Monday, April 15, 2013

Is Buying a Second Home an Investment?


Are you someone who thinks that buying a home is an investment? Do you hear from elders and random relatives about being an intelligent investor and buy a house in some place where you have absolutely 0% idea of relocating to? Buy it now, property prices are soaring, you can make a profit in future – this is the standard dialog you will hear almost all the time. Every month there is a property show or property exhibition by large builders in major cities where they sell properties like cakes and cookies. It is easily possible for the normal individual to get tempted by all this hoopla about property investing and even think about buying a house that we don’t need. If you are one of those guys, this article is just for you…

Who this Article is Not For:
This article is not for the first time home buyer. Every individual dreams of owning a house, something they bought or built. There is nothing better than being able to fulfill this dream. If you are someone who is planning to buy your first home, this article is definitely not for you.

This article is for all those guys who already have a home (where they are living) and are contemplating buying a property just as an investment – esp on Loan.

Is Buying a Second or Third Home a good idea?

YES – If you are paying Cash in full to buy the house
NO – If you are going to take a loan to buy the house

The YES part is a no-brainer. So, let us concentrate on the NO Part of the answer.

Buying a Second or Third Home on Loan – A BAD IDEA!!!

Whatever I am going to explain below is just simple mathematics. Let us say you are buying a home worth 60 lakhs. As part of the standard process, banks offer loans worth 80% of the property value and you fund the remaining 20%. Let us assume that you were approved a loan of 50 lakhs and you came up with the remaining 10 lakhs and are thinking about buying this property that you feel is an awesome deal…

Rate of Interest on the Loan:

Home loan rate of interests vary from bank to bank but they are usually in a certain range. Depending on whether you want a fixed rate or a floating rate loan, your rate of interest and EMI will change. The average interest rate for floating rate loans in India currently is in the range of 10% to 12% whereas for fixed rate loans it is 12% to 14%.
For our calculation purposes – let us assume your home loan is at 12%

Loan Tenure:

Buying a home is a huge investment and the EMI is going to be significant. So, most people choose a long tenure so that they can repay the money in smaller amounts every month. For our calculations, we will check three tenures – 10, 15 and 20 years.

Tenure = 20 years
EMI Per Month = 55,054/-
EMI Per Year = 6,60,048/-
Total Money repaid = 1,32,12,960/-
For a 50 lakh loan, we are repaying 1.32 crores at the end of 20 years

Tenure = 15 years
EMI Per Month = 60,008/-
EMI Per Year = 7,20,096/-
Total Money repaid = 1,08,01,440/-
For a 50 lakh loan, we are repaying 1.08 crores at the end of 15 years

Tenure = 10 years
EMI Per Month = 71,735
EMI Per Year = 8,60,820
Total Money repaid = 86,08,200/-
For a 50 lakh loan, we are repaying 86.1 lakhs at the end of 10 years

If we consider the 10 lakh initial investment you made, the amount you incurred at the end of the loan to buy your property (that was worth 60 lakhs at the time of purchase) will be:
• 96 lakhs at the end of 10 years – Almost 60% appreciation from purchase value
• 1.18 crores at the end of 15 years and – Almost a 100% appreciation from purchase value
• 1.42 crores at the end of 20 years - Almost a 125% appreciation from purchase value
Do you really think your property will be worth that much at the end of those durations? I don’t think so..

What if Property Prices continue to rise like the past 10-15 years?

Yes, that is a valid question. If and I mean a big IF property prices continue to rise like what it has in the past 10 to 15 years, then your property may be worth much more than what you will end up paying for the loan. But, this IF is a really big IF due to the following reasons:
a. The boom in property prices was fuelled by the industrial growth in the country. This has been happening for close to 15 years now. If you watch the market price movement of properties closely, you would’ve realized that the rise in property prices isn’t as sharp as it was just 5 years ago
b. Builders and Promoters are making a killing profit selling properties which many intelligent buyers are able to figure out. As a result, people aren’t buying properties when they are launched. Builders make never-before-never-again kind of offers at launch to attract customers but if they cant attract enough people, they reduce the price and offer better deals as time goes bye. People who book apartments at launch are paying around 4-5% more money than guys who book a few months later, esp in cases where the demand for the apartment is lower.
c. The price of property has been fuelled by industrial growth only to a certain extent. The remaining price rise has been artificial inflation done by our businessmen and agents. Just because people claim that property prices are going up doesn’t mean it is actually going up. It is being pushed up by our crooked businessmen and agents so that they can make a profit.
d. The Indian housing bubble may burst any time… The indian housing market boom is closely resembling the US Housing Market burst that happened 4-5 years ago. In spite of inflated prices, the demand for houses still looks like is pretty good but this isn’t permanent. The builders and banks in india are doing the same mistake that our friends in the US did. It is easily possible that the Indian housing bubble will burst very soon and if it happens, you can surely see a solid correction in property prices.

