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Real Estate investments with EMIs – Tread with Care
Kavitha Menon kavitha@ppfas.com
Akash works with a IT company and has a great salary package. He made his first investment in property using an EMI in early 2003. The property value had doubled by 2005 and he decided that property was the best investment to make. Since his salary too had doubled in the same time, he decided that the extra savings can go into another property by using, you guessed it, EMIs. Then the third one happened in 2007 and one more in 2008. Using a heady mix of personal loans, loans on existing properties and regular mortgage loan our friend had accumulated several crores of property .There was just one problem . He had practically 80 % of his salary going towards various loan payments. The liquidity crunch was severe. 2008 came in with recession and salary cuts in its wake. That's when the alarm bells started ringing.

Real Estate investments unlike others have peculiar features

1. They involve large outlays.

2. Real estate transactions costs are very high,considering broker costs, stamp duty and registration fee

3. They cannot be bought or sold piece meal

4. They are illiquid most of the time

5. Real Estate returns come from rentals and capital appreciation. Both need to be considered by making a property purchase.

6. They are very long term assets

Here are some widely believed myths about real estate investments that led to Akash's situation – 1. Rentals will cover most of the interest - The element of leverage that involves putting in little equity while taking a huge loan with EMIs repayments had made fortunes for those who invested early during the real estate rally. However the properties purchased latter were at high levels. Rentals hardly covered a small fraction of the EMI and net outflows were therefore very high. Besides a loan is a loan is a loan. Greed and the need to make a fast buck makes loans to buy real estate attractive, but the interest on loans will eat into a large part of your returns if you have made a purchase in a wrong cycle.

2. The tax benefits of taking a loan are very high. Yes if you belong to the highest tax bracket you do save Rs. 50000/- (30 % of the Rs. 150,000/- exemptions given to interest on Housing Loans). But any interest over this limit is paid in full with no tax exemptions. Also since tax slabs have expanded in this financial year, the exemptions look less attractive.

3. Real estate prices never fall. In realty like any other asset real estate too has a cycle and can have periods of correction and overpricing. The laws of demand and supply affect real estate too. Not all supply will be absorbed at any price level. Too high a price, too low the affordability and prices will correct. Real estate did correct during the recession and he was unable to liquidate when he needed the funds.

Akash was not prepared to face the contingency of a job loss or a pay cut .Housing and mortgage loans are a boon to those looking at buying their own home , but cannot fund the same upfront. However to buy property, via the EMI route to block all your additional savings is not right. Real estate can lock in investments for a long time. Look at more liquid, but equally attractive investments assets like gold and equity. These investments can be easily sold due to a very vibrant market, involve low transaction costs and can be liquidated to the extent of your requirement i.e. piecemeal.

Once again I reiterate the importance of having a financial plan and an asset allocation plan

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