While I’m on vacation, my mom called me up to let me know that she heard news about a house on sale in Bangalore. It’s rare that I hear such excitement in her voice. I could tell she was eager to hear me say “Let’s go for it!” because it has been her only material ambition for over 20 years – to own a house. My dad never really was interested in investing in a house and my mom kept seeing house prices soar from under INR 200,000 to more than INR 2,000,000. I can empathise with her for I have seen stock prices explode 30 times while I sat on the sidelines :)
I feel bad (even guilty at times) that while I go on to achieve all I want with education and career, I’m unable to offer her this satisfaction of owning a beautiful house. So, the emotion got the best out of me and I asked her “Mom, What price are they quoting?” She said “3,000,000 Rupees, its high, but lower than what was offered a year back. They are offering such a good price because they are in need of money urgently, so we need to get back to them as soon as possible!”… I began to wonder if this might be a good investment after all. I told my mom that I’ll call her back the next day and began to ponder over it. I must admit it gave me a sleepless night because it is something I really want to do for her.
But then, if I were not to back this up with some simple calculation, this entire year of MBA studies would be a waste, so I quickly crunched a few numbers…
The average expected rent for the house today is INR 6000 per month, which means INR 72,000 per annum. Assuming the average inflation rate over the next decade will be a whopping 10%, the rent would increase at the rate of 10% as well during that period. Assuming that I get really lucky and secure a housing loan for only 6%, I can use this rate as the cost of capital. If I were to discount the total cash flow for the next 10 years (72000+79200+87120+…..+186750) by 6%, the Net present value of the house is INR 900,000!!
Ok, let’s do a reality check. NPV is 900,000 for the cash flow of next 10 years assuming I get a housing loan at 6% and the current quote is 3,000,000… lol.
The actual PE ratio if we were to in fact buy the house at INR 3,000,000 is close to 26! I then begin to wonder when was the last time a company on BSE had a PE ratio of 26!! Long time back, I hope. Imagine, even if a stock like Infosys had a PE ratio of 26 because you expect it to grow 40% (not 10%) per annum and then you are asked to invest not only all your wealth but also leverage yourself 10 times or more (by borrowing) to invest in that single stock!!! I doubt any rational person would do that, even if he is greedy. Certainly not if he is enlightened by the CAPM model…
Long story short… The next day I spoke to my mom and told her “Mom, it’s not a good idea”. She replied “Yeah, I’m not interested anymore either because the kitchen’s Vastu (Indian Feng Shui) is not right” :)