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.

Liquidity

Real estate is probably the most illiquid of all common investment avenues. If there is an urgency to sell a property the value could drop drastically. Selling at 'market price' is counted in number of months not days.

Tax treatment

Real estate attracts capital gains tax. The advantage is that we can use indexation benefits to our advantage. The indexation index is announced every year by the Income tax department. This is a number which links the inflation to property values. By using indexation, we can estimate the true appreciation of the real estate after adjusting for inflation.

The tax on the sale of the only house or agricultural property can be brought down to zero by reinvesting the sale proceeds in a new house or agricultural property. The capital gains can also be invested in low interest yielding capital gains bonds.

Convenience

Real estate has a low level of convenience. It requires a large corpus for investment leading most of us to take up loans. Here are a few smart marketing companies that sell land in installments. However the overall cost for such deals is very high compared to one time payments.

The decision after buying a property cannot be reversed quickly or economically. The cost for registration, brokerage charges and taxes prevent us from getting rid of a wrong purchase quickly.

Summary

Traditionally, real estate has been the major investment avenue across the world. The trend is not due for a change as the capital appreciation is good. However the points to be thought about are that:

Capital appreciation can be enjoyed only when the property is sold or when the value is unlocked through a mortgage loan or reverse mortgage.

The house that we live in is not a financial asset as it has negative cash flow.

Rent proves to be a stable and reliable source of income. This however is only applicable to properties that are free from loans.

Overall convenience is low for real estates.

Rediff.com Business

Dubai World crisis will certainly impact the Indian realty sector which has not even fully recovered from the Lehman Brothers crisis

Parry Singh, managing director of real estate equity fund Red Fort Capital, the debt crisis many again drive banks to tighten their credit policy, a move that could jeopardise the credit flow into the realty sector.

“It will also adversely affect the sentiments of investors. Indian developers get lots of funds from Dubai that will be severely affected,” Singh said.

Singh said a large number of buyers of high-end projects are from Dubai. If they become reluctant to buy properties following the crisis, the realty companies will be hit, he added.

“However, the severity of the damage is yet to be calculated.”

Added Anuj Puri, chairman of real estate service provider Jones Lang LaSalle Meghraj (JLLM): “There will be certain impact of this crisis in terms of business sentiments even when the indian realty sector seems robust.”

If the default in Dubai turns into a sovereign default, there would be “real economic issues”, which may hit several countries, he added.

According to engineering and construction major Larson and Toubro, the Dubai debt crisis is “worse” than the financial crisis that followed the collapse of Lehman Brothers in September 2008.

Faced with funding crisis, the Dubai government Wednesday asked the creditors of state-owned Dubai World and property group Nakheel for a six-month standstill on interest payment.


To read more, please, visit Indian realtors unfazed by Dubai crisis

Indian real estate companies are collectively looking to raise $US4.5 billion of equity

Hot picks for investors, say analysts, are companies that have land banks located within city limits in India's seven biggest cities: Mumbai, New Delhi, Kolkata, Bangalore, Chennai, Hyderabad and Pune.

Some examples are unlisted Godrej Properties and Oberoi Constructions, which have assets in India's financial capital and the country's most expensive real estate market, Mumbai.

During the IPO boom of 2007, the larger the land bank, the more successful the IPO, said bankers. Now, it's more about cash flow.

Land banks in prime locations and a focused building strategy, where projects can be developed in the next five years, will also be better valued.

“Having a large land bank will go against you this time as it shows that the builder has no focus,” said Shobhit Agarwal, joint managing director at the capital markets division of Jones Lang LaSalle Meghraj.

To read more, please, visit Sceptical market greets $5bn in Indian public offerings | The Australian