Whether to buy or rent a house is an important question. One that merits modelling multiple variables and their corresponding cash flows in Excel at leisure! In this article, I compare the IRR from purchasing a house with a 20 year home loan versus the IRR from renting the same house and investing the down-payment and the difference between EMIs and rents through-out the home loan term. I have considered the tax implications of both the alternatives – tax exemptions u/s 24 and 80C for the Home loan and the deductions as per HRA in case of living on rent.
For easier reading, I have denoted IRR for house purchase as IRR-P and IRR for renting the house as IRR-R. Setting assumptions like long term house price appreciation and rent escalation based on actual historic movements and rent capitalization rate, interest rate, yield on investment etc. at levels that to my mind seem reasonable, the IRR-P trumps IRR-R hands-down. Assumptions on net salary, basic, HRA, and DA are required for computing tax benefit on HRA exemption. I have attached the model with this post, so you can tweak all the assumptions to your heart’s content!
- Rent capitalization rate (Cap rate) is the most sensitive variable in determining whether one should buy or rent a house. Put simply, the price that you are willing to pay for a house should necessarily take into account the market rent that is being asked on the same or similar apartments. As a corollary, the rent you are willing to pay for a house should necessarily take into the account the price that is being asked for the same or similar apartments.
- The higher your income, the more you benefit from purchasing a house than renting it.
- Higher house price drags down IRR-P as the tax exemption on interest payments is capped at Rs 150,000 per annum irrespective of how much interest you actually pay.
- If long term property price appreciation rate is same or only slightly more than long term rent escalation rate, IRR-P is lower than IRR-R.
- The higher the leverage on the home loan, the higher the IRR-P.
Snapshot of the assumptions and the resultant IRRs:
Sensitivity of the IRRs to the variables:
Excel File: HomeLoanVsRentCalc
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