Portfolio

Get the plot right

Meera Siva | Updated on November 22, 2014 Published on October 12, 2014

Dreaming about owning a piece of land? Here’s how you can go about picking the best one

“Buy land. It will surely appreciate because they are not making more of it.” This is an oft-heard wisdom from traditional financial pundits. And there is merit in the advice. According to Tamil Nadu Government registration data, land prices have appreciated 30 per cent annually from 2002 to 2012. Data from other parts of the country too read similarly. For instance, price data for Bangalore’s central business district show that land prices increased 22 per cent annually between 2011 and 2013.

Likewise, even as property prices in Mumbai were soft in 2012 and 2013, data from real estate advisory firm Knight Frank show that land prices grew a healthy 16 per cent annually.

It is therefore the potential price appreciation that is the strongest argument in favour of investing in land. All of us know at least one person who bought land dirt cheap that later turned into a multi-bagger. Such windfall gains may happen in any location as demand grows, infrastructure develops or jobs become available nearby. One such example is the area near the Outer Ring Road in Bangalore which got a boost when IT majors set up their offices nearby and road connectivity improved.

Another way land prices get a sudden boost is when the build-able area for a given plot size, known as Floor Size Index or FSI, is increased by local authorities. Consider a locality with FSI of 1.5. This means that 1,500 sq ft can be constructed on a 1,000 sq ft plot. If FSI increases to two, the allowable construction increases to 2,000 sq ft. You can view this as equivalent to the land ‘expanding’ 33 per cent to 1,333 sq ft for the same FSI.

Land also requires relatively less capital investment compared with buying an apartment. For instance, you can purchase land in the outskirts of cities for ₹300-500 per sq ft. This is typically one fifth to one tenth of the cost of a mid-income apartment in similar locations.

Also, when your time horizon is long, say, over 15 years, land may be a better investment than a flat. This is because buildings deteriorate but land seldom declines in value. So, after 20 years or so, an old building will be valued closer to the land price in that area.

Besides as an investment, you may also want to buy land to build a home after a few years. Owning land substantially reduces your investment at the time of construction.

What to buy

There are four popular routes to take when buying land, based on your risk appetite, holding period and investment size.

One option, which is gaining traction lately, is to buy agricultural land. The costs are much lower than residential land and this provides a large upside potential if it is re-classified as suitable for housing layouts.

Sample this. An acre of farm land costs ₹5-25 lakh compared to ₹1.5 crore for an acre of residential land (at ₹350 per sq. ft). While you can expect around 10 per cent gains even without reclassification, the value increase will be based on factors such as soil fertility and water availability.

This route is for those with a penchant for taking speculative bets. There are also various restrictions in purchasing agricultural land. For instance, NRIs and, in some states non-agriculturists, cannot buy farm land.

A less restrictive but speculative option is to buy unapproved land. These plots are not deemed residential by the local authorities, so you will not get construction permit, basic amenities such as drinking water, drainage and transport facilities. Also, you can lose your investment if the land is allotted for infrastructure or other development projects.

But when the plot is ‘regularised’ and becomes part of an approved residential layout, the land value gets re-rated, leading to doubling of prices. Alternatively, you can buy a plot approved for residential purpose. This may be a less perilous option compared to an unapproved plot, though returns could be lower — around 15-25 per cent depending on the locality. That said, this option is not risk-free and you have to watch out for encroachment, especially if you leave it unattended.

A safer option is to go for a plot in a gated community. The price can be higher by 30-40 per cent, but it comes with a few advantages. For one, though you need to perform legal checks, the land title is likely to be clean and encroachment is also less likely since the layout is fenced.

You may also have infrastructure such as water and power already set up. Some layouts also come with common facilities such as parks and club houses. These features also make it easier to sell the plot at a later time. Returns can be healthy too, in the 10-20 per cent range annually, based on how well the area develops.

How to buy

If you thought buying a plot was a breeze since it does not require choosing between different floor-plans and features, think again. Buying land is usually more time-consuming than buying an apartment due to the legal due diligence needed.

Once you identify the locality and the land that meets your needs, the first step is to get a copy of the land document. Take the help of a lawyer to confirm whether the owner has full rights to sell.

Also, be sure to check on any entry or access rights granted to others through the land, which may not be disclosed. With the land details, apply for Encumbrance Certificate from the local sub-registrar’s office. In many states, this can be done online. This will give you the land ownership details over a period of 30 years and tell you if all legal dues have been paid.

You must also check if the land has approvals for residential purpose. It also helps to check the water quality in the area to ensure it is potable. Additionally, it is advisable for you to independently employ a surveyor to measure the plot and compare it with the survey department’s copy.

Given the high registration charges, it may be tempting for buyers to opt for a power of attorney (PoA) from the seller. The PoA gives the right to maintain, rent, lease, mortgage or sell the property. But this method can be risky as it does not transfer ownership rights and it is always advisable to go for complete ownership transfer.

In case the seller is not the original owner, you need to check the PoA that authorises the seller to carry out the transaction on behalf of the land owner. For example, if the seller is not in the country, the PoA must be signed before a consulate officer or a notary in the country of his residence.

Is it safe?

In spite of all the checks, you may land in trouble with the purchase. One unpleasant surprise may be the Government takeover of your land for developing an industrial or infrastructure project.

Sure, you will be paid based on the prevailing guideline rates and the Land Acquisition Act has increased compensation to up to four times the guideline rate in rural areas (upto two times in urban areas). Still, actual market rates are typically much higher since guideline values are not revised periodically.

Encroachment is another bugbear of land investors. This can be in the form of ‘squatting’, where someone puts up a structure on your land. Alternatively, local muscle-men can arm-twist you into ‘selling’ your land at a dirt cheap price. These risks can be greatly reduced by buying land in a gated layout.

And, like all real estate investments, land is illiquid and selling it may not be quick. The larger your plot, the harder it may be to find a genuine buyer. The issue is somewhat reduced if your plot size is small. Also — albeit relatively rare — land can lose value. Take the recent example of the land price ‘bubble’ caused by the speculation of where Andhra Pradesh’s new capital will be located. Those who gambled on a wrong location will be ruing their decision now. Avoid such event-based speculation and take a long-term view.

Real estate investments are inherently risky and also illiquid. So, limit investments in this asset class to 20 and 30 per cent of your portfolio, excluding your residence, advice investment experts.

When to sell

Exiting land investments needs to be thought through well. If you are not in need of funds, you can make an opportunistic exit based on price appreciation. Check with a local broker to get an idea about the prices. Also, selling when the market sentiment is upbeat can fetch good returns. One way to gauge market mood is the uptick in the number of transactions happening at the local registrar’s office.

If you plan to meet any big expenditure with the sale proceeds, do it well on time. Sell the land when the price seems acceptable — a year or two before the event — and invest the proceeds in a fixed income investment. If you purchased the plot for self-use, selling off a chunk can help cover the home construction costs.

Costs and taxes

When buying a plot, you have to budget for legal expenses and registration charges besides the land cost. Also, you may want to secure your plot by fencing it, which may add to your expenses.

On an ongoing basis, you have to pay property tax on the vacant land every year. You may have employed a local caretaker to watch your land. One way to save cost is to share an arrangement with other plot owners in the area. In a gated layout, maintenance charges may be around ₹1-3 per sq ft annually.

When you sell non-agricultural land, the gains you receive are taxable as capital gains, similar to the sale of other property. The gains can be long-term or short-term and taxed accordingly. However, agricultural land sale gains are taxable only if the land is located within 8 km from urban limits.

Also read: >Buy, hold and build your own home

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