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Most people build a nest egg for their retirement by investing a regular sum of money into a systematic investment plan (SIP) of a mutual fund or buy a pension plan from an insurance company or regularly invest in a bank recurring deposit or government backed instruments such as PPF and NSC, etc.

A very few well-informed consumers are also opting for the newly launched New Pension Scheme. But there is another very effective means to build a sizeable pension corpus — buying another residential house for the purpose of deriving rental income as well as long-term capital appreciation.I will illustrate this with an example.

Prabhat Varma has ability to make a down payment of Rs 2 lakh and can service an EMI of Rs 6,000 every month (in other words he is able to save Rs 6,000 per month).
This means that he can invest in a house worth Rs 11 lakh for which he will be able to get a loan of around Rs 9 lakh. The EMI for this 20-year loan at 9% is around Rs 8,100 per month, which Varma will easily be able to pay from the rental income (estimated at around Rs 3,000 per month), clubbed with the existing savings of Rs 6,000 per month. The tax deduction on the home loan (for rental properties the tax deduction will continue even under the new direct tax code) and any potential increase in rent in later years is just an icing on the cake.

Even if we assume a rather conservative 10% per annum capital appreciation, the property will be worth Rs 74 lakh at the end of 20 years. Thus, the easy availability of home loans even for residential property bought for the express purpose of renting it out effectively turns this investment into a SIP into real estate.

While Varma crystallises his plan for another house purchase, he should keep few of these things in mind:

l This is not about the house that you are staying in, the house in question here is purely for investment purpose.

l An investment horizon of at least 10 years is needed for this to be effective, so if you are planning to retire by 60, and then this is not for you if you are already above 50 years of age.

l This is much riskier than a bank fixed deposit (the expected returns obviously are higher to compensate for the higher risks) and so if your risk appetite is low then this investment is not for you .

l A meaningful real estate investment will require much larger initial investments, as also much larger continuing investments. Also, the flexibility to miss a regular investment installment is not available, since the continuing investment is by way of loan repayment.

l It is not important whether you would have liked to stay in that house or not. The idea is to buy the same from a rental perspective. In fact, buying a house in smaller towns that you have some knowledge about and connections with might be a great decision, given the fast pace of growth that is likely to be experienced by smaller towns and might give good returns over a 20-year period. Investment in real estate is a relatively high maintenance investment in terms of dealing with societies, finding and dealing with tenants, etc.

Though state and local laws are fast changing, tenancy laws in some states and property taxes in some cities make renting out a property a non-viable option. So avoid investment in such areas.

A second house is an ideal investment proposition for the likes of Varma, who like to save regularly in traditional assets such as real estate. How about you? Are you like him?

The writer is CEO, Apna Paisa, a search comparison engine for loans, insurance and investments.