‘Housing’ your investments

Weigh the financial and other risks before you buy into property as an asset

Globally, financial planners use a mix of asset classes to build a portfolio to meet different goals of an investor. One popular asset class is property as it can provide stable income as well as capital appreciation. While the allocation to real estate is not low globally, it is exceptionally high in India. But before you tread the traditional path, it helps to look at the risks, returns and suitability.

Betting on benefits

There are many reasons and situations where property purchases can be a good choice. For example, property markets go through cycles, and buying low can fetch good returns. You can also spot opportunities — in select micro-markets based on infrastructure growth, or select properties such as distress sales — that can be good deals.

Property has been a good asset over long holding periods. For instance, data from an October 2017 report by the Bank of International Settlements showed that house prices had been growing in real terms by over 2 per cent per year on average for 50 years in 13 out of 20 advanced economies.

Data from NHB Residex index for Chennai and Mumbai show that annual returns have averaged 15.5 and 11.8 per cent, respectively, between 2007 and 2017.

Also, when interest rate is low relative to rent, you can pay for the house through a loan, and cover the interest with rent. For example, in the UK, interest rates are currently at 0.75 per cent while housing rental yields in markets such as London is 4.4 per cent.

Property can be a good bet in both falling and rising interest rate environments. When inflation is high, rents tend to increase, providing a hedge for your income.

Indian issues

Rosy theory and global data aside, the reality in India is close to being thorny. One, there is no reliable or long-term data on house prices and rent, or any relationships to how they behave in different cycles.

Two, prices tend to go through bubbles, and it is difficult for common investors to assess fair price and potential for capital growth. Data from NHB’s Residex index from 2007 to 2017 show that housing prices in Bengaluru (where job growth was good), for instance, appreciated only 43 per cent over the decade — an average annual increase of 3.6 per cent.

 

Three, rental potential is not very good. Sample this: rental yield for residential properties in most metro cities is 2-4 per cent while the interest rate on home loans is about 10 per cent. Data from ArthaYantra’s (a financial advisory platform) 2017 report on buy vs rent estimated that the average out-of-pocket cost per month in Pune was ₹16,694 to rent and ₹58,900 to buy.

Even with tax benefits, renting is preferable even for households with an annual income of ₹25 lakh, in cities such as Chennai.

Four, renting out can be a challenge. For instance, in suburban or peri-urban locations, where price growth potential is higher, renters ask for minimal social infrastructure — schools, shopping, hospitals and transport. Also, housing societies may place restrictions on the type of tenant and may not allow letting out a flat for short-term stays or to bachelors.

Five, there are expenses that dent return. Ongoing maintenance on the house, including painting and handling plumbing and other break-downs, tend to increase as the house ages. Also, your tenant may hurt property value with poor upkeep.

Six, you need to put time and effort in handling issues that flare up by finding reliable help in a timely manner. In general, not paying rent, refusing to vacate and even criminal litigations are not uncommon in rental properties. As a result, many owners prefer locking up the house and foregoing rents, reducing the attractiveness of the investment. Data from the 2018 Economic Survey 2018 showed that over 12 per cent of the total urban housing stock lie vacant.

Your choices

Buying a primary home for own occupation may have different considerations such as emotional comfort in home ownership. But before you quickly jump in or reject a property for investment purposes, ask these three key questions. One, how does the estimated return from this property compare against alternatives such as financial investments. For example, if the house price must appreciate in double-digit percentage every year for five years to give the same net return (after commission and other expenses) as an FD or other low-risk investments, you can pass on the opportunity.

Two, what are the risks and their likelihood when you bet on property that promises high return? For instance, if infrastructure development plans or job growth in the locality may be helped by new policies, you can consider it more favourably. Three, can you handle the illiquidity of the investment during your holding period? This could mean assessing your ability to handle cash-flow issues in paying EMI, even when there is loss of rent or income.

The writer is co-founder, RaNa Investment Advisors.

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