6 common mistakes in real estate investments

Oct 31, 2015 / Dwaipayan Bose | 44 Downloaded |  11595 Viewed | | | 3.5 |  16 votes | Rate this Article
Real Estate article in Advisorkhoj - 6 common mistakes in real estate investments
Picture courtesy - PICJUMBO

Buying a house is a major aspiration for most families. Enticed with the idea of owning a house and seeing their assets rapidly appreciate in value, countless Indians have invested a large part of their savings in real estate. Many cities and suburbs have seen a veritable real estate boom in the last decade. However, boom very often creates a bubble which ultimately impacts investment returns. Over the past few years, we have seen a slowdown in the real estate sector. High interest rates and oversupply situations prevailing in many real estate markets have been attributed to the slowdown. Real estate investment calls for substantial commitment of funds both one time and on an ongoing basis, if you are taking a home loan to finance your property purchase. Real estate is a very complex investment and there are a number of factors involved which many investors casually ignore. For us a house is an emotional purchase, but we should not forget the financial consequences related to it because it has a very long lasting impact on our finances. There are six common mistakes that people make in real estate.

  • Since most people buy a house by making a small down payment themselves and borrowing the balance amount as home loan many people over extend themselves while buying a house. Consequently they end up in a situation where they have very little savings after paying the home loan EMI, while they remain saddled with the debt. Home loan borrowers should note that for the first 7 to 8 years, 65 - 70% of your home loan EMIs goes towards interest cost. Now if interest rate goes up, as was the case from 2012 to 2014, many home loan borrowers saw their loan tenure extending beyond 20 years even after paying regular EMIs. How much EMI can you afford? The most commonly used rule of thumb is that your home loan EMI should be at most 40% of your gross monthly income. Many home buyers actually follow this thumb rule. But following a thumb rule without due consideration towards your personal financial situation and goals can have very adverse consequences. You should factor in your household income, expenditure, investments and liabilities in your real estate investment decision. Good financial planning practice suggests that you should set aside sufficient part of your savings towards adequate life insurance, health insurance, emergency funds and your long term investment goals. Financial planners recommend that you should be able to save at least 15% of your monthly income, after paying the EMI and other expenses.

  • Many people make pre-launch bookings at what they think are bargain prices. They do not factor in possession delay, which is more often than not, the norm with most builders in our country, including the biggest names in real estate. Some builders compensate for possession delays, but if you see what they pay in terms of compensation, it is a miniscule percentage of your home loan interest cost. Also, if your possession is delayed, you cannot claim any income tax benefit under Section 80C for home loan principal repayment or Section 24 for interest payment.

  • Many people do not factor in potential changes in their own personal situation while buying a house. Mobility is an integral part of career and life these days. There are numerous instances of people having to relocate to a different city soon after buying a house in another city. Let me give you the example of a friend from Kolkata, who bought an apartment in Bangalore when he was working few years ago. Two years after he bought the house, he relocated to Noida to pursue a better career opportunity. He lived in a rented accommodation in Noida while paying home loan EMIs for his Bangalore apartment. His plan was to sell the Bangalore apartment and buy one in Noida, but the possession was delayed by 3 – 4 years and he did not find buyers. This year he was handed the possession of his house and around the same time he got a great career opportunity within his own company to work in their San Francisco office. In the short time window he had before his relocation to the US, he was not able to either find a buyer or even someone would rent his Bangalore apartment. As a result, he is paying for an expensive rented accommodation in San Francisco and at the same time paying the home loan EMIs of his Bangalore apartment which is lying vacant.

  • We often underestimate how much interest we have to pay on our floating rate home loans over the tenure of the loan. Home loan interest rates have now come down a bit, but over the last 3 to 4 years home buyers were paying around 11% home loan interest rate. Furthermore, people do not realize that, if you have a floating rate home loan, the bank may not reset the home loan interest, even if the interest rate goes down and if they do, they will take at least 3 to 6 months before bringing down interest rates. In a declining interest rate environment, people who already have home loans are in fact at a disadvantage compared to people who take new loans. Invariably, people who take new home loans will pay a lower rate of interest than people who have older home loans. You can say it is unfair, but it is the reality. You have the option of refinancing your home loan by another bank, but it comes at a cost. The prepayment penalty, if the source of prepayment is not your own income is around 2% of your outstanding loan

  • We often underestimate the cost of buying a house. We do not factor in brokerage, registration and stamp duty, interior design work, cost of furniture and fixtures related to the new house, property tax, maintenance costs and escalations thereof. All these additional expenses come out of our savings or investments set aside for another purpose.

  • We often overestimate the returns from our real estate investment. If you plan on renting out your new house, you should note that rental yield of your house will be much lower than your home loan interest. Very often we vastly overestimate the capital appreciation potential. This is because we do not do enough research on our own and instead believe in what the broker has to say. Some investors enquire about the capital appreciation from other investors in the same project. Do you think that, people who have invested in the same project would like to believe that they made a bad investment? You should check if road widening which your broker said will take place in 3 months has legal hurdles, or if the promised shopping mall is really going to come up opposite to your building is really on track. You should do adequate research before you zero down on a property you want to purchase. If you know any home owner who has been staying in the neighbourhood where you want to buy a property, you should enquire about prevailing rates and escalations over the last few years. You should also look at listings on popular property listing websites like magicbricks.com, 99acres.com, allcheckdeals.com etc. A word of caution when you look at property listing on these websites. Not all listings are genuine. Some listings are out there just to grab your attention. Look at listings posted by the actual seller, and you can get a sense of the prevailing property prices. Do not depend on a single agent. You will get multiple perspectives when you speak with a number of agents. Doing your own research will arm you with the knowledge to protect yourself against mis-selling and misinformation.

Conclusion

Many investors are today stuck with real estate investments that are either illiquid or cannot be put to any productive use. As a result they are either facing financial stress or are compromising on other equally important financial goals like life insurance, health insurance, retirement planning etc. Real estate is one of the most important components of our asset portfolio. However, it can easily also be a liability and source of stress for us. If you plan your investment carefully and avoid the mistakes we discussed in this blog, you will be stress free and be able to achieve all your financial goals.

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