Property Investment is a big craze in India among all asset classes. One of the factors which boost Property Investment is income tax deductions on Home Loan. It is one of the reasons for very high property prices in India. In my opinion, Home Loan Tax deductions are more of a subsidy. If you are buying a property for self-occupation, then you should buy without giving 2nd thought. It makes perfect logical and financial sense. In this post, we will discuss the scenario wherein buyer purchase property for PURE investment purpose, i.e., the property is let out. Few years back, Property Investment through Home Loan made perfect sense. Reason being, very low-interest rates, healthy rate of appreciation and high rental yield. The economic conditions have changed. The ground realities are different now. Therefore, if you are considering a Property Investment through Home Loan, then you should do a 360-degree evaluation of your decision. If you can buy a property from own fund sources, then key considerations will be diff then what is being discussed in this post.
Avoid Property Investment through Home Loan
Let’s understand why you should avoid property investment through a home loan with a real life example. One of my friends is quite worried from the last couple of months. When i asked him, he told that he has closed existing Home Loan. Now he is considering a Property Investment through Home Loan. He is in a dilemma whether to go ahead or not in current conditions. I suggested him to consider following points before taking any decision
(a) The Reason for Property Investment through Home Loan: It is vital to ask yourself why you would like to invest in property. The most common reasons that i came across are
– To avail income tax benefits
– For savings
– My parents suggested
– I don’t know where else to invest
– I want to invest in my hometown
Trust me if your reasoning is also one of the above mentioned then please drop an idea of property investment. Always remember that you will be availing Home Loan for property purchase. The interest component increases the overall cost of the property. You should have a strong reason to invest in property through Home Loan. As i mentioned, it’s a good decision if you are buying from own sources or have received the bulk amount from investment, inheritance, etc.
(b) Net Return: Any reasoning or logic does not suffice till backed by the strong number on the table. I am not sharing any complex calculations as it may confuse the buyer. You can do a simple calculation to check whether it makes financial sense to invest in property through a home loan or not. For net returns, you need following data points. If you don’t know the exact value, then you can assume or guesstimate based on current data points.
X = Home Loan Interest Rate
Y = Opportunity Loss*
A = Annual Rental Yield or Rental Savings (% of Property Cost)
B = Approx Avg Appreciation p.a.
C = Income Tax Benefits (% of Property Cost). For example, a tax deduction of 3.5 lac on 50 lac property means 7% annual value. With the repayment of principal, the income tax deduction reduces over a period.
* Opportunity Loss is the returns you could have generated from your contribution that is normally 20% of property value. Assuming, you would have invested this amount in Debt Funds / Arbitrage Fund with an annual return of 10% on buyer’s contribution i.e. 20% of property value. Superimpose this no for 100% i.e. 2% on 100% of property value.
If (A+B+C) >= (X+Y) then it makes perfect sense for property investment through Home Loan else you can SKIP your decision.
In the current scenario, (X+Y) > (A+B+C) therefore property investment does not make financial sense. Without Home Loan, the calculations are favorable if you identify right project at the right price.
(c) Under Construction Property: It’s a common perception that under construction properties are good for property investment. The reason being, payment is deferred, and the buyer can sell property near completion. My thought process is different. A property investment should be avoided in under construction project. You should always shortlist resale property. Some of the reasons are
- Rental Yield i.e. component A will be NIL for under construction property
- A buyer cannot claim tax deduction till he/she receive possession of the property
- A delay in the under construction project can increase the cost exponentially
- Lastly, the resale property is available at the discount compared to under construction proper
(d) Property as an illiquid asset: If your property investment is through Home Loan then your risk quotient is very high. In a case of any unfortunate event of loss of job or life or urgent fund requirement, it becomes impossible to liquidate your investment at short notice. The financial situation becomes grim when the property investment is through a home loan. An investment/asset becomes the biggest liability in such circumstances.
