property for investment ? Do we have REITS in India ?

  25. Hi

    It was a very good analysis. This confirms my decision making to stay in rental house than buying a house on emi. It is better to buy small properties in cash in many numbers over a period of time and sell all of them once you decide where you are going to settle down in life. In today”s life assumption of staying in one place during the career is illogical and no body is certain where he is going to pursue career. Just because you have a own house in a city, will you compromise on not moving up in career if it beckons from other part of the country or world. I have seen many people sticking to their own houses and not moving up in life because of the emotional attachments. Pl correct me if I am wrong

  26. Dear Hemant,
    I’m in talks of buying a flat (670 sq ft, 10 yrs old) at Rs. 21 lacs (South Kolkata). However, the owner has said that I make the agreement with him at the prevailing Government rates, which are much lower, and pay him the balance in cash, so that his capital gains tax liability is reduced. However, this would mean that I’ll have to make additional down-payment to the bank for my loan, resulting in greater cash outgo from my purse. Is there any remedy (legal or otherwise) to this difficult situation I find myself in?

  27. Hi Hemanth
    I am 26 yrs. I started my career recently and started my investment Currently i have some investment mentined below –
    PPF (Opend on Jan-13 with 10,000/-)
    Two MF SIP – HDFC (G) – 1000/month ,
    SBI Gold (G)- 2500/month

    RD – BOI- 6000/month
    RD – ICICI – 2000/month
    RD – HDFC – 2500/month

    I am planning to buy flat next year, by that time i need money for down payment. I can save another 30,0000/- per month apart from above investments. Please suggest me the best options to help achieve my goal.

  28. Hi hemant,
    I just went through your post on the housing property bubble and affordablity… One food for thought is… although on nominal terms the property prices seems to have gone up in last 3 years(but if you see in dollar / rupee terms they are below the 2008 levels)
    So basically the prices have not risen it is our currency which has depreciated and I believe real assets like Precious Metals or Real estate are the only hedge against a depreciating currency (and if the currency appreciates it indicates growth thereby increasing affordablity.. so both ways we are safe)

    Imagine some one Investing in FD in last 3 years… he has actually lost out coz prices of everything else(even food products) have risen much more

    so we may like it or not but we have to invest in real estate not to earn more but to protect ourselves…

    M i thinking in the right way or is there some mistake in my logic ?

  29. Hi,
    I have a Q regarding buying apartment for renting by selling the plot vs keeping the plot for appreciation in future.
    If I sell a plot I can buy three 2BHK apartments in decent area and will get 10 k each rent in Bangalore. what if i don’t sell the plot and keep it for future appreciation ?
    which one will be more beneficial ?
    thanks

  31. dear hemant
    as usual this too was a great article.i too is in a dilemma whether to buy a house or stay rented .buying a house now means i may become asset rich cach poor for the next 10 to 20 years.(am in my early 40 s). so still waiting to get more insights from your blog. thanks dr teny

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