Lastly:
If you still feel that property investment is safe and you feel that property prices will rise invariably, you should read one last comparison.

If you invest the same Rs. 6 lakhs (50,000 per month) in yearly fixed deposits that pays 8% interest per year and let the deposits cumulate for 20 years, your deposits will be worth as follows:
a. At the end of 10 years – 94 lakhs
b. At the end of 15 years – 1.76 crores
c. At the end of 20 years – 2.96 crores
Even in the case where your property values surged to these numbers, are you really making all the profit? The bank is going to eat a huge portion of your money – between 46 lakhs and 92 lakhs depending on your tenure. Why pay the bank so much money just because you want to see a meager profit at the end of 20 years? If you rather invest in a bank fixed deposit, you will end up making more profit.

Trivia:
The cost of property 20 years down the line is not your profit. You need to deduct your initial payment of 10 lakhs and the repayment you made to the bank from it and the remaining amount will be your profit. Some people ignore the bank repayment part. I bought the home for 60 lakhs and sold it for 1.2 crores after 15 years. A 100% profit – right?
Unfortunately No. If you just scroll up and see the calculation, your cost incurred on the house for the 15 year loan was 1.18 crores. Do you really want to invest 1.18 crores and get a 2 lakh profit after 15 years?
I am sure – your answer is a NO.

What if I am going to rent out my second house and/or Avail tax benefits on it?

In this case, the whole calculation may change but not by much. You will get a rental income that will be around 20 – 30% of your EMI payments which is good. But, considering the amount of money you will end up repaying the bank and the property value after the loan, it may not be that good a deal. Even if you manage to get tax benefits on the second house, the actual profit you will end up making at the end of 15 or 20 years will only be mediocre at best. It can never equal the kind of returns you will get if you actually invest the money in proper investment options like Bank Deposits, Equities etc.

Some last words:
This article was not for first time home buyers or for people who are buying a home by paying full cash. For you guys the above logic does not hold good because – for the first time buyer, a home where you and your family will live far outweighs these calculations. Similarly, for the cash buyer, you will end up making a good profit nonetheless because you aren’t paying anyone, any interest.

Let me reiterate my opinion – I am not saying that don’t buy a house. I am just saying that don’t buy a second or third house on loan. For your first house, ignore these calculations and buy your second or third house only if you can pay cash for the house…

Happy Investing!!!




39 comments:

  1. Hi Anand

    Very nice article. Eye opener for me ,

    Sekhar

    ReplyDelete
  2. This article seemed to have been written for someone like me-a bit too late on the advice if you ask me. But hoarding cash is not really helping anyone is it?

    Besides when one sees flat cost quadruple in five years the assumption will be stronger that buying property is the right thing to do! Esp. when the old loan is closed.

    ReplyDelete
  3. I have a question. I have a house I bought for 9 lakhs taking a loan of 7 lakhs 6 years ago. Its a 1 BHK and now priced at around 20 lakhs. I am considering a second home putting in 30 lakhs and taking a 30 lakh loan and buying it at 60 lakhs. Do you think this is worth it ?

    ReplyDelete
    Replies
    1. Yes, this sounds like a good idea to me...

      Delete
  4. What about the unlimited waiver on interest paid on the second home loan. This is offered by the GOI. There is no limit to the interest paid on the second home loan. Its unlimited which means that youw ould end up in the 10 percent bracket very easily if you take a second home loan. ANy comments on this ?

    ReplyDelete
    Replies
    1. No. It does not work this way. Yes, there is unlimited waiver but that is under the condition that you consider rental income from the house as part of your total annual income. only a house in the heart of the city can actually help reduce your taxable salary by that much but unfortunately the standard rental that is applicable for a property of that size (as calculated by the government or the actual rent will be considered as your income so, obviously you will be back in the higher tax bracket.

      Anand

      Delete
  5. Hi anand
    Post Your view , If i brought the second home on loan for 20 years of tenure.and sold it after 6-7 years ..
    then what you think ..Plz Comment

    ReplyDelete
    Replies
    1. Buying a house is a long term commitment. Even as an investment, in order to really see the benefit of appreciation in the value you need to give at least 10 years.

      On top of that, in the first 6-7 years, you would've paid off only around 20-25% of your principal amount because home loans work on diminishing balance wherein the banks charge you lot of interest up front in the first few years and as days go bye, your principal amount goes up and interest goes down.

