FAQ - Real Estate
I want to invest into Real Estate, what are the options available to me?
If youwant to invest in Real Estate, you have the following options:
- Residential: houses, apartments, duplexes... generally safest, usually returning around 2-5% as Cap Rate plus capital appreciation.
- Commercial: factories, shops, offices... usually provides higher returns around 7-10% with tenants paying out-goings... often much more expensive, banks more choosy about lending.
- Agricultural: Land used for farming is another option you can explore if you are looking for an income generating Real Estate Investment.
- Real Estate Funds: Many alternate Asset Managers have come out with real Estate based funds for investment into Real Estate which range from joint ownership of properties by the Unit holders to complex deals which may provide for guaranteed returns, or equity participation or other structured products.
What Is Typically Involved In Beginning Real EstateInvesting?
Buying an investment property is no more or less complicated than buying yourown home.
The process is basically the same:
1. Pre-qualify:your offer is a much stronger one if the seller knows your financing is readyto go.
2. Choose your investment: use the help of your team of experts toadvise you, when needed.
3. Make an offer: if you are purchasing in a development, pricingmay be pre-determined. But if you are purchasing a single family home, forexample, there is some room to bargain. Don’t "low-ball”. Sellers may beinsulted and not look at any other offer from you, just based on that.
4. Purchase Agreement: The contract you and the seller will sign,listing out the specific agreements. Here are some common elements:
Amount of deposit/earnestmoney · Specifically states you’re the price& terms of the agreement Proposed financing you have chosen (this is why it’s good to pre-qualify)
· Rescission period – the amount oftime you have to change your mind for any reason. This is different from stateto state and varies on the type of investment property you purchase. Forexample, for a condo or town home in Minnesota, you have 10 days from the dateyou receive your "Condo Docs" to withdraw and get your earnest moneyback. After that, the seller may keep your earnest money.
State the intended closing time thatyou and the seller agree upon.
5. Closing:On this date you will finalize your purchase and officially "take title” to theproperty. At this time, the balance of your arranged down payment will be due.For example you and your lender agree that putting 10% down is the best optionfor you and you put 2% down for your earnest money already, you will need tobring a cashiers check for the additional 8% to closing. Your lender will giveyou the exact amount plus any closing costs you are paying for upfront.
How do I decide whether buying a particular property a good use of my Money?
In India, historically, RealEstate has given good returns to the investor. However, the picture is not always rosy for the average investor. A good guide is to consider the 10 year G-SecRate and long term equity returns. The expected return should be atleast mid way between the two.
Are there any ratios I can look at to decide the profitability of the Building?
Yes, you can look at the followingratios to make a financially sound Real Estate investment decision:
Cap Rate: Caprate is the ratio between what a building costs and what it makes, somethingsimilar to the PE Ratio of a stock. Itis mathematically defined as Net Operating Income / Purchase price.
Thus, a property paying amonthly rent of Rs 30,000 and costing Rs 1 Cr will have a Cap Rate of 3.6%.
Gross Rent Multiplier: An important ratio to the seller, it measureshow many times the property is valued in relation to the rent received and isinverse of Cap Ratio.
Debt Service Ratio: If you have taken a loan to buy a property,this is an important ratio for you. Itis arrived at by dividing the Net Operating Income of the property by Its debtobligation. If the ratio is more than 1,it means that the rent you receive is higher than your EMI and the property iscovering up for its loan.
Retur non Investment(ROI): It is the most important ratio for you as ithelps you understand what the property is paying to you. It is arrived at by dividing the Net Incomeof the property by the total investment. Thus, if you get a rent of Rs 30,000 on a 1 Cr property, and pay an EMIof Rs 12,000, your ROI is 2.16%.
Howdo I make sure that my property pays for itself?
We buy Property to make moneyfor us, but the truth about Real Estate investing is that the rental yields are very low and thus, the major return from an investment comes from the Capital Appreciation at the time of the sale. As, Real Estate Investments being a long term in nature, it becomes important that we do not get into a debt trap and should not have a negativecash flow. The most important thing to note is that the total outgoings on a property are much lower than the Incomeit generates.
Is it prudent to take a loan while buying a property or should I try and financethe purchase myself?
Taking a loan can be goodfinancial decision while buying a house for both Residential as well asInvestment Needs, as you get tax breaks for the same. However, you have to keep in mind that theamount of your EMI should not be substantially higher than the rent you paidliving in a rented accommodation.
If you are buying forinvestment make sure that the Debt Service Ratio is at least above 1.25 so thatyou can cover all the costs of the owning the property.
What are the tax benefits on offer for taking loans on Real Estate?
If you have taken a loan forbuying a house, you can deduct Rs 1 lac of principal repayment u/s 80c and youcan deduct the interest upto Rs 1.5 lacs per annum
Should I have different parameters for buying a House for Residence and one forinvestment?
There are obviouslydifferent parameters which you need to focus on for buying a House forResidence and one for investment. Whileconsidering the returns on the property, Rental Income plays the differentialin a property purchased of Investment and self residence. Therefore, other things being equal you canbuy an expensive property if you want to put it on rental, as the rentreceived, will help you offset sum cost on a regular basis.
What are the different criterion to look at while comparing a Residential andCommercial Property for investment purposes?
Although, Commercial RealEstate has a much higher Cap Rate and the quality of Earnings is better thanthose in a Residential Property, it requires a much higher professionalProperty management skills and is not everyone’s cup of tea. Therefore, the most important criterion whilechoosing between the two is to consider the level of involvement andprofessional skills of the buyer.