Buying real estate? Read this first!

Traditionally real estate in the form of the house that we live in has been the single largest investment for most of us. This is seen not only in India [ Images ] but across the world. Let us now apply the metrics that we attribute to investments in general to real estate and see the answers that come up.

Current income

If the investment is on the house that we live in ourselves, there is no current income. This is one of the main negatives about the house that we live in. In a financial cash flow perspective given by Robert Kiyosaki, it is not an asset. Because the house is cash flow negative owing to the maintenance activities and tax that we have to pay for it.

Rent from a house or commercial property is a good source of current income. Although at current bank rates the rent from a house is generally only about ½ of the loan EMI, the catching up happens only after the loan is closed. A 1000 square feet house will cost conservatively about Rs 2500/- per square feet (in B class cities like Coimbatore, Kolhapur, Guntur, etc) leading to the house value of Rs 25 lakhs. A loan for 80 per cent of the value (Rs 20lakhs) at current interest rates (9 per cent) and 15 years term will require an EMI of about Rs 20,300. The rent for the same house in the mentioned cities may not top even Rs 10,000.

If we had 5 per cent yearly increment on the rent as part of the agreement with the tenant, the rent will be equal to the EMI in the 14th year.

Another aspect of the real estate property which requires attention is that the cost of maintenance also keeps growing. For example, Akash had to spend Rs 35,000 for a sump rework in a house build by his grandfather. The original cost for the construction of the house itself was only Rs 30,000 including the compound wall, and a fountain in 1967.

So a fully paid up rental property is an asset with good current income otherwise financially it is a liability.

Capital appreciation

Real estate appreciates in capital – particularly the land. The building generally depreciates. Recently the National Housing Bank launched the Residex, an index which will track the capital appreciation of real estate house properties. The data is updated for 3 years now. Over a period of time, the index can be used as a good measure for the capital appreciation of housing properties.

A key aspect of the capital appreciation is that, it can be realised only when it is sold. And generally the house that we live in is the last of the assets that we sell. This has to be factored in before we make the house the largest investment in our lives.

The capital appreciation of the house can favorably be used in the form of a mortgage loan for business purpose or in the form of a reverse mortgage post retirement. The land that cost Akash’s grandpa Rs 100/- per cent, is today worth Rs 600,000/- per cent. This is at a compounded annual growth rate of 23 per cent. Other property locations (grandsons) may or may not be so fortunate.

Risk

The risk with real estate is that it can go down sharply. The current worldwide economic turmoil is because of real estate prices dropping more than the expectation. The other risk is related to its liquidity itself.

Real estate prices in India do not have a formal/scientific basis for quoting. Brokers are the key pins holding the structure together. The same property may be quoted at different prices by the same broker for selling and for buying. The difference in amount goes to the broker – this, apart from their consulting fees. The pity is that often the difference is more than the profit for the owner of the property itself.

The other risk is that only a portion of the sale price may be registered, the rest is paid as ‘grey or black money’. Accepting such deals are counter-productive when we go for the selling as we have to bear the brunt of extraordinary capital gains.

The situation is changing but very slowly for comfort.