      Even if you manage to sell the house at a good price, you will still need to repay the amount you owe the bank. So, unless you desperately need the money, selling wouldnt be advisable under this scenario.

      Anand

      Delete
  6. What is this unlimited waiver being offered by GOI, mentioned in comments above? Can you please explain?

    ReplyDelete
    Replies
    1. When you buy a second house, the government assumes that it will be rented out and assumes a notional rental income against your total income and offers you unlimited tax benefit on the interest component of your home loan.

      for ex: If your loan EMI per month is Rs. 50,000/- per year it works out to 6 lakhs. at the end of the year, the bank is going to give you a interest statement which may state let us say 3 lakhs of this was interest

      In this case, the government allows us to deduct this 3 lakhs from our taxable salary if - we include rental income from that property in our tax returns. let us say your actual rent on that house is Rs. 15,000/- and the notional rental in that area according to Government is Rs. 20,000/- the government will consider Rs. 2.4 lakhs as rental income and allow you to deduct 3 lakhs as expense. in this case, the actual rent or the notional rent as decided by the government - whichever is higher is added to your annual income.

      Is this clear?

      Anand

      Delete
  7. Hi
    Nowadays I learn that there are no penalties if you repay your bank loan. Suppose I take a 30 lakh loan for 20 years at current interest rate and
    regularly repay every year - say 1 or 2 lakhs, then would it not reduce the net interest that I would pay on the second house?

    For people like me who do not have lot of cash in hand but have very regular income, the bank loan is the only way out. In such cases, will this
    kind of repayment, especially in the first 5-8 years, would help?

    Please comment.
    RG

    ReplyDelete
    Replies
    1. Hi RG,
      Yes. The whole idea here is that if you continue the loan tenure for the full 20 years, you will pay a lot of interest. If you can regularly make pre-payments and finish off your loan in less than 10 years, you can obviously save a lot of interest money you will be paying your bank.

      Anand

      Delete
  8. eye opener and well said....also the house depreciation could be included...which would offset the rental income which is still a meager amount of the total value of the projec.

    ReplyDelete
  9. True a second home might not get great returns. But consider this scenario I have a home worth 30 Lakhs at the outskirts of the city. It is loan-free and mortgage free. It is earning me a monthly rental income. I don't want to live in it because it is very far from the my workplace/kids school. I also do want to sell it. Now I want to go for a second home -which is expensive, ready-to-occupy and nearby to office/schools, helps get tax rebate and also helps avoid paying rent myself! Do you think buying a second home on loan in this scenario is a good idea?

    ReplyDelete
  10. Does not account for time value of money...The EMI is not changing over 20 yrs..so whatever EMI you are paying now...will be worth less 20 yrs from you. That is why EMI. At the end of the tenure, you need to consider this overall time and then value the money paid to the bank and then ascertain the property value.

    ReplyDelete
  11. Do not agree with the differentiation between a home bought with cash or with loan.. Even if one buys in cash, one needs to consider the opportunity cost of the amount invested in the second home.

    ReplyDelete
    Replies
    1. I agree but the guy paying cash is only risking his opportunity cost while the one taking a loan is risking that plus paying interest. So, obviously the latter is worse. right?

      Delete
  12. Hi Anand,

    Although login remains same, is it worth going for 1 BHK (under 15L price) by Home loan?

    ReplyDelete
  13. Hi Anand a wonderful article everyone (who think about 2nd home) must read I would say !! just need your kind response on this - I own a flat in good locality and its loan free. I have surplus money (15L) for which I thought to invest in property since I see now if I buy 2nd home I need to take loan and the story as you explained above will start ! but my issue is how best (in safe way) I can use this 15L as investment (beating inflation/purchasing power etc).. Thanks !

    ReplyDelete
    Replies
    1. Thank you Anonymous. Check out my books - http://anandvijayakumar.blogspot.sg/p/books-by-this-blog-author.html

      You can find good investment ideas in both my safe havens book as well as the tax saving book

      Delete
  14. Hi Anand,

    I have 70 lakhs cash from my savings and zeroed on 1 cr property, rest of 30Lakhs i opted for loan. I am looking this deal from pure investment angle.
    Property has a potential to offer me appx 30k rent and has a reasonable appreciation appetite as it is close to economic activity. Idea is to sell this property after a 5 year window meanwhile paying the EMI as well. How does this auger .?

    ReplyDelete
    Replies
    1. Yes, it sounds like a decent proposition considering the fact that the property value is not going to depreciate and you are going to make a decent rental income as well.

      Delete
  15. To the writer: I'm not criticizing your logic, but I think your calculations, on which your conclusions are based, seem off the mark.

