When can you make money in real estate? You probably can if you buy really low, strike a bargain and get a great deal, or if you are lucky with an investment you never thought would really show double-digit appreciation (for this, you need to have already made the purchase at a price that seems like a real bargain in retrospect).
Bargain buysA recent JLL report quotes an official saying that project sales are typically spread out at 18 per cent at the time of launch, 55 per cent during construction and 27 per cent on project completion.
It is usually the 18 per cent who make the real killing. But normally, retail buyers looking for a home to live in find investing in such projects premature, given the long delivery timelines.
Builders usually sell a significant portion of the property to early investors to bring in cash early to fund the project construction. Such sales are often at huge discounts with these investors looking to cash in on a resale usually at the pre-launch stage.
With the current slowdown in the real estate market, the need for cash may prompt a few early bird investors to sell at a slight discount to the prevailing prices, opening the doors for retail buyers to seek bargain buys.
Look before you leapBefore you jump in to buy, scrutinise the documents. Also, ascertain that all dues to the builder have been paid by the previous owner in case of a resale. If payments to the builder are pending, the price should be adjusted accordingly.
More importantly, early stage development involves significantly higher risks stemming from uncertainty around their permissions, funding, delivery, and often results in delays.
Evaluating one’s ability to wait it out under such circumstances is usually a wise course of action.
A delay in possession lowers your returns on the property and should be evaluated thoroughly before making the investment. First, the opportunity cost of your own funds is high; you might have been better off investing in other asset classes. Second, in the case of borrowed funds, the interest cost can bite you. You will also lose out on the potential rental income.
Delays eat into returnsHere’s how a delay in possession can impact return on your investment.
Consider a property purchase for ₹1 crore in December 2015, where 20 per cent is self-funded and 80 per cent is borrowed at 11 per cent per annum.
If the property is available for possession in June 2017 (18 months from purchase) and then let out for the next three-and-a-half years (42 months), the investor is looking at locking the money in for about five years (which is a fair horizon when looking at property as an investment).
The rent generated on the property is ₹35,000 per month with an annual growth of 10 per cent.
We assume an annual appreciation in property value of 8 per cent per annum. This makes the selling price ₹1.42 crore.
After taking into account the interest paid, expenses incurred and all taxes applicable, the internal rate of return on the ₹20 lakh invested is 9.41 per cent per annum.
Worth mentioning is that if the property does not appreciate significantly, you could be left with low returns. You would be better off investing in bank fixed deposits. Now let’s address the issue of delay as this investment doesn’t come without that risk.
The Table illustrates the return the investor gets for every six months of delay.
An 18-month delay in this case shaves off more than a percentage point returns, assuming the same holding period and planned year of sale.
Wouldn’t you be better off putting that ₹20 lakh away in a safe five-year fixed deposit?
For all the trouble of searching for a property, going through the purchase process, raising a loan, paying EMIs, letting it out and then finding buyers for a sale, you get returns, which are similar to what fixed deposits provide. In fact, a delay could make it worse than having left the money in your savings bank account.
Hence, the best course of action while negotiating pre-possession properties is to get a great deal on price (or the benefit of buying early) and ascertain the impact of delay and your ability to handle it.
The writer is the co-founder and COO at BigDecisions.com