I have a friend of mine who got married about 6 years ago. He had savings of about 50 lacs when he got married. As soon as he got married, he started scouting to buy a house. He liked a house that was coming at a price of 1.25 crores.
He had 50 lacs, his parents helped him with about 35 lacs and he opted for a loan of 40 lacs for a period of 15 years. After that, he moved to US and with his higher earnings, he cleared off his housing loan in 4 years, instead of the planned 15-year period.
Now, he is earning a rental income and he can bank on the associated capital gains on the property. Good story right.
Now comes the twist.
He came for his yearly vacation to India recently. He and his wife visited us for dinner and they were mentioning about investing in another property. They had identified a property worth 1.5 crores.
I let it pass as I wasn’t too interested. However, they kept at it and so I decided to join in the conversation and the discussion went thus:
Me: Why are you buying this property?
Them: For investment reasons and for capital gains.
I really did not follow the logic. So, we left the dinner cold and started doing the math.
They had 60 lacs as cash in hand and they were going for a loan of 90 lacs at an interest rate of 8.5%.
Me: It is then not an investment and it is a borrowing.
Them: But, we should be able to pay off this loan in 5 years with our earnings
Me: That is not the point. I went ahead and asked them what is the rental income that you are expecting?
Them: About 2% of the property value in a year
Me: So, you are borrowing at 8.5% interest rate for a return that is going to be about 2%. Now, what is the capital gain that you are expecting?
Them: It would double in 15 years
Me: If you put your money in an FD account at 6% interest and not touch it for 13 years, your money would actually double. Their original EMI for 15 years was 89K/month and for 5 years, it works out 1.85 lacs/month. You really don’t have to borrow and take this risk to double.
Then we did this table together:
| Actual | With 6% int. in 5 years | Loss/Gain | ||
| Down payment | 4000000 | 8000000 | -2000000 | |
| Loan amount | 9000000 | 11000000 (Repayment in 5 years) | -2000000 | |
| Rental Income | 300000/year adding up to 1500000 for 5 years | 1500000 | ||
| Total | -2500000 |
Assume that you didn’t buy the house and you still manage to invest 1.85 lacs in RD or FD at 6% interest
| Actual | With 6% int. in 5 years | Loss/Gain | |
| Down payment | 6000000 | 8000000 | 2000000 |
| RD/FD deposit | 1.85 lacs/month | 12900000 | 1900000 |
| Total | 3900000 |
We really didn’t consider the inflation related to these investments as well as the earnings.
Once we did the math, they both were pretty convinced that it didn’t make sense to do this as an investment. They were really happy that they didn’t sign on the dotted line for both the loan as well as the purchase.
As far as I am concerned, buying an apartment and expecting capital gains are things of the past and it would be foolish to do so. However, you can take some risks when it is a house where you intend to stay. At least, you are enjoying the purchase.
How have people made money out of real estate?
You must have heard your previous generations talk about how they made a killing with their real estate investments. There are multiple sources of gains in the price of a property:
- Taking loans to buy a house and selling after a year meant good profits in the initial years. That bubble has burst now.
- Conversion of agricultural or barren land into a residential or commercial land meant a lot of appreciation. This benefit isn’t going accrued by those why buy an apartment
- The coming up of physical infrastructure that will make this land usable for the new purpose will mean additional appreciation. This benefit isn’t going to come through to those who buy an apartment
- Improvement in livability or commercial viability as the areas gets populated more and more. This benefit isn’t going to come through to those who buy an apartment and whatever that comes through would be marginal as the builder has already factored in all this into his price point while selling
- The period booms and busts and the increase in price due to inflations are the only two factors that you would gain as appreciation
Your previous generations bought property at an early stage. As a result, all the gains accrued to them over a period of two to three decades. Now, we buy an apartment from a real estate developer and the only gains you accrue are volatile market conditions and inflationary increase.
