04 October, 2014

People are like lemmings when it comes to property

This time, I’m dealing with a subject people love and would hate me for this piece – especially the ladies. We are talking about properties.

Apart from apparel & jewellery, another area which holds their fancy is properties. Women crave to have a home of their own. I have not understood that feeling, though. I have not even been able to convince my wife. But the craving for a home is overdone.

Since I have anyway embarked on a perilious mission, let me start lobbing the stink bombs! I’m going to bust some myths which have been used as props to buy properties.

1.       Good houses are very expensive to rent -   Have you tried buying good houses? Are they cheap? If they are unaffordable to the extent that you need to sell the family silver and take a king’s ransom as a loan, why don’t you just rent the house?

Most people can afford to rent decent houses rather than only living in the houses they can just about afford. Read this statement again. Therein lies the irony. Most people buy a matchbox like house as that is all they can afford. They pay EMIs most of their lives. And compromise on living in a decent house today.  They live their entire life in a dungeon when they could have rented out a good home, in a place of their choice, with a view they would have liked; they can even change the house, the area, the view when they get fed up with it!

Pic Courtesysairaajyamrealty.wordpress.com
But since they think it is expensive, they do not explore that option.  Let us take an example and check out. I have my office in Nerul, Navi Mumbai.  A 2 BHK ( with pitiably small rooms ) would cost about Rs.90 Lakhs here ( not including brokerage, registration, stampduty etc.).   That should see the final figure ballooning to about Rs.96-97 Lakhs.  However, the same flat is  available on rent for about Rs.16,000/-pm ( Rs.1.92 Lakhs pa ), all inclusive.  So, you are paying just 2% of the flat value as rent. The owner does not get even 2% return, as he needs to pay society maintenance, property tax & income tax on the rent received. He would probably get a net return of 1.2% on his property. When someone is subsidizing you like this, why not take advantage?!

2.       Rent will go up astronomically in future -  Rents do go up by about 10% in most cases, so as to cover inflation. But so does one’s income in most cases, to cover inflation. Income increase is a lot more in many cases. So, this does not wash.

3.       Rent paid by us goes down the drain, without creating as asset, unlike EMI  -  Let us again look at the facts… let us take the same example of the Rs.90 Lakhs property… rent paid would be Rs.16,000/- pm but the EMI would be Rs.67,400 pm ( assuming he is eligible for a loan, has the capacity to repay it & takes a loan of Rs.67.5 Lakhs amounting to 75% of property price @10.5% ). Also, he would have liquidated his personal savings of Rs.23.5 Lakhs ( for 25% upfront payment ). He would also have spent between Rs.6-9 Lakhs on stamp duty, registration, brokerage … The interest loss ( at 8% pa ) on these amounts paid by him interest, would be about Rs.2.65 Lakhs or about Rs.22,000/- pm. By booking the property, he is infact losing Rs.89,400/- pm, when he could have just paid Rs.16,000/- as rent today and invested/ reinvested  the other Rs.73,400 pm. The net result is infact astoundingly good if one were to invest these sums diligently!

4.       I will have to keep moving every year -  No landlord in his senses would want a good tenant to move. This is mostly an unfounded fear. Mostly one is able to stay for three terms atleast. Even if one needs to move, you can get the next house without any hassle through a broker. And moving is no problem as packers and movers are always there. The cost of brokers and packers is miniscule in the overall scheme of things.

5.       My children are studying in this area hence we need a home -  Whichever area one is residing, one can always get another house in the same area. Lots of times, one can get a house in the adjacent road, adjacent building and sometimes, within the same building!  A broker can ensure that.

6.       I have to change the address often -  Now, that is a genuine reason for once. This is a hassle. Changing the address once every 3-4 years is irritating- but can be managed. If you would like to buy a house only to take care of this, you can count yourself among the brightest chimps!

7.       I want a house so that I can save taxes -  This looks logical, but does not have much merit. On the first/ residential property one can deduct the loan interest upto a maximum of Rs.1.5 Lakhs pa, from the taxable income. That means a tax saving of about Rs.46,500/-pa, in all. But, even if you stay in a rented house, you can claim deduction for it which would be the lower of –
·         Actual HRA received
·         Actual House rent paid less 10% of basic
·         50% of basic in a metro, 40% otherwise
Rough estimates suggest that the amount saved here would be of a similar amount as a loan situation. Hence the argument that I want to buy a house to save taxes is totally flawed.

8.       Properties give best returns-  Buying a house for investments is fine, if you have sufficient investments in financial assets and your asset allocation indicates that diversification into other asset classes like property is desirable. Please note that, in this case we would not be investing in property because it gives the best returns, but because of diversification needs.

But, when you do buy a property, please understand that it is locked up for a longtime, has ST capital gains tax implications even if you are able to sell in the near term ( within three years )

 , has longterm capital gains tax implication irrespective of when it is sold, earns very little in the time the property is with you, has to be maintained and need to go through the hassles of putting it on rent ( if it is a house/ shop ), repairs etc.

Longterm returns of property is in high single digits at best, taking into account all costs involved.  Properties also depreciate. A house in a 20 year old building will command 70-75% of the price of a house in a new building.

Equities have given over 17% compounded returns from 1980! Equity oriented assets in addition are liquid, are not subject to taxes ( after 12 months ), are hassle free, portfolio can be refreshed from time to time & also give annual dividends ( the annual quantum of returns is at a similar level as properties ). 

Where people make a mistake in terms of properties is that they get carried away when they see the gross returns in rupee terms ( like Rs.1.1 Crores ) instead of a compounded annualized return of say 9% ( which is what it would have amounted to ).

9.       I can leverage and create an asset by taking a loan in case of property -  One could create an asset by leverage-agreed. But, when you leverage you are exposing yourself to risk. Also, you need to pay interest on the loans taken, which comes to a huge amount.

Let’s take an example. In a loan of Rs.50 Lakhs at 10.5%pa interest for 20 years, one will pay an interest of Rs.70 Lakhs! How cool is that?! If you can afford to service the EMI ( about Rs.50,000 pm ) for a Rs.50 Lakh loan, you could also invest that amount in say an equity fund yielding 12% pa returns and get to a corpus of Rs.4.9 Crores!!!  If you have been sleeping till now, this should wake you up!

Properties are good to invest if they are a part of an overall investment basket.  If one has only property investments & that too with leverage, it can be dangerous.  Property investments are being made for all the wrong reasons.  It is emotionally appealing but infact is a plain Jane, in terms of real investment appeal.  Invest only if it passes all tests of a good investment. If you mix emotions with investments, you are bound to end up on a sticky wicket. We would like to avoid that, won’t we?

Author : Suresh Sadagopan   |   Founder    |   Ladder7 Financial Advisories  |  www.ladder7.co.in

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