When should I buy real estate and how much can I afford?

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Can I afford a house? 

If you are a young middle-class Pakistani, that question seems almost pointless. The real estate market is so ridiculously overvalued in Pakistan that it seems pointless regurgitating well known truisms.  

But just to hammer it home one more time: the total value of residential real estate in Pakistan is around $1,211 billion (yes, that is $1.2 trillion), according to estimates by Elphinstone using data from Zameen.com and the Pakistan Bureau of Statistics. This is 3.32 times the total size of the Pakistani economy in 2020.  

If one compares this to the US, the real estate market over there is around 1.64 times the GDP. By Elphinstone’s calculations, that means the Pakistani real estate is significantly overvalued and prices would need to fall by about 50% in order to reach the same levels relative to income as those in the United States.  

But you do not even need the numbers to tell you that. Any young Pakistani with a family and looking to buy their own home will tell you it is hard to be able to afford a home in most parts of urban Pakistan. As a result, most people continue to live in a family home, with some people continuing to rent. Many people in both situations would very much like to buy a home but cannot afford it. 

We do not mean to downplay the benefits of a joint-family system; there are many for everyone involved. But home-ownership for young families is a goal that is not in conflict with the joint family system: elderly parents can move into their children’s homes, some families might choose to have their adult children move to homes nearby, and still others may decide to buy a home and rent it out. 

At Elphinstone, we believe in financially empowering people, and we believe that most people would like to own some property at some point in their life, and that it is entirely appropriate for them to do so and to plan accordingly. 

Elphinstone cannot change how overvalued the real estate market in Pakistan is, but we can give you tools to figure out how – and how much – you can afford in terms of buying a home.  

Our advice to our clients is based on an assumption: most people only need one home as the primary piece of real estate that they own. Our model is not built to allow for savings for multiple homes, though it can be modified by our clients to change how much they can save for, and as a result, perhaps afford more than one property.  

Our general advice on the matter is that one home is enough for the needs of most people, and any additional capital available for investment is best placed in other asset classes, not real estate. Our reasoning? Because a primary home tends to be one of the biggest assets most people own, so investing in real estate beyond one’s primary home can result in over-investment into real estate as an asset class, and prevents a person from realising the risk-reducing benefits of diversification as well as the additional returns that are available from investing in stocks. 

Here is how our model works. If you identify that you need to save up to buy a home, it will then ask you what age you would ideally like to buy a home so as to be able to calculate how long you have to save up for a home. 

What should you set as your home-buying age? Generally, SmartRupee recommends setting the age at between 45 and 55 years of age. This allows younger clients to have more time to save while still leaving open the possibility of a mortgage term between 10 and 20 years. (Not interested in borrowing? Keep reading.) 

What if you are close to these ages already? Set the age to at least 10 years older than you currently are to maximise your savings opportunities. If you are above 55, set it to the default of 65 years of age. 

Next, it will seek to determine your expected income by the time you buy that home, which will determine how much you should be able to afford in terms of a home. The general rule of thumb is that a home should not cost more than four times your annual income.  

In the next step, the model will then determine how much you will be able to borrow for a mortgage – assuming long-term average interest rates on mortgages – and how much time you have left until the age of 65 (Pakistani banks do not allow people to continue making mortgage payments past the age of 65.) 

Once we know how much of your home price you can borrow (no more than 75% to allow for at least a 25% down payment), we then determine how much you need to save for in terms of a down payment in total (not adjusted for inflation). We then add those two amounts to determine your total home purchase price, and then adjust it by home-price inflation, which is higher than regular inflation. 

This inflation-adjusted number will tell you the current price of the home that you will be able to afford at the age you say that you want to buy a home. So, for example, if you are 30 years old, and you say you want to buy a home by the time you are 45 years old, the inflation-adjusted price will give you the current price of the home that you will be able to afford in 15 years.  

This will allow you to look up what kind of home you will be able to afford by the time you can buy a home, knowing that your savings and investment plan is designed to allow you to catch up with the price increases that will take place between now and when you will eventually buy. 

What if you do not want to borrow any money to buy a home? The model will tell you how much of a down payment you will have available at the home-buying age you choose: that amount equals what you can afford without a loan. 

Have religious reasons to want to avoid a conventional mortgage? Islamic options are available from many banks in Pakistan. 

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