How Property Investment can make you a Millionaire

Before I introduce you to property investment let me tell you this is no ‘Magic Wand’ or a ‘Genie’ or a ‘Get Rich Formula’. In other words property investing has its own risks and rewards like any other investment, so the warning here is not to take this advice at face value, because investing in property is more complex and dynamic in nature.

What works in one location may not work in another, moreover, affordability, cost, tenure of investment and returns can vary on a case to case basis.

Before you take decision it is important to do some due diligence as you would do for any large ticket investment. If you take the right steps and invest, property investing can provide you safe, sound and reliable returns on a consistent basis for a long period of time.

What’s so special about property investing?

Once you identify a good property and invest you can be assured of returns either in the form of

Periodic Rental Cash Flows or
Value (Price) Appreciation over a period of time
A form of Shelter to live in

The first point highlights the ability of property to generate income. Where the property is meant for one’s own use the owner benefits from rental savings (that he has to incur if he were to rent a house/flat).

The second point shows that property is an asset that appreciates in value over time, which qualifies it as a ‘productive asset’. Unlike cars, furniture, etc the price of property gradually moves up overtime even though there can be downturns and sluggishness at times due to market fluctuations.

Given these advantages, property investment is worthwhile, even if one takes a loan to build or buy a property. The rewards of property investing can be significant and long lasting if one has the patience to invest for the long-term.

Although the benefits are not quick or significant as in stocks it can be much more stable. In fact over a period of time a property can deliver returns closer to equities or even more.

When to buy & What to buy?

We are not going to dig deeper here, because this has been dealt with in a separate section on “What to look for when you invest in an apartment”. “What to buy” (in case of an apartment) is covered in this article or section. To put it in a nutshell you need to do a study or research of your chosen location and compare different properties on a set of parameters to decide on what to buy.

As far as timing is concerned, it is highly subjective like equities. When equities are at low and people are selling its quite hard to give a “Buy” call, although logically it may seem good. The timing of a buy and sell can vary on case-to-case basis, which we will avoid. Now our focus should be on how can one build a net worth (net assets) of Rs.1 million (Rs. 10 lakhs) by investing in a property.

Route to a Million

You can become a millionaire (in terms of networth) over a period of time by simply investing in a good property, assuming all other financial factors are constant. To demonstrate this I require your patience, so if you can invest some time you can unlock and discover a whole new world of possibilities.

Ranjit, who joined a knowledge process outsourcing firm in Hyderabad was a native of Ongole, Andhra Pradesh. After a few months his parents decide to shift base to Hyderabad along with Ranjit to a rented flat close to Madhapur, on the outskirts of Hyderabad which is also becoming a Cyber city or IT-ITES hub.

A couple of years passed by and Ranjit had been investing in stocks, FDs, etc., but he was keen on investing in a house or a flat, because he could see good price appreciation and rental income in Madhapur and surrounding areas. Similarly the tax benefits on housing loan were another plus point, which he wanted to tap as his salary was gradually moving to the upper bracket levels.

Ranjit decides to buy an apartment worth Rs.30 lakh. He was keen on several other options such as buying a site or an individual home, but buying land was highly risky given the risks associated with bad titles and frauds prevalent in the region, moreover, loans were not available for plots. Individual homes were too expensive and required a lot of effort in terms of maintenance and upkeep. So finally a flat was the best option for him.

A Personal Balance Sheet (for property)

This is a simple statement showing your assets and liabilities. If you are not familiar with a balance sheet just remember assets are what you own and liabilities are what you owe. To buy an apartment Ranjit applied for a loan and finally managed to get Rs.27 lakh sanctioned from a bank. He had to put Rs.5 lakh from his pocket, which he managed by using his savings, household jewelry and by paying it in 3 installments.

His Personal Property Balance Sheet looks like this:-

Liabilities	Rs. Lakhs	Assets	Rs. Lakhs
Home Loan	27	Apartment Value	32
Ranjit’s Equity	5
Total	30	Total	32

Benefits of leveraging (financing)

Leverage is the use of borrowed funds to invest in order to generate returns that are significantly higher than the cost of the borrowed funds. In other words if one is able to borrow at 7% and get returns of 10%, she is able to make more money because the returns are higher than costs (10%<7%). The difference will be the profit or gain on investment. In case of property this benefit can be seen and realized over a period of time.