Concluding Remarks: As an investor, you should consider property investment without Home Loan. You can check out following alternatives wherein your property investment is in small amounts. It will not strain existing financial resources.
- Buy in joint ownership: You may form a partnership with your near and dear ones & purchase a property in joint ownership. In such cases, It is advisable to clarify all the terms and conditions, i.e., distribution of profits, time of exit, dispute resolution process, etc. before purchase.
- Reality Private Equity Fund: This is another professional way of property investment. There are large no of Reality Private Equity Funds in India and min investment amount is Rs 5 lac. These funds have a lock-in period of 3 to 5 years as they need time to generate meaningful appreciation from property investment. Also, note that these are private funds and not regulated by any financial regulator. The investment risk is slightly on the higher side, and liquidity is on a lower side.
- Real Estate Mutual Funds/REITs: These options are currently not available in India. First REITs (Real Estate Investment Trusts) will be launched very shortly. It will be listed in the stock market and controlled by the regulator. The property investment under REITs will be for the generation of rental income. The best part is REITs will also invest in commercial properties where the yields are higher compared to residential properties. Therefore, investors can expect higher returns from property investment through REITS. The more details about REITs will be available only when it will be launched.
- The stock of Real Estate Companies: This is an indirect way to participate in the real estate sector i.e. ride the growth of real estate companies. Currently, most of the listed real estate companies are in bad shape. You can still find some good names like Godrej Properties etc. In short, you will indirectly make property investment through the stock market. The performance of listed real estate company will depend on the performance of real estate sector. The best part of this option is that investment can be as low as few hundred rupees, and your indirect property investment will be 100% liquid.
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HI Nitin,
I am planning to buy an A Khata flat in a 11 year old building in CV, Raman Nagar, Bangalore. The building is well maintained with dedicated maintainace staff (Car parking, Gym, Security, CCTV coverage and multipurpose hall, badminton court and some open space), approach of the building is very good from main road and I am planning this for my end use for lets say 8-10 years.
The building belongs to a reputed builder and construction quality is good. This is going to cost me around 47 lakhs including registration cost.
I want your opinion on this as I am around 28 years old and let me know whether this make sense as a long term investment as well as my current residential needs (my and my wif’s offices are at moderate distance)
Never mind but why you’re going for 11 year old building ? Thats one point you should re-consider !
Dear Suyog, Actually the area which I have mentioned is not coming up with new building or projects, there are 2 to 3 new projects however the price for 2 BHK starts above 1 Cr., There are few new buildings coming up within 50 lakhs budget but they are not legally correct as those building have left no open space and all are deviated so the flats are B Katha.
So I am thinking rather than going for B Katha go for A Katha Flat which is legally better and I can rely upon this.
CV Raman Nagar is good area to invest sandwiched between OMR and Old Airport Road.
Thank You Nitin!, I know replying on this little late however anyhow I missed the thread on this.
I want to know whether this cost including everything (semi furnish) worth for that building?
I have not seen the property therefore cannot comment but the price seems to be OK.
Thank you very much Nitin!!
Keep educating/informing us. Kudos..
Great informative article.
Excellent study….
You may request for extension of the sanction period. Normally 3 months extension is provided without any additional charges. 0.2% MODT charges are mandatory. You may ask for details of all other charges.
Thanks Nitin for your reply. Bank executive says I need to pay 0.2% as stamp duty for the loan amount + some Rs. 2000 bugs for mortgage. Im not sure if its correct or not, how can I know if the charges levied are correct and not some cheap trick of the executive.
As i mentioned you may clarify from bank executive. Also demand payment receipt for all the charges except for some misc charges like notary etc.
