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Can We Invest in Property in Today’s Market?

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Invest in house propertyMost Indians prefer investing in house property, at the expense of other asset classes (except perhaps, Gold). The security of a physical asset is psychologically preferred over other non tangible assets such as Equity or Bonds.

While property has given extraordinary returns in the past many years in most markets, it is not realistic to assume that it will continue to do so in the future. This article attempts to examine the economics of buying house property for investment purposes in the current economic scenario.

1. House property in India, on an average, has in the past traditionally given very good returns (anywhere between 8 to 15 % per annum annualized rate of return) over the long term (around 10 years or more) on the per square foot rate of the property. Over the short term, the rate of return may vary widely, thereby resulting in either super profits or even heavy losses, depending upon which side of the wave you are caught. Thus, invest in property for the short term (less than 10 years) only if you are interested in a speculative activity than an investment.

The cost of a property, apart from the basic rate, includes other extra amounts payable to the builder such as parking, MSEB charges, Club house charges, Gas connection charges, legal charges, floor premium charges, etc., as well as amounts payable to the government towards taxes such as stamp duty, registration, service tax and VAT. These amounts together increase the cost of the property by around 20 – 25%. Many of these charges are not recoverable when the property is sold, hence should be regarded as expenses on which there are no returns, rather than as an investment.

Secondly, when a property is sold after a few years, it may not fetch the same rate as a new property would fetch. The rate might be lower by around as much as 0.5% for each year the property has been in use. (E.g. a 10 year old property might fetch a rate which is up to 5% lower than a new property of the same quality and at the same location).

2. Gross rentals from renting out residential house property on an average, are typically around 2 to 4 % of the prevailing property value in a majority of the rental markets. However, many expenses such as property tax, monthly maintenance charges, repairs, etc are typically borne by the owner, which reduces the net returns from rentals to not more than 1.5 to 2.5 % of the prevailing property value.

3. Most investments in house property are funded through home loans. Interest burden is a huge cost and adds manifold to the cost of the property. A loan taken at an average rate of 10.5 % per annum for 15 years will double the loan amount repayable i.e. interest paid over the period will be equal to the loan amount! So a loan of Rs 50 lakhs repaid over 15 years @ 10.5 % per annum interest results in a total repayment of around Rs 1 crore over 15 years, which includes Rs 50 lakhs as interest.

Home loan rates of interest tend to be around 1.5 to 2.5 % more than the prevailing rate of inflation. Thus, if the prevailing average rate of inflation is 9% p.a, the home loan rates would be somewhere between 10.5 & 11.5% per annum, which in many cases is more than the rate of return from property over the long term.

4. Finally, when a property is sold, Capital Gains tax is payable thereon. Such tax can be avoided in some cases, but to save tax, the sale proceeds have to be invested in another property or in low return bonds, which generally make little economic sense.

5. On the positive side, the main advantage of investing in property is the possibility of compulsory saving towards an asset through the loan repayment, which otherwise would have been very difficult. However, this advantage by itself may not be enough to overcome the other disadvantages listed above.

6. It would be seen from the above that in many cases, the net returns from property (after considering additional non recoverable upfront costs, interest paid, net rentals received and tax effects on interest, rentals and capital gains) rarely exceed the rate of inflation, thus many times leading to negative real returns. This is especially the case when the property is funded through home loans, instead of buying it outright. If the long term inflation rate is around 9%, the increase in property rates over the long term should be at least 12 to 13% per annum, for the returns to beat inflation.

Thus, the chances of property giving above average returns are not very high, especially when it is funded with borrowed capital. While there may be cases especially in the fringe areas of a developing city, where returns on the basic property rate may exceed 12 to 13% per annum over the long term even in these times, these cases however, are more likely to be the exception rather than the rule, and would also require some amount of luck, apart from a lot of hard work, for the investor to identify such properties.

Add to it the fact that property is a very illiquid asset, which may require months or even years to dispose of. Besides, it is a big ticket investment which cannot be sold piece meal, hence has to be sold entirely even if a part of the value is required in cash. In case of emergency large scale fund requirements, it may not be possible to raise the cash quickly.

To conclude, it is this writer’s view that purchasing a house property only for investment purpose may not be a very smart idea in the current economic scenario of already high property prices, along with high inflation and high interest rates. The only reason a property should be purchased is if it is a first owned property which is intended for one’s own residence.

About the Author:

The Author, Paresh Shetiya is a Chartered Accountant and Certified Financial Planner. He can be reached at expert@investmentyogi.com

  • Rahul

    Good analysis.
    On other side, the appreciation of property is the gain which you cannot ignore.
    The real problem is, if we are not investing in property, which other place to invest which will give good returns compare to appreciation of property?

    • Av Suresh

      Yes, You are right Rahul. The past ten years has seen a tremendous appreciation in the real estate space. Land has been the ruler. However, there is no guarantee that this would continue. We could this with housing slump in US. Similar situation may or may not arise in India, but we need to be cautious. Investment in real estate is good when mixed with debt, equity, gold, etc. Diversification should be the key to go ahead.

  • Ravi

    Very good information. One point to add is benefit of income tax on interest,
    If gross int payable is 10.5% on an average, if income from rental is 1.5%, then for a 30% bracket income tax payee, the net int payement is (10.5-1.5)*0.7 ~6.3%. If apreciation is more than10%, then the investment must is worth. The risk is onlyiquidity. -Ravi

    • Yogi Cfp

      Thank you Ravi. That’s a good point to add.

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