Sunday, May 11, 2014

Real estate investment vs Fixed deposits


In the past week, I have been requested by quite a few of my readers to share my views on this article that came in TOI which shows that investing in FD's gives better ROI than Real estate.(http://epaper.timesofindia.com/Repository/ml.asp?Ref=VE9JTS8yMDE0LzA1LzA2I0FyMDIxMDM%3D)
 The article gives calculations for a scenario wherein someone invests in a 50 lac flat (10 lacs down payment and 40 lac loan) – registers it and gives it on rent. After five years, the flat is sold at double the value. The author then compares the returns with another scenario where in someone invests the same amount as down payment and the registration amount in a Fixed deposit and the EMI payments in a Recurring deposit. The post tax returns at the end of five years show that the second scenario (of FD/RD) is giving better returns.
The table explaining the scenario along with the comparison is given below:
Here are my views on this article:
  • The calculations done for the scenario are accurate. If you buy a readymade flat, register it, give it on rent and sell it after 5 years at double the value – you will stand to lose vis a vis a fixed deposit. No doubts about it.
  • However, the scenario is by itself not accurate  (even though the calculations are). Investors who make money through investing in real estate do not follow this scenario. Here is what they do differently:
  • Investors do not invest in a flat that is ready to occupy (this is the scenario given in the TOI article). Investors invest as early as possible – preferably in the prelaunch phase. The time between prelaunch and actual hand over is appx 4 years -in these 4 years, the property appreciates by about 80% (assuming around 15% appreciation per annum - the same % as taken by TOI over 5 years). Here the pre emi load slowly increases ( as the loan from bank is paid in instalments based on progress of construction) unlike the scenario in TOI where the investor is paying full EMI from the first month.
  • Investors do not register the flat - they sell it before the registration. As you can see, registration and stamp duty is pretty high (6-10%). Registration costs puts you back by  almost 18 months of rental income. So registering, then giving it on rent and then selling it within a few years does not make too much sense.

So as an investor, if you want to make money – you should not buy a readymade property with 80% loan, register it, give it on rent and sell it after 5 years. If you do that, you could as well be doing a FD/RD as suggested by the TOI article and get better returns.
But there is a way to get better ROI than FD in Real estate - you should invest early in prelaunch stage – leverage by paying only 20% upfront – and then pay pre-emi's for the remaining four year period (which starts small and goes up over time). When the property is ready after 4 years – I recommend that you do not register it.  You should be able to sell it at appx 80% over the original value. This is what most smart investors do and you can do it too - and easily get better ROI than FD.

 

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