By Sanjay Kumar Singh & Amit Shanbaug, ET Bureau | 8 Sep, 2014, 10.26AM IST | Economic Times
Sushmita Sinha, 47, a business woman based in Noida, is eager to buy an apartment, but is assailed by doubts on many fronts. Should she buy now or wait for some more time? Have the prices bottomed out or could they fall further? Every day she comes across newspaper advertisements from builders offering discounts and sops, each seemingly more attractive than the other. This avalanche of special offers has left Sinha confused. How should she go about assessing their real worth?
Then there are the complexities of taxation and insurance associated with the purchase of a house, all of which she finds perplexing. Like Sinha, thousands of buyers across the country want to purchase a property now, but don’t have the answers to the abovementioned, and several other, questions.
In this week’s cover story, we provide the required answers, tell you about the many pitfalls that you should avoid, and also offer a comprehensive road map to help you undertake what is, perhaps, the single largest, most expensive and important investment of your life.
1. Don’t wait for prices to correct
Barring cities in the South, which have witnessed a considerable price rise over the past 12 months (see table), prices have been either stagnant or have risen marginally in the top cities. They have corrected in only a few pockets.
Says Om Ahuja, CEO, residential services, Jones Lang LaSalle India: “Prices have dropped in only a handful of projects in specific locations and extended suburbs. These are not relevant overall because either these locations or the specific products have inherent flaws.”
To wait for a correction in prices from now onwards would amount to living in a fool’s paradise. With a stable government coming to power, a Budget that had several positive provisions for the realty sector, and GDP growth reviving in the April-June quarter, the sentiment in the realty market may improve. So, buy property right away. Prices have already bottomed out. Since the pace of transaction remains slow, builders are still offering price discounts and other sops. Once the sales pick up, they may withdraw the offers.
2. Don’t expect quick gains
Those investing in real estate now should not expect prices to rise sharply over the next year or so, the primary reason being that they have already increased to a high level in most cities, especially in Mumbai and the National Capital Region (NCR). Says Anshuman Magazine, CMD, CB Richard Ellis South Asia: “The sales volumes have gone down in Mumbai and the NCR because prices in these cities have risen very high. In places like Bangalore and Chennai, where prices are still at a level that can be absorbed by the market, sales are still happening.”
Another factor that will prevent prices from appreciating is the huge pile-up of inventory in most cities (see High inventory will keep prices under pressure).
Even though sales have slowed down, developers keep launching projects because they have invested huge sums in land and need to earn returns. According to Pankaj Kapoor, MD, Liases Foras, a real estate research firm, “Prices in the top cities will be under pressure for the next year or two due to the accumulation of a huge inventory. Efficient markets maintain 8-10 months of inventory, but in most Indian cities the level is much higher.” Owing to cost escalation, developers can’t cut prices. So what we are likely to see is time correction. “Sales won’t pick up until people’s incomes rise to a level where current realty prices become affordable,” says Kapoor.
If you are investing in real estate now, have an investment horizon of five years or more. Also, expect more modest returns than in the past. Says Magazine: “The time for quick and abnormal gains from real estate is over.” He adds that Indians will have to get used to more normal gains from realty in the future, as is the case in the mature markets of the West. A normal rate of return implies one that exceeds the inflation rate by a few percentage points.
3. Factor in borrowing costs
The interest rates on home loans are currently in double digits. A combination of factors, including high prices of apartments, high home loan rates, and slow growth in salaries in urban areas owing to the economic slowdown, has made it difficult for people to buy a house. Those buying property as an investment must live with the fact that while they will have to pay 10-11 per cent interest on the loan, the current slowdown in the realty market means that the value of their property may not appreciate at all, or may see a single-digit rise. So their net gain may be negative in the short to medium term.
More people would buy property if home loan rates were to soften. However, it is hard to predict when interest rate cuts by the RBI, which allow banks to cut their loan loan rates, will happen. Much will depend on the trajectory of inflation. Another recent development that could prevent the RBI from cutting rates is the expected rate hikes in the US, which could begin some time next year. A Barclays report issued after the monetary policy review on 5 August said that they expect policy rates to be eased by 50 basis points by end-2014. However, what actually happens will depend on the flow of data.
