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.
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.
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|
|After Tax Income|
|Value of House|
|EMI Vs Income|
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.