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PERSONAL FINANCE
MONEY MINDER'S MAILBAGr
Reality and the
Realtor
By Larissa
Fernand
Dear Money Minder,
After the spurt until 1995-96, real estate prices
have declined across the commercial, residential, and retail segments. Many investors are
convinced that prices will never scale those heights again. Would you say it is still
possible to invest gainfully in real estate?
A Reader
Dear Reader, it is true that real estate prices have declined
across-the-board since the 1995-96 boom. It is also true that pessimists are selling the
idea that no one can ever make money from investing in real estate. But if you are willing
to put up with a long gestation-period, and can sink in a large sum of money, investing in
real estate wisely will give you a good deal.
The thumb-rule when opting for any form of investment is to
consider two factors: income-generation and capital-appreciation. Land, despite being a
form of investment, has rarely been interpreted in terms of income-generation. Take a look
at the global real estate market. There you have three sets of players: the developers,
who buy land and build on it; the users, who are corporates and residents (foreign and
local); and, finally, the investors, who are the go-between. They buy real estate from the
developers, and lease it to the users.
But here, as Ashish Velkar, office director, Cushman &
Wakefield, puts it, ''the first two act as investors since the number of individuals who
actually view property as an investment is limited.'' However, the times are changing, and
although there is a fair amount of truth in the predictions about a huge spurt being
impossible, there is ample scope for investors to enter the real estate market for fairly
good returns.
Dear Money Minder,
I get your point. But is it possible to generate
lucrative returns by way of capital appreciation in real estate? Or is a long
holding-period involved?
A Reader
Dear Reader, real estate has always been considered,
primarily, in terms of capital-appreciation. Investors were always of the opinion that the
price of land would never fall; the same opinion was foisted in favour of investments in
gold, but that, as you know, has proved unwise. Now, the downturn in property prices has
made investors all too aware that if prices can skyrocket, they can plunge as well. As
Elizabeth Paarry, director, Richard Ellis, puts it: ''There is no way that property prices
will continuously zoom.'' So, capital appreciation is certainly not going to provide very
lucrative returns. But those interested in considering property as an investment should be
willing to hold on to their investment for 10 years at least to reap the benefits of
capital-appreciation.
Dear Money Minder,
What is the period for which I should stay invested
in real estate so that I get attractive returns and the benefit of capital gains?
A Reader
Dear Reader, as an investor in real estate, you have to bear
with a long gestation-period. To begin with, there's the minimum three years for which you
have to stay invested to get the benefit of the long-term capital gains tax. The three
years do not commence from the date of construction, but from the date of possession of
the property. Your capital gains are calculated on the basis of the cost-inflation index,
which has 1981-82 as the base year.
Assume that you acquired a property in 1981 for Rs 20 lakh,
and sold it for Rs 80 lakh in 1994. Your investment of Rs 20 lakh is multiplied by the
cost-inflation index for 1994 -- which is 259 -- and divided by the index in the year of
acquisition (100). This works out to Rs 51.80 lakh. Deduct this amount from Rs 80 lakh --
and the balance of Rs 28.20 lakh is taxable at the flat rate of 20 per cent. That is, you
pay a capital-gains tax of Rs 5.64 lakh. So, your profit is Rs 54.36 lakh. Now, if you
invest the taxable portion -- which is Rs 28.20 lakh -- in a new property, you won't have
to pay the capital gains tax. And if you invest part of it -- say, Rs 10 lakh -- you will
be taxed only on the balance.
After the wait of three years for the capital gains benefit,
you may have to wait for a further seven years, on an average, to allow for
capital-appreciation. Real estate is not as volatile as shares are; so, you may not see as
many ups and downs in prices. And there is no way you can really lose on your investment.
Then, should you need finances, you can always get them by raising a loan on your
property.
Dear Money Minder,
All that is fine. But is it possible to make money in
the period between the buy and the sell?
A Reader
Dear Reader, you can always lease out your property to get a
return on your investment even as you await capital-appreciation. You can do this by
entering into what is called a Leave & License (L&L) agreement. L&L is very
popular with landlords since it does not give the occupant -- or tenant -- any ownership
rights. The time-period for occupation is specified in the agreement and, on an average,
ranges from 11 to 33 months.
In the case of a lease, it is, generally, a plot of land that
is leased out. Such leases have a much longer time-frame, and can extend upto 99 years.
Moreover, in the case of a lease, the occupant can go in for a sub-lease to a third party
-- a right which is not granted under L&L. What L&L does is to license the
occupant to occupy the space for the period specified. Hence, an L&L is more
restrictive from the tenant's point of view, but more secure from the landlord's. A
rental, on the other hand, is nowadays shunned by landlords since tenants are known to
claim tenancy rights, and refuse to relocate.
If you, as a landlord, offer your apartment on an L&L
basis, you can generate income out of your property in two ways. One, of course, is in the
form of the monthly rent. The other is from the deposit. That is, the lumpsum which the
licensee pays you. You can invest this deposit in a safe avenue, and generate regular
income. However, the deposit is refundable, and must be returned to the licensee when the
agreement expires.
Dear Money Minder,
I'm sure the trick lies in fixing the right return.
Can you tell me how I should go about doing that?
A Reader
Dear Reader, start by fixing a quote on the basis of the
market value. If you are open to negotiations, fix it slightly higher than you would like.
