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Jaitley's New Real Estate Pipe Dream: Where Rents Equal EMIs

Sep 13, 2016


Nostalgia is a funny thing. It makes you remember the good things you had and the good things you lost along the way (with due apologies to Bob Marley!).

The finance minister Arun Jaitley recently said: "(The) housing market in India, it had picked up. During Mr Vajpayee's government, bank rates had come down to such an advantageous level that it was easier to buy an apartment than rent it out. That sort of situation had existed where the EMI has been reasonable. I think that's the direction in which we have to slowly push our economy." Jaitley said this at The Economist India Summit 2016, in response to a query on how the government plans to improve the stressed housing market.

What did Jaitley really mean here? First and foremost, he was remembering the good old days of the Vajpayee government (between 1998 and 2004). During those days the rent one had to pay while renting a house, was very close to the EMI one would have had to pay by taking on a home loan and buying it instead.

The question is how did this happen? This is something that Jaitley did not tell us. And one can't blame him for it, given that there is only so much that one can say in response to a query. The real estate market had seen a boom in the 1990s. By the late 1990s the market had started to crash and kept unravelling over the next few years. Then the dotcom bubble burst in 2000-2001, the stock market fell after the Ketan Parekh scam came to light and the real estate prices crashed.

Hence, for the period that Vajpayee ruled the country, real estate prices were reasonable. In fact, as late as 2005 (a year after Vajpayee lost the 2004 Lok Sabha elections), property prices, even in Mumbai suburbs were fairly reasonable.

So, the EMI was low because the prices were low and it had nothing to do with lower interest rates.

Also, as I have often said in the past, lower interest rates aren't going to make any difference to Indian real estate. Let's understand this through an example. Let's say the property you are looking to buy costs Rs 80 lakh. The bank gives a home loan of 80 per cent against the market price of the home. This amounts to Rs 64 lakh (80 per cent of Rs 80 lakh). The downpayment that will have to be arranged for is Rs 16 lakh. The home loan is for a period of 20 years and the interest to be paid on it amounts to 10 per cent per year. (The prevailing home loan rate is around 9.5 per cent. But we will work with 10 per cent just for the ease of calculation).

The EMI on this amounts to Rs 61,761. Let's say the interest rate on home loans falls (the reasonable EMIs that Jaitley was talking about). Let's say the interest rate falls by a fourth to 7.5 per cent per year. The EMI will fall to Rs 51,558. This will mean a saving of around Rs 10,203 per month.

Of course, the home becomes more affordable if such a thing were to happen and home loan interest rates were to fall by a fourth.

Now let's take a look a scenario where home prices fall by a fourth or 25 per cent. The value of the property falls to Rs 60 lakh. The bank now gives a loan of Rs 48 lakh (80 per cent of Rs 60 lakh). This would automatically make more people eligible for the loan than there were when the home loan of Rs 64 lakh had to be taken. The downpayment required falls to Rs 12 lakh. This is Rs 4 lakh lower than the Rs 16 lakh downpayment required earlier, making things significantly easier.

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What about the EMI? At 10 per cent per year and for a period of 20 years, it works out to Rs 46,321. This is more than Rs 15,000 per month lower than the earlier EMI of Rs 61,761. Even at 7.5 per cent, the difference in the EMIs comes to close to Rs 13,000 per month. Also, it requires a lower downpayment of Rs 4 lakh. Further, at a lower value of the home, more people would be eligible for the loan, as a lower EMI needs to be paid. A lower EMI can be paid with a lower income.

Also, in this transaction I haven't assumed a black component, to keep things simple. But if prices fall, the black component also comes down. Also, I feel a 25 per cent fall, as has been assumed here, will not make much of a difference, the prices need to fall more than that.

The point being if Indian real estate has to get back, prices need to come down. Let's take the argument forward. Mr Jaitley talks about an era where rents and EMIs were equal. Now, what would it take for the rents to be equal to the EMI, in the time that we live in.

Let's take the same example again. The value of the home is Rs 80 lakh. The rental yield (rent dividend by the market price of the home) these days is around 2-3 per cent. Let's take the upper end of 3 per cent. At 3 per cent on a home worth Rs 80 lakh, the rent works out to Rs 2,40,000 per year or Rs 20,000 per month.

If one were to buy this house, the bank would give a home loan of Rs 64 lakh (80 per cent of Rs 80 lakh). The EMI on this would work out to Rs 59,656. (Now we assume the real prevailing home loan interest of 9.5 per cent per year).

Over and above this, the buyer would also have to pay Rs 16 lakh as a downpayment. This means that this money will no longer be available for investment. If the buyer had this money in a fixed deposit which paid around 7 per cent per year, this would mean letting go of interest of Rs 1,12,000 per year or around Rs 9,333 per month. Hence, the total opportunity cost of buying a house worth Rs 80 lakh works out to Rs 69,989 per month.

Now compare this to the rent of Rs 20,000 per month. What this tells us very clearly renting is a no-brainer as of now, as far as numbers are concerned. Of course, there are other problems associated with renting which an owned home does not have.

