Real Estate Can Be A Tricky Trap

Mark Twain’s famous saying always rings in my mind “Buy Land, they’re not making it anymore“. Interesting quote – isn’t it ? The supply of land is known and we all know that despite of man’s efforts, the overall supply can not be increased materially. Man has tried and perhaps has been successful in increasing the available surface area by building flats. However, there is a limit – how many flats can you build within the same area ! As a result the price of real estate tends to go up year on year. Hence, I don’t dispute upon the fact that real estate may be amongst the best available investment options, provided you can afford it and can wait for a long term.

The motive behind this article to highlight a few aspects which makes this highly lucrative investment option screw up the financial position of investors who overstretch their budgets. Lets go through them one by one :

1. Notional Gains only – The easiest way to sell a real estate to a gullible investor is to market the near by properties and reflect that the prices have gone up by x% in past couple of months. Not sure how many investors would have faced it, but in my network of people, almost every one say that their property’s price has doubled / tripled in last couple of years. How do they know that ? The pricing of Flats / houses / plots are not listed any where. Their prices are what the builders or buyers quote. Unless you have been approached by a buyer with a definitive price, the price of your property is all in the air ! If you ask the builder for your flat’s price, you are ought to receive a positive reply to keep you smiling – after all the builder needs to sell his flats and get the regular installments. Try the following :

a. Ask your builder about the going rate of the flat. If he says it is for example Rs. 5000 per sq. feet, then ask him to buy it from you at that price. I am already chuckling to hear your builder’s response. I have tried it personally with 4 builders and all ended up quoting 20% less price in case I wanted to sell the property to them….

b. Ask a broker about the going rate of your flat and tell him that you would love to sell your flat at the rate quoted by your builder. You would be lucky if there is a buyer to pay you the price.

 

2. Very Poor Liquidity – This is the biggest issue with real estate market. When you want to sell it, it would take months if you are lucky to get a  buyer who is ready to pay you the price which you are looking out for. I am aware of several examples where the people are waiting for several quarters and end up selling their property at a discount considering lack of buyers who would want to buy their property. And in such a scenario if you are desperate to sell your property, then the price of your property is what the buyer is prepared to buy at – don’t be surprised if the buyer shaves off 10-20% from the value of your property.

 

3. Big Tickets means big risks – House property is not a cheap investment option. In metropolitan cities, an average flat costs around 40-50 lacs. In other cities, it may start at around 15-20 lacs. The sheer value is mind boggling and hence even a slight mistake in the investment decision can result in uprooting your life’s saving. Just think what percentage of your saving does your house comprise of and if something happens to your house, what impact would it have on your asset base.

 

4. Servicing Home Loans – Big value houses require big value housing loan. And big value housing loans require a big time effort to service the monthly housing loan EMI / mortgage. On an average, 1 lac loan requires Rs. 1000 monthly EMI. Hence a 40 lac loan on a 50 lac property would require Rs. 40K per month EMI. I have a couple of contacts (may be they are reading this article and are frowning upon) who have taken close to 80 lacs loan and have to shell out Rs. 80K per month EMI. I would assume that their earning levels would be able support 80K per month mortgage / EMI. But even for a person earning over Rs. 2 lac per month would end up feeling uneasy to see approx 40% of his salary going towards EMI. And in most cases the person would be paying another 30-40K towards his house rent !

 

Cash Flow Crises5. Screwed Up Cash Flows – In the above paragraph, you would realise that over 50-70% of your family’s net cash would end up being used towards your housing loan EMI plus rent. And all of a sudden you would realise that just 30% of your salary is left towards other expenses such as schooling of your children, family budgets, etc. A person would not be wrong to feel stressed and frustrated on his financial position such that even after earning several lacs he / she is living a life of a pauper – just because he has ended up investing in a housing property which his cash flows can’t really support or if he can, he has to squeeze his family’s right to enjoy a decent life style. Earlier he could enjoy a family outing once a year, however now after buying a property, he can not even think about one.

