Make use of home rentals to square off EMIs

Rajeev Chockalingam is currently working in Mumbai and hopes to retire in a farm house near his hometown, Coimbatore, a tier II city, after the next 10 years. However, he wants to ensure he has enough funds to support this retirement and also make his retirement dream come true, without having to resort to debts in the later stages of life. In essence, he wishes to invest in property, hoping it will yield exponential returns by the time he is ready for his plans.

If you are like Rajeev, who is looking at investing in real estate, there are two options available. Remember ‘invest’ in real estate and not purchase to occupy the property. A house is an investment when you look at making money from it – either in the form of rentals or by re-selling it at a higher price. That is why in personal finance, the self-occupied property is never counted as an investment asset.

Let’s look at the options available:
1. You can book a flat when the project is launched and sell it off when the project is completed

2. You can book a ready-to-move-in property and start getting rentals right away. These rentals can partially fund EMIs. Which of these is better? Forgetting the practicality angle, financially which of the options makes sense?

Option 1
When you book a flat, you have to put in only a smaller sum of money. The return on investment may be better.

However, if you were to borrow to purchase the flat, you might have to keep paying pre-EMI or interest on the amount borrowed until you can sell the property. This is an expense without any tax benefits.

Not to forget the capital gains tax angle. If the property is resold for a profit within 3 years of agreement date, then the gains are fully taxed with no scope of tax saving.

Option 2
The above problems with purchasing and selling a flat can be partially negated when you purchase a ready-to-occupy property.

You can purchase the property with a loan and start paying EMIs immediately. Which means both the interest paid without any limit and also the principal repaid up to a maximum of Rs1lakh (under Sec 80C) can be claimed as deduction from taxable income.

There are many options to also save tax on capital gains when a property is sold after 3 years. Until then, rentals can also be enjoyed.

However, the situation has its own hassles.

Income earned as rental is taxable as income from house property.

On an average, the rental income from house property will be in the range of 3% to 5% of the value of the house. Which means, say you buy a house for Rs50 lakh and avail an 80% loan, your EMI for a 20-year loan @ 10% will be about Rs39,000. In addition, the same property will yield about Rs15,000 to Rs18,000 as rent. The rest of the EMI is a cash outflow from your pocket.

If you have the capability of shelling out the additional Rs20,000 from your other income, or if you have a bulk amount of Rs30 lakh which you can invest in the property and restrict your loan to about Rs20 lakh so that your EMI matches the rent – then this whole proposition will work wonderfully.

More importantly, finding a good tenant is a big task in itself. On an average, expect your house to earn only 9-month rental in a year. Assume that for about 2-3 months in a year, the property will lie unoccupied but your EMI remains. You should have the ability to stomach this.

Therefore, the tax advantages and the fact that you may be able to resell the property for a substantially higher price after a longer period are the positives. The adverse cash flow situation this may entail is an obvious negative of this option. Also, please remember a house property is an illiquid asset. If you are stuck with it, that will be a long-term stuck together affair. Go for it, if you understand these well enough.

In the case of Rajeev, this may work to his advantage if he chooses his property carefully post research and chooses a location that has scope to appreciate. As it is a long-term investment, it may work out if he plans to partially pay off his EMI using the rest from his rent if he is able to find good long-term tenants. However, he could also consider the option of investing in land rather than an actual property as the condition of the property will deteriorate with time. The obvious disadvantage here is the fact that land loans are not easily accessible and he would have to fund the entire EMI with other income sources. Apart from this keeping an eye on the land and protecting the asset long distance is not a very easy proposition

The writer is CEO, BankBazaar.com