One of the biggest financial dilemmas NRIs face while living in the U.S. is whether to buy or rent a house. For many NRIs, real estate has long been considered a safe investment and a necessary part of their portfolio. But, renting a home is often considered less than ideal because it seems as though you’re throwing money away on housing costs. Specifically, paying a landlord a few thousand dollars month after month – without getting any return on that money or any degree of ownership in the property – may feel like a waste, particularly when you can afford to purchase a home.
As such, NRIs may be drawn to buying a home instead of renting as a traditional vehicle to build wealth. However, homeownership comes with many upfront costs, as well as the ongoing expenses of interest and home maintenance.
The prevalent thought process amongst NRIs is that real estate prices always go up. Consequently, the only question they have when it comes to buying a house is affordability; they usually ignore the short- and long-term implications and risks of owning a property.
Real Estate Prices Don’t Always Go Up
Most US-based NRIs witnessed the real estate boom in India in the 2000s. During those heydays, it was not unusual for prices to double in just a few years. Unfortunately, this created a false sense of comfort and a perception that real estate prices move in only one direction. But, realistically, this is not always the case; housing prices can be volatile in the short term, just like any other asset class.
S&P/Case- Shiller U.S. National Home Price Index
Based on data from the Case-Schiller U.S. National Home Price Index, in the last two decades, housing prices declined 28% of the time for a one-year holding period. Sometimes, the crash could even be so prolonged that it could take decades to recoup the losses. For instance, on average, residential properties in Japan are still down 50% from their peak levels reached in 1991. Clearly, real estate prices have the potential to be volatile and stay depressed for long periods of time.
The Rent vs. Own Debate
To determine whether NRIs should buy or rent a house in the U.S., let’s analyze the economic implications by taking the example of a two-bedroom apartment in two markets with different price levels and rental yields: Sunnyvale, California, and Edison, New Jersey. This scenario assumes that the purchase is for a self-occupied home financed through a mortgage; it does not consider buying a second home as an investment property.
In this option, you would put down 20% of the purchase price and then pay the rest through a 30-year mortgage.
In this option, you would live in a rented house and invest the amount equivalent to what would have been the down payment on the house – in an equity index in the U.S. stock market, for instance.
Accordingly, the cash flow difference between the rent and monthly mortgage payment would be added or subtracted from the stock portfolio. Let’s calculate the net worth for these two options and see which one looks more attractive. We’ll use the long-term historical total annualized nominal returns from real estate and the U.S. stock market for our comparison.
*Historically, the total return from US Real Estate has been 9% and the same for the US Stock Market has been 11.4%.
Source: “The Rate of Return on Everything.” https://www.frbsf.org/economic-research/files/wp2017-25.pdf
*Long-term inflation of 3% has been used to arrive at nominal returns.
Sunnyvale, California: Mortgage for a 2-Bedroom Apartment
Based on these assumptions, the net worth at the end of 30 years would be roughly $4 million for those who bought a home and $7 million for those who rented. As you can see from the graph, the value remains more or less the same until year 14; after that, the power of compounding kicks in, and the equity portfolio outperforms the real estate.
Edison, New Jersey: Mortgage for a 2-Bedroom Apartment
The outcome for Edison looks more or less the same as it did in Sunnyvale. Based on our analysis, the value of holdings at the end of 30 years would be roughly $400,000 for those who purchased a home, as opposed to $800,000 for those who chose the rent option. As you can see from the graph, the value remains more or less the same until year 16; after that, the rent option outperforms the buy option.
So, from a purely economic point of view, it makes more sense to rent a house and invest the surplus in a diversified portfolio of equities.
Other Factors to Consider
Granted, there are additional factors to take into consideration when NRIs decide between buying or renting a house.
NRIs need to recognize that liquidity is the most valuable benefit of investing in a portfolio comprised of equities and bonds versus buying a home. Having the ability to get money out of an investment in a matter of days can be beneficial should a job change or other, similar life shift take place that requires a reallocation of available funds. Obviously, real estate does not offer this level of liquidity, which makes it a less suitable investment than most believe it to be. Furthermore, transaction costs could be as high as 6% to buy or sell a house.
Visa Status Insecurity
Most important, purchasing a home may not be the best financial move for those who are unsure of their visa status. Owning a property only makes sense when it is a long-term commitment of five years or more. Moreover, if your visa were to expire within that timeframe, it would be challenging and costly to manage a property while living in another country. Ultimately, NRIs who have established permanent residency where they plan to work for the long-term may have a more sound opportunity to buy a home. However, even in these cases, homeownership should be viewed from a usage perspective – not as an investment.
Tax Benefits of Mortgages
One factor that weighs in favor of buying a house, is the possible tax deduction of mortgage interest. Because mortgage interest is eligible for itemized deductions on federal income tax returns, owning a home may reduce your tax bill.
Therefore, if you rent, rest assured that you are not throwing away your money. Rather, you’re actually giving yourself a better chance to build more wealth in the long run. The decision to purchase a home is not always based solely on economics. Sometimes, the attraction to own your own home is high; but, even in that case, avoid any unexpected surprises later by being aware of everything you need to take into account before entering into this big purchase.