Book Title: If God Was Your Financial Planner
Author: Suresh Sadagopan
Publisher: Westland Business
Number of Pages: 314
Date Published: Aug. 21, 2023
Price: INR 370
REAL ESTATE: THE REAL STORY
When I reached home at six that evening, Madhu was surprised. She asked me how come I was back home so early. She quickly ran her hand over my temples and neck to see if I had a fever. She turned and looked at me quizzically. I simply said that I had completed the tasks for the day and hence had turned in early.
I had an early dinner that night. My thoughts were turned to what had happened during the day, even though I had a book in my hand and was trying to read it.
I could hardly believe that I had been able to prevail upon Vishal and Preeti on a touchy subject like buying a house. The Lord has helped me here too, I thought. I had explained three of the myths of real estate. But there are many, and they are endemic. Almost everyone is in the grip of these myths, which is why people across the country invest heavily in properties.
As some other myths related to buying property came to my mind, I noted them down so that I would be able to relay them to others in the future. Here they are:
Myth 4: We are truly happy in our own house
We all buy a house that we can afford. Many times, the house that we can afford is not always the most suitable one for us to live in. Hence, most people who buy a home somehow adjust and stay in it, even though it is unsuited to their situation.
For others, they can buy a reasonably-sized, comfortable home that will be good to live in. But that home may not be in the neighborhood they desire.
There is another category of those who can buy the right home in the right locality and are absolutely happy with their purchase. But because they have spent so much, and have taken on massive loans, they have to tighten their finances for years on end. Their lives will be thrown into disarray if there is any disruption in their income. Any new goals or expenses can again cause problems for such people, at least in the initial years. They are often left with no wiggle room.
The last category consists of those who are able to buy the right type of home where they want and have the means to do this comfortably (with some loan, which is easily serviceable). But this is a tiny category.
The number of people who are truly happy in their own homes is quite small indeed.
Myth 5: Buying a home is a way to force saving
It is. But that cannot be the reason to buy a home. It is probably true for an undisciplined person, who will squander money if there are no forced savings, like in the case of home loan EMIs. But everyone is not so undisciplined.
One can set up monthly investments, which can get debited from the main savings account at the beginning of the month, real estate: the real story to achieve the same result. Here, one has the flexibility to pause the investment or scale down if an unforeseen event occurs. This option is just not available if one has bought a home on loan. EMIs cannot be paused.
If there is a job loss, one still has to service the home loan. Else, the property will get confiscated by the home loan provider and auctioned. Any default would also impact one’s credit score, subsequently affecting one’s ability to borrow as and when needed.
Myth 6: Property is the only asset that appreciates constantly and offers good returns
This is the biggest myth of them all. The property market is prone to long up-and-down cycles. Property prices are down or have steadied across the country after about ten years in the dumps. In many places today, one finds it difficult to sell property, even if offered at low prices.
The built-up stocks are high, and the stock under construction is still substantial. When the offtake of property is low, the entire real estate sector gets stressed.
Real estate had given stellar returns between 2003 and 2008. Those returns were a one-off aberration and probably will not be replicated for a long time. The typical return on property (capital appreciation and rent) is between 4 per cent and 9 per cent. That looks like it is very low. That’s because we seldom add up the cost of interest we pay on a home loan over time to the cost of the property. In most cases, the interest paid overtime would be as much or higher than the loan amount itself.
Let’s take an example. Let us say that one acquires a ₹2 crore property (₹1.8 crore is the cost and ₹20 lakh is for registration, stamp duty and incidentals, which cannot be recovered while selling) with a ₹50 lakh down payment and a loan of ₹1.5 crore.
If the interest rate is 8.75 per cent a year, the interest amount paid over time would be ₹1.68 crore during the loan tenure of twenty years. If the interest rates were 10 per cent, the interest paid on the loan over time would be ₹1.97 crore. This is a substantial cost, which most ignore and calculate returns based on just the quoted cost of the property.
Also, people spend large amounts of money on doing up their homes, which cannot be recovered while selling. Repairs and property maintenance also take up a good sum over time. All these costs need to be factored in.
Even after doing so, there are some properties which give double-digit returns over long periods of time—but they are exceptions.
Property should just be seen as another asset class. People fall in love with it instead. The fact that it has a tactile feel to it and gives a sense of ownership is a deceptive lure that makes people fall for property. As an asset, properties have several negatives— they are illiquid, cannot be partially liquidated if one requires some money and have a huge concentration risk (a huge amount of money gets stuck in just one property; if for some reason that locality is out of favour, then the property price will not increase).
Myth 7: Low-cost home loans allow one to leverage and increase wealth, which no other asset allows
Home loans are indeed low-cost. But the fact is, there is still a cost even if the interest rates are low, the absolute amounts are massive. For a big home loan, the monthly payout would be substantial for a long time. We had shown that for a ₹1.5 crore loan, one would be paying as much as ₹1.97 crore as interest (if the home loan interest rate is 10 per cent a year and the loan tenure is twenty years).
Any disruption in income would cause problems—especially for those with multiple home loans. It is a huge gamble that one is undertaking for a long period of time. If one encounters problems in the future, it may not even be easy to dispose of the property and recover the money. Property is mostly illiquid and takes along time to sell.
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Hence, with such huge leverages, people are taking huge risks. They assume that their income will be stable and rise throughout their life, that there will not be any disruptive events in life in between, that the property invested will appreciate over time and so on.
Life is never linear. It has its ups and downs. Hence, people getting into such a huge gamble invariably get stuck. We have many clients who are in this unenviable situation.
Myth 8: Properties are an excellent way to set up a steady income stream
Properties can be rented out. But there are problems. Property rental yields are very low in India. A residential property costing, say, ₹1 crore can be rented for, say, ₹25,000–30,000 a month. After paying society charges, property tax and income tax, the total yield comes to just 2 per cent or less. So, if someone wants a good income stream from their investment, their property would not be able to offer that. In this situation, the property they own is like a fixed deposit (FD) that yields only 2 per cent.
In some cases, there are problems with a tenant not vacation time. It can also get stuck in litigation, which, as we are aware,can be time-consuming and money-draining. The various problems when a landlord rents out a property have been covered earlier (see Myth 3).
Some people say that commercial property is way better in terms of returns. Commercial property can indeed give better returns when compared to residential property. But even this is not true across the board. Commercial properties bought in the wrong places would be difficult to rent out.
Vacancy periods can be long in commercial property, so one should be extremely careful when choosing them. The loan rates for commercial properties are much higher than for home loans. Unlike residential property, there is no provision for the set-off of the interest portion of the EMI in income tax sections.
The other problem is the black money portion in real estate. While it has come down in recent years, it is still a bane in transactions. The service class struggles with this; they need to convert their tax-paid money into cash as some portion of the transaction is in cash.
A simpler way to set up a regular income would be to invest the money in a financial asset, say a simple FD, and get much more with a lot less hassle.
Other than the many myths that people believe about buying property, there are several mistakes that they commit when it comes to their properties.
Excerpt taken from the book If God Was Your Financial Planner with permission from Westland and Suresh Sadagopan.
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