If the rent has to be equal to the EMI plus the interest lost on the downpayment, then is has to go up by nearly 3.5 times its current levels. If it has to be equal to the EMI, then the rent has to go up around 3 times. The other option is that the property prices need to crash big time so that EMIs come down dramatically and are equal to the EMI. Both options can be ruled out.

What will happen instead is that rents will rise gradually and property prices will fall gradually, in the years to come, but not dramatically (given that there are too many vested interests at work).

Only that is a given.

What this really tells us is that the finance minister Jaitley's dream of a time where rents are close to EMIs, will remain a pipe dream at best, unless the real estate prices crash big time. Also, there is a fundamental disconnect here, the cost of owning something has to be greater than the cost of renting it.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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9 Responses to "Jaitley's New Real Estate Pipe Dream: Where Rents Equal EMIs"

Suhas Ramakrishnan

Sep 16, 2016

Good note! Thanks. I was wondering though about a scenario where the lending rates also gradually come down making the gap between renting and owning smaller. In the above example, hypothetically, if the interest rates fell 80% over time, and rents and property prices stayed where they were the EMI would equal rent.

In reality though, given our population is so young and growing the property prices look to stabilize at some reasonable affordable level and then start moving up gradually. Hence, the upward trending rent curve would cross the downward trending EMI and property price curves until a crossover point at which it will start making more sense to own a home.


Sarat Palat

Sep 14, 2016

With the increasing population and owning an house is considered one of the basic need in India, I doubt the price of flats will come down.


Dhanush Dhari Misra

Sep 14, 2016

Throughout my service career from 1964 to 2004 I have been approaching different banks and financiers like LIC and HDFC for a housing loan. I had housing plots bought from Government housing boards in different towns. However the banks and other institutions always found some reason to not to give me loan.

I got a loan from HDFC in 2006 after my retirement (in 2004) for a flat by a builder (Z estate), because the builder was in constant touch with HDFC to make sure that his customers are able to get the loan. After 10 years the rent has exceeded the EMI.

In contrast quite a few of my classmates and juniors who joined civil services including the state civil services (like Orissa Administrative Service, Bihar Administrative Service, Orissa Police, Bihar Police and Bihar Financial Service, not to speak of IAS, IPS etc.) at much lower salaries got housing loans within two to three years of joining the services. One class mate who became a Mining Officer in Orissa told me that he did not need the loan as he was building the house gradually from monthly income.

I believe my other friends in the civil services who did not take the loan, did not need it as they were "building the house gradually from monthly income."

In each and every case of my friends in civil services the rent of the newly built house was equal or more than the EMI. In many (may be most) cases the tenants were Government Undertakings which sometimes were the banks themselves.

So I feel Jaitley's dream is very realistic for the people who form impenetrable rings around the ministers and other policy makers to make sure that analyses like those of Vivek Kaul's diary do not reach them.


Anil Divate

Sep 14, 2016

I had heard that one of the causes of the real-estate crash in US was that since the EMI was only a trifle more than the rent, many people felt that it is better to buy than to take on rent.
Many of the new owners were a) people who did not have the capacity to accept even a 15%+ fall in the price of their house and b) people whose future income was uncertain to a significant extent.

The goal of the government should have been to make rents affordable.


Suresh P Vasudevan

Sep 14, 2016

Thanks Mr. Kaul for opening up my mind to the fact that our FM is a Financially Illiterate person. Blabbering, without basics is like giving a Political Speech, where all those who attend such meetings are their own, paid & brought, people, who are totally unconcerned of what the Neta is speaking.

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Sep 13, 2016

What happens to the 7th pay commission effect?With added salaries and the cyclical effects on the economy what will happen to the real estate segment?

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ramakrishnan k g

Sep 13, 2016

that was spot on.I remember the adverts of HDFC and others where the cost of EMi vs rent was the highlight !Reasonable prices was what started the boom somewhere around 2000.

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Deepak Padher

Sep 13, 2016

Sir Ji,
Perfectly correct. I do agree with you.

One small suggestion - While calculating my NET EMI, I should subtract the Income Tax deduction ( 35 % ) from my EMI.AND also calculating net interest on FD , I must subtract income tax to be paid on interest ( 35 % ).

Is it correct ?


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Bapoo M. Malcolm

Sep 13, 2016

Have been advising my clients for years to sell their houses and stay in rented premises instead. But there is this middle class thing about "Owning a 1 & 1/2 BHK". And then renting it out!

It is land prices that must drop first. Then flat prices will follow. But the available land is and will be kept locked up, for one reason or another. Expansion, by links to the hinterland, will remain only on paper. That keeps prices in the city as high as possible. Had predicted in 2006 about a fall in prices upto 25%. It's worse but that is because of builders' greed and that of land owners. If prices, in rupee terms, are the same as 10 years ago, it actually means they have fallen. But not enough.

As you rightly said, water finds its own level. But that can take years. So, the Adam Smith solution. Let the market take its course. Let the builders burn at the stake. Arun Jaitley is a politician, not an economist, at least in thinking and behaviour.

Put you in the same class, in public-comprehensive economics, as Ankleswaria Iyer. As I ask my students to read him, so will I with you. Thanks.


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