Rent vs Buy a Home in India in 2021 - 4% RULE By AssetYogi | RENTING vs BUYING - YouTube

Friends, we get a very common question that whether we should rent or buy a house

This is a big dilemma for people and was for me as well in the past

That's why I made a Rent Vs Buy calculator for myself and I also made a detailed video on it

You'll get that video in the 'i' button on the top of the screen

We discussed all the aspects in details in that video

Whether financial, i.e Quantitative aspects or Qualitative aspects

Such as convenience, emotional angle, long term Vs short term, flexibility

So do watch that video if you want to do the calculations in detail

But there was one more problem that came out from that video

People asked for a quick formula

Is it necessary to do so much of calculations in excel and after that, we'll be able to decide

So it's our work to simplify things for you and we love it

And we love to push the barriers

That's why I thought of making a thumb rule and let's call it Asset Yogi Thumb Rule

From this, we'll be able to calculate in a way that if a value comes out which is less than the thumb rule value, then you should rent

And if more than that value, then you should buy a house

This calculation can be done by anyone within 2 minute

And we'll see how to do it in this video. So stay tuned

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Friends, let me tell you before starting this video that this formula is over-simplified

That means it is used in taking quick decisions and quick calculations

But if you want to do the exact calculations then you can use the rent Vs buy calculator and watch my old video

And if we talk about our thumb rule, then we'll

calculate the cost for rent and buy a house

And If we compare both the costs, we'll get to know which one is profitable

So here, we'll take cost which we cannot recover

Like if we're renting a house, that cost will not be recovered

So first of all, let's consider the case of renting

So what is the Non-Recoverable Annual Cost here?

Let's say the rent of a house is Rs.20,000 per month

Then that is a Non-Recoverable cost and we'll not get it back, so this is a simple cost in renting

But there's a Non-Recoverable cost in buying a home as well

And here is what we do mistakes in calculations. So understand carefully

So what is the 1st non-recoverable annual cost

We pay Property tax + Annual Maintainance of a house

If you stay in an apartment, there is security cost, CCTV camera cost, and there are many more other maintenance as well

And even if you stay in your own house then there is the painting cost, repairing costs are there

So if we take average in the world

Then we can easily assume 1% of the total home value as the total annual maintenance cost in a years

And the property taxes are not that high in India but if we see world over, there are few developed countries where the taxes are very high

So I assumed that the total cost of Property tax + Maintenance is 1% of the total house value

Let's say if a house is worth Rs.1 crore, then Rs.1 lakh are spend

It's not necessary that Rs.1 lakh will get spent at once, it may be possible that you installed interiors and spent Rs.5 lakhs at once

So if we take the average, we can assume1% cost in a year

Another cost is Cost of Capital

Understand this, it is mainly the interest

Most people borrow a loan while buying a house

And we'll never get back the interest of that loan

So there are 2 portions in EMI, one is Principal

So as you're paying the principal, you're getting the house

And since you are getting the house in your name, you're getting that back and it will also be appreciated

But since the other interest component is non-recoverable, so we have to take its value

Let's take an eg. if anyone purchased a house worth Rs. 1 crore

And Rs.80 lakhs loan is borrowed then let's assume that 8% is the interest of the home loan

So we have to consider this

2nd Cost of Capital is 20% equity which means the downpayment

If anyone did a downpayment of Rs.20 lakhs then you have to take its cost also

Because if you would have invested that much somewhere else, then you may have got returns

So it also has a cost. So take the cost which you would have earned there

So let's take that cost 12%

Let's say that person invested some money in stocks and got 15-16% returns, some in PPF, etc.

So that person might get better returns than the home loan

That's why we considered on average 12% returns from equity

Now we have to calculate its average

So how do we do it?

