Yesterday I met an old friend after a long time (lets call him 'S'). Some four years ago he purchased a flat in Bangalore Sarjapur area for around 70 lakhs. He mentioned that the price of his flat is touching 90-95 lakh now and he was happy with his investment making awesome returns.
I was not sure, since I have always been wary of Real-Estate true returns. I wrote a post in Nov 2010 questioning the same. So in this case, I did a quick back-of-the-envelope calculation.
Purchase price of flat = Rs 70 Lakh year 2010
Down payment = Rs 15 Lakh
Loan Amount = Rs 55 Lakh for 20 years
As per the floating rate of interest, his EMI comes to around Rs 54500 (although due to floating nature, his tenure has changed, but let me not add it).
Till now he has paid
54,500 X 48 EMI = 26.16 lakhs + 15 lakh = 41.16 lakhs
Current quoted price = Rs 90 lakh (Assuming he sells at 95 Lakhs, but he wont get entire money, since buyer will deduct the stamp duty, registration charges etc, lets say 5 lakh is deducted).
Outstanding loan amount = Rs 50.92 Lakh, So his balance earning = 30.08 lakh
This amounts to a loss of 11 lakhs.
Even if you include the tax deduction he received on interest and principal payment, it will not be more than 2-3 lakhs, which still puts his investment in red.
I have not even considered the opportunity cost of the investment money or the builder related issues causing delays and shoddy construction, which will compound this loss to much more.
A real-estate investment on borrowed money is a really bad deal.
Whats the solution? My solution is simple
1) Never believe the fact that real-estate prices will keep on increasing.
2) Instead of buying a house now, invest the EMI amount in recurring deposit. For e.g. if you plan to take a loan of Rs 50 laks today, rather invest Rs 50000 per month in a RD
3) Wait for your RD to be give you more than 50% of your house cost. In this case, in 3-4 years you will have close to 25-30 lakhs
4) Search for a house in the same budget (believe me you will get it even after 4 years), but now you can actually pay half cost of the house by cash.
5) Take loan for remaining amount (EMI 25K now) and keep saving the remaining 25K in RD
6) In another 3-4 years you will be able to fore-close your loan with the RD.
Let me apply the same to my friend S's investment
So instead of EMI, he puts it in RD, 54500 Rs * 48 = 26.16 lakhs + RD interest = 30 lakhs (post tax).
Purchase price of flat = Rs 70 Lakh year 2014 (he can still get a house around 70 lakhs in many good parts of Bangalore)
Down payment = Rs 15 Lakh + 30 Lakh = Rs 45 Lakh
Loan Amount = 25 Lakhs
His now EMI = Rs 24, 792 + he starts another RD of 29708 Rs per month. So in 4-5 years (by 2018) he would have cleared his home-loan.
The bottom-line in this plan is that you pay very little interest to the bank and hence can make your real-estate investment profitable.
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