You should calculate your rent taking into account a couple of factors. The inflation rate
must be considered. And, as with any form of investment, your return should be higher.
Then, benchmark against bank fixed deposits and government bonds, which are high on
safety. But, while comparing returns, make allowances for the capital-appreciation on your
property.
Let me explain this further. Assume that a landlord is
looking at an annual return of around 15 per cent on his investment in an apartment that
cost him Rs 25 lakh. He can ask for a deposit of Rs 10 lakh, and a monthly rent of Rs
22,000. The Rs 10 lakh lumpsum can be parked in a one-year bank deposit for interest at
the rate of 11 per cent per annum. That would earn him Rs 1,10,000. The rent would amount
to Rs 2,64,000 by the end of the year. Thus, his total earnings would be Rs 3,74,000 -- a
14.96 per cent return on his investment of Rs 25 lakh. Now, if he does not need Rs 22,000
every month, he can put the sum in a fixed deposit, or any other instrument, thereby
increasing his return. This, however, is just an outline. If the landlord wants a higher
sum as deposit, the rental will have to be cut down, and vice versa.
Of course, I have assumed that no loan was taken to purchase
the apartment. If that is the case, both the rent and the deposit will have to be
increased substantially to cover for the Equated Monthly Instalments (EMIs) on the loan
amount. (The EMIs would, however, give a tax-break, which has to be factored in as well.)
Then, I have not told you about the income-tax. It will, of course, depend on the
tax-bracket that you, as a landlord, are in. Besides, there will be other payables, like
maintenance, and property-tax. All these must be taken into account while calculating the
return.
However, the thing to remember here is that the return you
earn is in addition to the capital-appreciation during the period of holding. While
comparing returns, you would have to consider the capital-appreciation along with the
regular income generated by the property.
If you want to make money from an L&L, you should keep
the user in mind while selecting the property. For, it is the user who will, ultimately,
occupy the property, and generate income for you. On the flip side, investing in a
property that is attractive for the user will push the capital value up. The key,
therefore, is to choose property which will provide the best return not just in terms of
capital-appreciation, but also in terms of income-generation.
Dear Money Minder,
Are the risk-return equations different for
commercial and residential properties?
A Reader
Dear Reader, The equations do differ. As Velkar puts it:
''The returns will be higher in the case of commercial property, but so will be the
risks.'' If economic activity is hit, the one way in which firms cut their costs is by
downsizing. In such a situation, commercial property is the first to be hit. In the case
of residential property, prices are more stable.
Dear Money Minder,
When is the right time to buy real estate? I know
that location is a critical factor, but isn't the timing as important?
A Reader
Dear Reader, the right time to buy is when the building is
under construction. That turns out to be much cheaper. In such a case, make sure that the
builder is a reputed one. Always check with the developer for the commencement certificate
for full work, and make sure that all the titles are clear.
In this context, I should also tell you that you must avoid
buying a plot of land. Because the moment you buy the plot, you'll have to fence it, or
build a wall around it. Even that is no guarantee against encroachment. Then, getting hold
of the basic amenities, such as electricity and water, may be a problem. You also cannot
eliminate the possibility of claims on your land and, thus, litigation. Considering all
these possibilities, buying a ready-built house or apartment is a safer proposition.
With reference to your question on timing, it is a crucial
factor. Since income- generation is not the sole criteria, and capital-appreciation must
also be taken into account, timing is as important as the location. Even prime locations
at Nariman Point in Mumbai or Connaught Place in Delhi are as susceptible to downturns as
their less-fancied counterparts. And the maxim that holds for any investment -- buy low,
sell high -- is true for real estate as well.
Those who bought real estate in 1994-95, when the prices were
at their peak, will, probably, have to wait for around two decades to reap
capital-appreciation. In a way, they will be sharing the same plight as the stockmarket
punters who bought scrips like ACC at Rs 10,000 at the peak of the bull run in 1992. Then,
avoid buying in areas which have already peaked, or are going at high rates compared with
other locations. The chance of capital appreciation will be lower.
Still, deciding the timing is easier said than done. In the
past, there was a trend which guided investors: Mumbai was viewed as the benchmark for
real estate. As Sumit Anand, head of research, Colliers Jardine, puts it: ''If the prices
rose or fell in this metro, a similar trend would be evident in the rest of the country,
with Delhi following suit with a time-lag of three to six months. Bangalore and Chennai
would then follow.''
Hence, real estate investors could follow the trend by simply
keeping tabs on the prices in Mumbai. The trick worked even within locations. For
instance, within Mumbai, Nariman Point was the benchmark. If the prices rose here, the
prices in the suburbs also rise with a certain time-lag. However, this trend is weakening,
and it may no longer be safe to be guided by it. Mumbai is no longer the real estate
leader and, within Mumbai, it is no longer South Mumbai which dominates the estate prices.
In the absence of a trend, timing the investment remains a
difficult task. And opinion is varied as to whether real estate prices will start rising,
slump before rising, or just remain stagnant. For the seller of a property, waiting could
mean a further loss if prices happen to decline further. For the investor, the quotes are
already quite low. True, they could be lower, and the market may not have bottomed out.
But, given the gestation of 10 long years, the risk is not that great. |