We'll divide 80% by 8%, i.e 0.8 x 8% = 6.4%

For equity value, 0.2 x 12% = 2.4%

So when we calculate the weighted average, its called Weighted Average Cost of Capital

So when we add both of these, the cost of capital is 8.8%

It is called Nominal Cost of Capital

Which includes inflation. I'll further touch upon this topic

Now let's consider the Nominal Cost of Capital as 9% approximately

But here is a dilemma

Many people will say that when I am buying a house, the capital appreciation will take place

Definitely, that's right

But if you're renting a house, the monthly rent will keep on increasing

So we have to cover these things as well and then only our calculation will fit

That means it will be an apple to apple comparison

So for this, let's assume the monthly rent remains Rs.20,000

Inflation is 0, let's take it 0.

So if we remove inflation from here, then we have to remove it from here as well

that means the expensiveness

When the price of a house increases, the inflation also increases

And if you'll see on an average,

The average price increment of the last 25-30 years in real estate is roughly equal to inflation

Like if inflation is 6%, then the real estate will also be increasing at 6%

Anyways, stock returns generally beat the inflation

So inflation is included in the Nominal Cost of Capital

So we have to remove inflation from here

So let's say the average inflation rate is 6%, so we have to remove the 6% value from here

So now what is the real cost of capital

9 - 6 = 3%

So now we removed inflation from renting case and from the buying case as well

And you can give one more argument that you had your own money and you could have invested that money

and since you don't need to borrow a loan, you don't have to pay any interest on it

So definitely you could have invested whole money and it would be 100% equity

And if you would have invested that money in stocks, you might have got better returns

So there's a cost of ownership also and it's important to understand it

So now what is the total cost of buying a house

1% + 3% = 4% cost of ownership

So how we'll make a decision in this case?

If the annual rent is less than 4% of the total house value

Then we should rent that house because it's cheaper

And if it's more than

Then we should buy that house because the rent of that house is good

And you should buy it to not pay more rent

And if we see it as an investment, then if you're getting a rent of more than 4%

Then it can be a good investment

That's why you'll see that the commercial properties where the rent is 5, 6, 7% rent, are the better investments

That's why I decided the name of this formula the 4% Rule

Now let's understand this through an example and let's discuss some real-life examples

Let's consider example 1 of Delhi

Here, let's say the monthly rent of a house is Rs.20,000

Then the actual value of that house is around Rs.1 crores

So we need to find the annual rent as a % of home value, so what is that

If we multiply it by 12, we'll get a value of Rs. 2.4 lakhs

And if we calculate annual rent as the % of home value, then divide 2.4 by 1 crore

So 2.4/100 = 2.4%

How will we take decision?

If annual rent is less than 4%, then we should rent this house

So in Delhi, the rental yield of most of the houses is 2.5-3% in today's date

So staying in a rented house in Delhi is cheaper

Let's take another example

I am taking Chennai's example and this is also a real-life example

If the monthly rent of any house there is Rs.12,000 then the value of that house is Rs.30 lakhs

If we calculate the annual rent, multiply by 12 and it comes Rs.1.44 lakhs

For Annual Rent as a % of Home Value, 1.44 divided by 30 lakhs, that is 4.8%

4.8% is more than 4%

If the annual rent is more than 4%, then you should buy that house because it's profitable

Because if you'll rent it, you have to pay more rent

On the other side, if you buy that house, the rent will be saved

And you'll get good rent if you consider it as an investment

So buying decision is better here

So this was our simple formula named 4% thumb rule

You can easily take your renting Vs buying decision on using it

But as I told you, I took certain assumptions here that are based on long term averages

If you want to change a bit then you can make assumptions according to yourself

Maybe for someone, this is a 3-3.5% formula

For someone, this may be a 4.5-5% thumb rule

But I hope you got the logic and I use the 4% thumb rule

With that, if you want to understand the calculations in more detail or if you want to understand the aspects

that what should we consider for renting Vs buying apart from financial

Then you can watch my other video that you'll get in the 'i' button and the link will be there in the description

If you liked this video then do like and share it with your friends and family members

I am sure they'll also find it easy

If you have any suggestions related to this video or channel, then let us know in the comments

And also let me know how this formula is and would you like to use it or not

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Till then keep learning, keep earning, and stay happy as always.