Hello Nitin,
I have booked a property in Pune in Fifth Avenue Hadapsar in the month of May,2015, based on my discussion with builder I have agreed to withhold the agreement process by few months to save on service tax and VAT. Now the building is almost ready and we are expecting the completion certificate in few days. Now, I already had a sanctioned pre-approved loan from ICICI bank. I had a word with my bank executive and he says the the sanction would be valid upto 6 months. My loan was sanctioned on 20th May, so ideally the sanction would expire by 20th Nov, 2015. Nitin, do we have any ways to extend this sanction or can I get the loan re-sanctioned at zero processing fees ? Apart from this could you please let me know what are charges for taking home loan apart from processing fees. My bank executive says I need to pay 0.2 % of loan amount as govt tax and some amount for mortgage. Could you please help me in clearing my confusion.
Thanks,
Yogesh
good article nitin. However inflation vis -a vis asset creation through purchase of flat… how its placed, you pls through some lights.
I have particular queries. I am purchasing 1 bhk at Pune (earlier I purchased one 2 bhk which is self occupied) where my wife will be first applicant and I am second applicant. my wife is not employed. I will take home loan. I will put this flat on rent.
I am salaried person and pay tax in 30% bracket..
Now income from rent will be divided in-between us or I have to show full amount of rent it in my income statement.
Home loan interest rates are more or less linked to inflation whereas return on property is independent of same. Moreover, inflation cannot be predicted and may change drastically as we saw in last 18 months. From double digit, it slipped to negative zone. Therefore, the macro calculation shared by me in the post holds true from layman perspective.
In case of joint ownership, rental income will be divided in proportion of ownership in property therefore it will be divided between you and your wife though you can claim 100% tax deduction if you are paying FULL EMI.
Dear Nitin,
I had discussed with you about home loan interest component being completely reimbursed if property is let out. So if one purchases a ready to move flat and is able to declare it as ‘let out’, then wouldn’t the cost of the property be same irrespective of the home loan component?
In case of an under construction property, if the entire interest component can be refunded in five equal instalments, wouldn’t the only loss will be the loss of interest for the money to return?
Wouldn’t this taxation facility benefit the buyer so much that home loan interest rate won’t matter? Since you have mentioned home loan interest rate as a component of the formula for calculating net return, I have this question.
My apologies but could not understand your query properly.
Sir, the query is in reference to the part in your article ‘Always remember that you will be availing Home Loan for property purchase. The interest component increases the overall cost of the property’.
If a ready to rent house is purchased for investment only and can be declared as ‘let out’ for taxation, can’t the entire interest component of the home loan get refunded on claiming every financial year? This way the only amount being paid by the buyer is only the principle component of the loan.
If the property purchased for investment is under construction, then your other relevant article on the subject advises that the interest component of pre emi can be claimed in five instalments from the date of possession.
If the tax deduction for the interest component is 100% for let out property with no upper limit, how will home loan increase the property cost?
If this is the case, then the interest rate won’t affect the total cost as finally it will be returned to the buyer.
As long as a person can afford to pay the EMI with his income, he can purchase property for investment purposes without any concern for the home loan interest. Kindly clear my understanding.
The interest component is not refunded to the buyer. You can only claim tax deduction on same i.e. it is excluded from your taxable income as the case may be. In reality, the interest is still paid by the buyer from his income therefore increase the cost of property.
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Hi Nitin!
Congratulations on a very well written article on a very relevant topic …specially the way you have reduced the entire decision making into an mathematical equation, is really very unique!
However, I would like to bring to your notice that there seems to be an error in the explaination of “C” …
“C = Income Tax Benefits (% of Property Cost). For example, a tax deduction of 3.5 lac on 50 lac property means 7% annual value. With the repayment of principal, the income tax deduction reduces over a period.”
…the actual IT benefit would be a max of 30% of 3.5 lac , i.e. 1.05 lac and therefore approx 2.1% of 50 lac …isnt that what you meant, or am i missing something?
Look forward to your response.
Thanks.
Here in 3.5 Lac i considered 2 Lac interest u/s 24B and 1.5 Lac principal u/s 80C for self occupied property. Hope it clarifies.