    You say: "Some people ignore the bank repayment part. I bought the home for 60 lakhs and sold it for 1.2 crores after 15 years."

    But this isn't the case (considering current trends). As an example, a house worth Rs30 lakh has appreciated in the last ten years and is now worth Rs2 crore. I don't think you assessment of a house worth Rs60 lakh increasing in value to just Rs1.2 crore in 15 years is correct.

    However, that being said, there's no way we can predict when the bubble with burst...

    Full disclosure: I'm not absolutely sure my assessment is correct either.

    ReplyDelete
    Replies
    1. Hi,
      The past 10 years growth of the Indian housing industry cannot be sustained and its obvious with the slowdown of home sales, sluggish rental incomes etc.

      Of course, as you said, nobody can predict accurately so, everything is a best judgment opinion...

      Delete
  16. Hello Anand!
    Although your article was written almost 2 years ago.. i read it today.
    I own a 2 BHK house in an nicely developing area in ahmedabad. Bought it for 23 lakhs in 2013. now the price stands at almost 28-30 lakhs.
    My husband and I are thinking of buying another house in the same area at Rs 30 Lakhs.
    We will be able to pay 15 lakhs in cash. and are thinking to take loan for the other 15 (@9.3% from SBI, my husband is in SBI)
    the rent will be almost 8000 per month. Our monthy in-hand income (other than both PFs and NPS) is 110,000 and our EMI for the previous house is Rs. 17000.
    Both of us are 28 years of age.
    Would you recommend us buying a second home?
    Kindly reply.

    ReplyDelete
    Replies
    1. Anonymous - Buying a second house is a big decision and in order to properly answer the Questions you are asking for would require me to do a proper analysis of your familys financial situation and advise. Do let me know if you are interested in a proper financial advisory kind of service and if so, we can work out the fees & charges about the same.

      Thanks.
      Anand

      Delete
  17. Anand,

    What if you are saving 30% in income tax on interest part of the second home loan?? assuming 3 lack interest per month?

    ReplyDelete
    Replies
    1. OF course it will be beneficial and it will be more beneficial if you are paying a 5 lakh interest per month.

      If we are talking about 3 lakh interest the home loan must be for 5 crores maybe and property cost even more. So, if you count 30% of crores, of course the benefit will be much higher than when you count thousands as EMI payment

      Delete
  18. Nice Article Anand.
    You compared between buying second home on loan and investing the EMI in fixed deposits.
    Just continuing the line of thought - how would the numbers compare during sale of House which might incur capital gains (vs) Tax you would be paying on the interest of the Fixed deposits? Any thoughts?

    ReplyDelete
    Replies
    1. Hi,
      Capital gains is a something that would vary based on when you bought the house and when you sell it. Taxation on fixed deposits is straight forward and happens every year on the interest earned. So, i dont think the comparison is fair or even reasonable.

      Delete
  19. Hi Anand
    Just a question and i didnt see anyone asked it so far

    How about buying plot (in potentially developing area) now with some cash in hand and without any loan, after few years building a home along with a shop will that be a good idea ?

    Note - this is again for 2nd home buyer, who instead of taking loan now and paying interest, we can reduce the cost for plot now by paying full in case and take loan few year later to reduce to build home and shop.And we can look forward for reduction in home loan interest rate around 8% - 9%. What is your hough.

    ReplyDelete
    Replies
    1. The lower the loan component while buying the second home, the better it will be so, this seems to be a good idea. OF course, the area where you buy, the size of the shop etc will determine whether and how much profit you make.

      Delete
  20. HI, I made the mistake of buying second home on loan and now in a fix since rates haven't appreciated. I am currently running a loss. Would you suggest I sell at a loss or wait for rates to pick up? Or I should do part payment from my funds to reduce interest outgo at least to reduce further cost?

    ReplyDelete
    Replies
    1. Property market isn't expected to grow as magnificently as it did before but still if you don't need the money urgently then maybe selling is not a good idea. You can make part repayment to reduce your interest outgo.

      Delete
    2. Thanks Anand..

      Delete
  21. Very well written. You have rightly mentioned that property prices are growing from last 10 years and they are bound to fall. In the 2016 I am observing the pattern, income of people have not increased but prices of property are exhobirant which is beyond reachable for common people. Now in 2017 they are in saturation and from here how far prices will go is doubtful.
    Demand can be increased and so does prices when people have enough income which is not the case currently.

    ReplyDelete
  22. Hi Anand,
    What is your opinion in current scenario?....will you still advise to buy a second home as an investment

    Your calculations are easy to understand.

    Please revert

    ReplyDelete
    Replies
    1. It depends from person to person and on the situation. The generic answer may not be most appropriate here.

      Delete

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