4. Buybacks can be dicey
Currently, developers are finding it difficult to get loans from banks. So they are using buyers as conduits to borrow from banks, and are offering them guaranteed rates of return. According to market sources, the annual returns are in the range of 20-24 per cent on buybacks and assured return plans. What’s the catch in these schemes? One, they indicate that the developer is in financial dire straits and is, hence, promising high rates of return. Two, builders usually make these offers on the premise that, in the future, prices will rise more than the rate promised by them. The customer will then prefer to sell in the market and the builder will not have to fulfill his commitment.
But what if the prices rise slowly? The builder will then per force have to deliver on the promised rate of return. Warns Pradeep Mishra, head of Guragon-based Sainik Estates: “If the developer lacks financial strength, he may renege on his promise. The buyer will be left with no option but to go to the courts, which is not a desirable course for most people.”
If you do decide to enter such a scheme, assess the developer’s financial position and his credibility in the market.
5. Don’t factor in tax gains beforehand
You can avail of deductions on both interest and principal repayments on a home loan, subject to a few conditions. The deduction on interest is limited to Rs 2 lakh per year in case of a self-occupied property, but there is a catch. “If this property is not acquired or constructed within three years of the end of the financial year in which the loan was taken, the benefit gets reduced from Rs 2 lakh to Rs 30,000 only,” says Surabhi Marwah, tax partner, EY. In these times, when possession delays are rampant, this is a risk that all buyers run.
The deduction is allowed in full in case of rented properties. The deduction on interest is available from the year in which the construction is completed. Any interest paid earlier can be deducted in five equal annual instalments beginning from the year of completion. Such claim is also subject to the limit of Rs 2 lakh or Rs 30,000 for a self-occupied property. Section 80C also allows a deduction of up to Rs 1.5 lakh per year on principal repayments. “This is subject to the condition that the property is held for five years from the end of the year in which possession was obtained,” says Marwah. So don’t think of flipping properties bought on a loan.
6. Don’t be lured by special offers
Today, a range of price discounts and freebies are being offered by developers to expedite sales. Some are waiving the PLC (preferential location charge) or the cost of parking slot, or offering to pay the stamp duty on buyer’s behalf. Yet others are offering kitchen and bathroom fittings, or durables such as an air conditioner, even a car. Keep your primary focus on the apartment that you are getting in these special offers. How attractive is the location? What’s the area of the flat? What’s the per square foot rate at which the developer is offering the apartment? Is it at par with the rates prevailing in the market?
Magazine of CBRE advises that the buyer should calculate the exact monetary value of the offer, deduct it from the basic price, and then compare it with other offers. Says Ahuja of JLL: “Buyers should base their purchase decisions on the inherent value of the property rather than on freebies. Real estate is a significant investment, and it should not be influenced by smaller considerations.” Sanjay Sharma, MD, Qubrex, a Gurgaonbased realty consultancy, warns of another problem while buying in projects with steep price discounts and attractive special offers. “Developers are promising so many freebies that they may be severely underpricing their projects. There is a risk that such builders may not be able to complete the projects.” He warns that buyers should consider the financial strength of the builder before opting for these schemes.
Steer clear of offers that are too good to be true, he says. To get an attractive discount, buy in groups. In places like Greater Noida West, where supply is very high, you could negotiate a discount of 15 per cent or more if you can get together 15-20 people for a bulk purchase. The exact discount will depend on the quality of location, the builder’s financial position, etc.
7. Conduct due diligence
The most important factor while buying a house is location. Check the quality of infrastructure: how many hours of power cuts does the area face during summer? Pay attention to connectivity: roads, proximity to airport, and the possibility of metro connectivity in the future, if it doesn’t exist. Pay heed to the drivers of economic growth. “The places that witness job creation see a higher price appreciation,” says Magazine.
