I don't believe in investing in stocks or insurance, it is akin to gambling!” asserts Suresh Talekar, 32, a professional with a media company in Mumbai.
So, where did he put his money? Property. And not one but two!
Apart from a self-owned house at Kandivali, Mumbai, where he resides with his wife and parents, he has invested in the following properties:
- A one bedroom-hall-kitchen house in a prime location in Pune for Rs 25 lakh in 2007.
- A two bedroom-hall-kitchen house for Rs 17 lakh in Nasik (close to an upcoming Information Technology Park) in 2007.
The logic: He saves tax on interest paid on the home loans, plus he builds an asset.
The glitch: He has taken two loans to finance his homes and wiped out all his savings in making the down payment on them.
Loan Numbers:
DOWN PAYMENT (IN RS)
Pune
18 lakh
20
12.75
20,769
7 lakh
Nashik
10.40 lakh
20
12.75
12,000
6.60 lakh
Total
28.40 lakh
N/A
N/A
32,769
13.60 lakh
Two loans - was it a smart move?
”Smart move or not depends on his cash inflows and outflows,” says Sridhar Vetapalem, financial advisor.
In Suresh’s case, it was certainly not a smart move. Here’s why:
1. He has a fixed take home of Rs 50,000 per month. Recently, his wife started a Human Resource Consultancy firm, so there’s no contribution from her end yet. For a family of four, he has a surplus of approximately Rs 17,000 (Rs 50,000 less Rs 33,000 EMI on loans) and is living on a tight budget.
Smart Tip: Remember the maxim -- Do not pay more than 30 per cent of your income as EMI.
2. Sridhar continues, “He has over leveraged on real estate. Investing in one property is acceptable but without clearing the loan amount, investing in a second property is uncalled for. He’s sitting on liability."
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What Suresh wants to do next
1. For Nasik property: He wants to sell but is willing to wait if he gets a better price in the future. The ongoing rate is around Rs 20 lakh, which would leave him with a Rs 3 lakh profit.
Should he sell?
If he is not in urgent need of funds, he can wait. Financial Planner, Ramganesh Iyer says, “Property prices haven’t corrected as much. So, prices are likely to fall. Nevertheless, if Suresh is not in dire straits he can afford to wait.”
Associate Director of Strategic Research of Jones Lang Lasalle Meghraj, Aushotosh Limaya says, “It would be tough to sell for another 15 months in places like Nasik. At present, it is a buyer’s market, that is, buyers are in a bargaining position. Ideally, he should wait for a year and half and see how it goes."
Also, If he sells the house now, he would pay a short-term capital gains tax (STCG) of 30 per cent. So, his net profit would come down to Rs 2.10 lakh (Rs 3 lakh minus Rs 90,000 tax). If he waits three years, he would be liable for a lesser tax (20 per cent).
2. For Pune property:
He plans to rent it out to deal with the cash crunch. After enquiring, he found out that he could get Rs 10,000 per month as rent.
Verdict: Renting out is a good option to deal with the cash crunch.
What he missed out on
1. Diversifying risks: Suresh has 100 per cent of his money in real estate. His investment value is Rs 22 lakh (assuming Pune property would fetch Rs 30 lakh + Rs 20 lakh for Nasik property – Rs 28 lakh loan component). This is way more than what he should invest in one asset.
2. Life cover: With two loans and dependents, Suresh needs a life cover pronto – for at least Rs 50 lakh.
3. Medical cover: Since he has aged parents, he should take a minimum cover of Rs 1 lakh. If the company he works for takes care of medical reimbursements, he still needs a minimum of Rs 50,000.
4. Emergency fund: Suresh needs to set aside three months’ worth of EMIs and monthly household expenses to take care of emergencies.
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We offer you a comparison of how things would have worked out if Suresh had invested in a bank FD.
We choose bank FDs for a couple of reasons:
1. Since Suresh wanted to stay invested only for two or three years, he could have gone in for an simpler option of putting money in a FD. Property is a long-term asset, and it may not always be worth the trouble in short-term.
2. Timing the market/property market based on the situation at the time of buying a property, is never a good idea. With FD, not only is your money guaranteed you also get around 10 per cent return.
Let's do some number crunching, here.
Suppose he invested Rs 6.6 lakh that he paid as down payment on the loan, in a bank deposit that gave 10.5 per cent annual return. At the end of 19 months (that is from date of purchase of property till date) this amount would have become Rs 7.45 lakh (assuming post tax return from FD to be 7.35 per cent per annum).
Next, instead of paying EMI of Rs 11,600, had he invested this money every month in the same FD, he would have got Rs 2.34 lakh.
So his total earning from FD is Rs 9.79 lakh.
Let us compare this with his current returns from property.
Rs 20,00,000 Sale consideration
Rs (10,20,000) Loan outstanding amount
Rs (90,000) LTCG tax (30 per cent on profit of 300,000)
Rs (20,800) 2 per cent processing fee he has paid for the loan
Rs (20,800) 2 per cent prepayment fee he will pay if he forecloses the loan
Rs 62,000 tax saved on the interest amount of EMI
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Rs 9,10,400 Profit after tax
"Do you have any advice for Suresh? What do you think he should do -- sell his property at current prices or wait for a better deal? Post your suggestions and feedback."
Disclaimer: The contents of the article or are for information purpose only and are in no way meant to be advisory in nature. The author does not claim responsibility for actions taken by readers on the basis of the Article. Please consult your financial advisor for your personal money management.
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