 

6. Security Issues – When you are investing into any asset class, I am sure you would like to know the associated risks. The two biggest risks in a property market are fake property documents and Land Grabbers (commonly called as ‘Bhu Mafias’).. Did you watch the movie ‘Khosla ka Ghosla’ ? If yes, I don’t need to explain more. I have seen two examples of mafia groups claiming illegal possession over property and if their rights were questioned, the answer was given over a Gun Point. In other cases, fake ownership documents are produced by an illegitimate seller who ends up raking the mullah from an innocent buyer. Later on, actual owner of the property contests the right of the buyer. Poor buyer has lost his money (in several millions) towards a fraudster !

 

7. Wealth Tax Issues – This is one of the least known impacts of having multiple properties (residential). Most of the people on earning spree start with first property (flat or house), then second and third and so on. You need to know that as per the rules of Wealth Tax Act, a person is required to pay a 1% Tax on his Wealth over 30 lacs. One residential property is exempted from this limit. Also, if your property has been on rent for more than 300 days in previous year, then it is exempted. However, many people just buy the flats and keep them locked and hence expose themselves to Wealth Tax. For example, if you have two flats, one costing Rs. 50 lacs and other costing Rs. 60 lacs. You can claim one as exemption and on another one, you would have to pay Wealth tax @ 1% of Rs. 60 lacs less 30 lacs exemption i.e. Rs. 30K per year.

 

8. Poor Diversification – It is a famous and time tested saying that do not keep all of your eggs in one basket. Similarly it goes with your investments. Investing into real estate is not a cheap option. They are big ticket investment options and hence in many cases a person’s entire life’s saving gets invested into a single asset. If they are lucky, they have their employer’s Provident Fund or some PPF balances to their rescue. Others deliberately end themself into this mess whereby the sheer greed factor forces them to buy another property in expectation of big gains. I have so many examples sitting infront of me who have none except real estate as their investments. Have you considered what would happen if the prices of housing market stagnates for a couple of years ? Or what would happen if your property faces external shocks such as an earthquake, fire (in case you are uninsured), or other property associated issues such as fake documents ?? By sheer thought of it, I have cold sweat dripping from my head. Wake up and don’t give into the greed of owning just one investment class. Diversify your investments into other asset classes other than just Real Estate. Examples of other assset classes are Mutual Funds, Gold, Fixed Deposits etc.

 

9. Poor Rental Yields – You can make money out of Property investments via two ways – first is capital appreciation and second is via Rental income. If you are amongst the people who are looking out for a regular rental income to support your retirement, then I am sorry to say that Residential properties are not a good option. The rental yield in India is generally less than 4% of the value of the property and in most cases it is between 2-3%. You can do the calculation in any city where you live. Divide the rental income per month x 12 by the property value. You can get well over 8-10% if you invest in Fixed Deposits or in Monthly Income Plans offered by Mutual Funds.

 

Conclusion

As mentioned above, the motive of this article is not to scare away the buying decisions in favour of the real estate market. I would sincerely want every potential buyer to question their financial plan and check out if they are too heavy on real estate and would they need to balance their portfolio towards other asset classes. This would not only reduce the overall risk on the financial position of a person, but also make their gains tax efficient. Any ideas are welcomed.

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8 Replies to “Real Estate Can Be A Tricky Trap”

  1. Love mark Twains quote ‘buy land, they’re not making it anymore’…so true!

  2. Indeed – I also firmly believe this saying.

  3. nice information on realestate property,,,,
    thanks for sharing…

  4. One factor against real-estate investment is ‘corruption of own self’.
    A real estate deal in India forces one to be corrupt (registration fee/Khata/what-not). On the contrary, investing in mutual-fund/shares/ETF is clean. In line with the philosophy of look-inwards, one can reduce the corruption in their own life by minimizing real-estate transactions.

  5. Probably this is also one way of looking at it Sambaran.

  6. sir,

    kindly please clarify me with respecting to investing in flats:

    1. is it true that if we rent the flat, then we can take upto 30% of rental income as
    maintaince and repair charges
    2, is it true that,if we are renting the flat, then the property tax gets waived..means i dont have to pay property tax at all.

    finally= what other benefits do i enjoy by renting out my flats.

  7. Joshy,
    1. Yes. There is a standard deduction of 30% on the income from Flats.
    2. I am not sure about the property tax. But if you are referring to Wealth Tax which is charged @ 1% on the value of Residential Properties. If a property is rented, it is exempted from this tax.

    Other benefits – you enjoy a steady stream of revenue along with capital gain on your property.

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