Next, scrutinise the developer. Visit his older properties and ask the residents: did he deliver on time? How good is the quality of construction and the fittings in the project? The quality of people living in a project also has a bearing on demand and, hence, on price appreciation. Finally, find out who will manage the property after possession. Examine the agency’s track record. In high-end properties, especially, the quality of maintenance affects the quality of life in the project.
8. Commercial property is a better proposition
If you are investing in real estate chiefly for rental returns, commercial property may be a better proposition than the residential one. The rental yields in commercial property tend to be much higher. Says Samir Jasuja, founder and MD, PropEquity: “Typically, a commercial property can fetch a gross rental income of 11-13 per cent per annum of the cost of the property, while returns from a residential property will be in the range of 3-5 per cent.” The exact rental yield that you earn from a commercial property is subject to factors like economic sentiment, business growth, demand-supply situation and location.
Another advantage of investing in a commercial property is that the leases are usually for a longer period, typically 2-20 years. They are often secured by a bank guarantee, which offers a higher degree of certainty to the investor about his future income. Service tax applies only to commercial property, which leads to an extra 10 per cent on the property’s purchase price. As an investor, you can claim this service tax as ‘input tax credit’, which is charged on the property’s rental.
Unlike in a residential lease, the maintenance costs and repairs in the case of a commercial property are typically paid for by the tenant, not by the landlord. Finally, commercial tenants generally maintain the property better as it is their place of business.
9. Choose your lender carefully
Once you have decided on a property and are planning to take a home loan, you will have to zero in on a lender. The most important consideration here is the rate of interest. Many financial websites offer a comparison of interest rates. By entering your details on these sites, you can get a good estimate of the rate of return you could get.
The interest rate you get from the market will also depend on factors like your credit score, employment status, income, and the profile of the developer and property. Next, decide whether you will take a floating or a fixed rate loan. With interest rates currently on the higher side, you would, perhaps, be better off opting for a floating rate, to benefit from a possible decline in interest rates once the government and the RBI manage to bring inflation under control.
If you are extremely risk-averse, you may opt for a fixed rate loan. This type of loan will protect you from interest rate shocks during times of rising rates. However, these loans are costlier than floating rate loans. “In case of a fixed rate loan, check whether the rate is permanently or temporarily fixed. If it is the latter, check what the rate will be after the fixed period is over,” suggests Naveen Kukreja, group chief marketing officer, Policybazaar. com.
While deciding on the loan amount, try not to over-stretch yourself. “Ideally, your EMI should not exceed 40 per cent of your net salary,” says Kukreja. Enquire about the details of the processing fee that the bank will charge as this element too will add to your overall borrowing cost. Also enquire about the part prepayment facility. This is an important provision as it enables you to save a lot on interest cost throughout the loan tenure. Banks could have a limit on the number of part payments and the amount of prepayment you can make in a year, say, 25 per cent of outstanding loan. Some banks also offer discounts on the rate of interest and the processing fee to their existing customers. Avail of these offers if you can.
The RBI has barred banks and non-banking finance companies (NBFCs) from charging prepayment penalties from customers on floating rate loans, but they can still charge it on all fixed rate term loans.
10. Opt for term plan rather than home loan insurance
To cover your home loan liability, you will be better off opting for an online term plan rather than a home loan protection plan (HLPP) for a number of reasons. One, online term plans are cheaper than HLPPs (see graphic). Two, it is easier to compare the term plans offered by different insurers as premium, riders and sum insured options are the standard factors for evaluation. On the other hand, a bank offers a single option for HLPP.
The customer doesn’t get the benefit of comparing prices and can end up paying a much higher premium than the best plan available in the market. Another disadvantage of HLPP is that the payment is often through a single premium. If you prepay the loan before the full tenure—say, a 20-year loan within 10 years—you will lose the premium paid for the remaining term as that money is not refunded.
Finally, in case you transfer the home loan from one bank to another for the lower interest charged by the latter, there could be hassles in porting the home loan protection plan. Since the term cover is separate from the home loan, you can keep or jettison it according to your needs.