Avoid Property Investment through Home Loan

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.