An efficient way to gradually build wealth through reality

An efficient way to gradually build wealth

Second homes can also be purchased for Rs.50 lakh with good scope for value appreciation and tax gains

Most people with investable surpluses tend to stay focused on the financial markets, whether it is debt or equity. Very few venture into real assets such as Gold or real estate. An investment in a second home is an effective way to build wealth in the loan term. Let's examine the various reasons why this could even be the best form of investing for a salaried individual. Outlook for Real Estate Real estate prices in India have grown at between 15% and 20% annually, over the past 50 years, across cities and across various reasonably long (10 year) time frames. This growth is projected to continue, given the combination of various enabling factors. These include a favourable demographic distribution in the country, increasing urbanization and an increasing preference for nuclear families. Such returns are comparable to those in the Equity Capital Markets. In fact, there is the additional advantage that one is spared the variability and risks associated with investing in equities. For example while the BSE Sensex has multiplied 160 times since 1979, the components of the Sensex have been changing constantly. Tax efficiency There are several tax advantages that can be availed by investing in a second home. These include l The rent received from the second home (less 30% for repairs and maintenance) can be set off against the interest paid on the home loan taken for the flat. If the rent received is less than the interest paid, then the resultant 'Loss from House Property' can be set off against your regular income. Thus, there is a tax hedge provided be the property till it begins to pay for itself. l When the flat is sold, the acquisition cost (adjusted for indexation) is deducted from the sale proceeds and only the balance is taxable. Leverage The purchase of a second home is the only form of investment for which leverage is available for salaried individuals. All other investments, whether stocks, mutual funds or Gold need to be made out of one's own savings. It is possible to invest in a second home by putting only 20% of the cost of the home as one's equity, and take a loan for the rest. Financial implications So then, the financial logic for investing in a second home is simple. Assume the following. You own the asset by paying only 20% of the cost. Your average cost of financing the remaining is 10%. The rental yield is 3% and property appreciates by 12% every year. Your financial situation every year is as follows in the table below. As is evident, the return on the investment is quite healthy. The municipal taxes to be paid and the costs of maintaining the property have not been shown. However, the overall picture does not change significantly even with their inclusion. Psychological Factors A house is a stable asset and is not bought and sold frequently. Consequently, it allows a longer time frame for any appreciation to play out. There is no greed or desire to cash in when the prices are high and there is no panic when prices so not rise. An important psychological factor is that real estate prices do not fluctuate on a daily basis and there is no mark to market that is available on a daily basis. This makes the house a comfortable asset to hold. The Flip Side There are some factors that one needs to be aware of, before buying a second home. You should be comfortable with the monthly installment to be paid over the long term. Also, a property takes some maintenance and monitoring. Those with transferable jobs will find this especially challenging. Additionally purchase of property entails a thorough evaluation of the developer, his track record and other legal aspects of the property. In summary, a second property is a worthwhile investment, especially for the salaried class. It is an efficient way to build wealth in the long term.