Ranjit is happy moving to a new home, which enables the family to save on rents and have the pride of owning a home or a shelter for the rest of their lives. Rajit pays his installments or EMIs and after a period of 1 year, his personal property balance sheet looks like this.

Liabilities	Rs. Lakhs	Assets	Rs. Lakhs
Home Loan	26	Apartment Value	33
Ranjit’s Equity	7
Total	33	Total	33

What do you observe?

Is it good/bad or worse? The property value has moved up just marginally by Rs.1 lakh (about 3%) due the sluggish market conditions after the news of job cuts in US and similar trends in software and BPO sector in India. Ranjit’s equity has gone up by Rs.2 lakh, hence the return on equity is Rs.2 lakh divided by Rs.5 lakh, which works out to 40% over a year.

Here we are not taking rental savings and income tax benefits in to account. This is the power of leverage, which helps you to utilize debt to finance an asset purchase, whereby your investment is limited (Rs.6 lakh in this case).

Ranjit’s equity went up by Rs.2 lakhs contributed by an increase in the property value by Rs.1 lakh and loan principal repayment to the extent of Rs.1 lakh. If we ignore the increase in property value here, still the return on equity will be 20% (1lakh / 5 lakh).

Ranjit’s friend also advised him that he should probably have waited for another 3-6 months for corrections before buying. However, Ranjit was firm about his decision because the economic situation at the time of his purchase was not so great either.

Despite all the mixed feelings, Ranjit had his job intact and managed to service his loans well. He had a few credit card dues which got settled finally as he received some support from family to pay it off, so that he doesn’t have any loans except for the home loan.

Thanks to the good financial discipline due to which Ranjit was able to consistently pay his loans for another year without any delays or defaults. After year 2 the balance sheet looks like this.

Liabilities	Rs. Lakhs	Assets	Rs. Lakhs
Home Loan	24.5	Apartment Value	36
Ranjit’s Equity	11.5
Total	36	Total	36

The property value has gone up by Rs.3 lakhs when compared to the previous year, and loan outstanding has come down by Rs.1.5 lakhs. How did the loan balance fall so rapidly? This is due to the fact that during the first year EMIs were servicing the interest payments, while in the next year interest falls slightly, while principal payments increase. As more and more principal gets paid the outstanding loan balance would decline as illustrated. (Note: The loan outstanding shown is for illustrative purpose).

Ranjit is now a millionaire in terms of his property net worth which is Rs.11.5 lakhs (or Rs.1.15 million). We are assuming all other assets and liabilities will either be zero or positive. Assuming he has other personal assets worth Rs.1.5 lakhs, his personal wealth works out to Rs.13 lakhs (11.5+1.5), i.e. Rs.1.3 million.

The crux here is the fact that if Ranjit were to sell the property and if the market is normal he would be able to fetch Rs.11.5 lakh out of the deal. If he retains the property over a few years, his networth would expand further. After year 5 i.e three years from here on if property value appreciates by another Rs.4 lakhs and assuming another 3 lakhs of principal paid off, Ranjit’s Equity will go up to Rs.18.5 lakhs and after adding some personal savings and investments he would be worth more than Rs.2 million.

Conclusion

As rightly pointed out by the great Albter Einstein, the power of compounding is definitely the eighth wonder of the world, and I would put leverage also in to the same category. However, leverage can be dangerous because it can become a double edged sword that multiplies your losses as well.

Further, use of leverage to invest in risky assets without adequate collateral or risk control measures can lead to a total collapse, which is what happened during the sub prime crisis in the US.

However, if you look at the same period in India the impact of global crisis was minimal, given the strong risk management systems and policies put in place by the Reserve Bank of India and the banking system in general. I have also quoted in some of my previous writing that borrowing is not good for consumption although it is okay to avail credit once in while.

The only exception to that advice is the case of property investing where borrowing can work to your advantage over a period of time. Here Ranjit’s next step would be to manage this other investments well, while his property is making him richer.