Why Invest in a Home – Investing in Residential Property

Why Invest in a Home, investing in Residential Property

Why invest in a home? Real estate has been bought by people for pure self occupation or investment or both. Unlike stocks and other newer financial instruments, this has been known to common man for centuries even before stock exchanges came in to existence. Although property investing may not be a ‘cake walk’ for everyone, investing in residential property can give benefits to a person in multiple ways.

Returns from a Residential Property

From a pure personal finance angle, there are three reasons as to why one must invest in a home or invest in a residential property : –

1. Self Occupation: To have a safe roof/shelter to live in (or save rents)

2. Investment/Renting: For rental income or price appreciation

3. This can be a combination of Case 1 & Case 2: In practical situations due to change in personal circumstances a property’s can switch from Case 1 to Case 2 or vice versa or both.

For example Ravi who lives in Hyderabad in a rented accommodation owns a house in his home town Coimbatore. When he shifted to Hyderabad he decided to rent out his own house.

Case 1 shown above may seem like a pure psychological or emotional need rather than a financial benefit, but it can have a financial angle since one can save rents and be free from deposits that need to be paid to the Landlord when you rent a house. Further, owning a house also provides a safe shelter at all times. Sounds too trivial? Let me give you an example.

For instance if you lost a job or have a serious medical issue impacting your daily life, this can impact your income and daily life dramatically if you live in a rented accommodation. You may not be able to pay your rents, and there is a threat of increase in rents staring at you. On the other hand, if you have your own home you have a shelter to live in during bad phases.

However, let me put a caveat here. A person may not be able to buy and live in a house wherever he or she is. Due to change of job, profession, personal situation, etc one may be forced to move from one city to another. So in these situations living on rent in one city and owning a house in another is quite common. To sum up we can say that owning atleast one property is a good idea that one should be open to.

Why Invest in a Home – Advantages of Investing

I am not going to cover the safety or security aspect which we have discussed already. Lets look at the other advantages: –

1. Rental Income Stream

A property has the capability of providing a regular and stable rental stream over the years. Initially the rental income may not be significant even for a good property in terms of location and attractive price. For instance a property worth Rs.25 lakhs in Chennai in Sriberambadur a peripheral location may be fetching a rent of just Rs.7000 per month.

This is just a 3.36% yield p.a. (Rs.7000 X 12 divided by Rs. 25 lakhs) on investment. If you do your research in any other city or market the yields should be within 3-6% in most cases.

When you buy a property you should also assess if the market will improve in future and push up your rental yields to higher levels. If the yields go up then your investment is good, else you have to review your investment and see what needs to be done.

Taking the same example above further, lets say in 2 years if the location – Sriperambadur developed in to a mega auto city the rents suddenly move up by 50%.

In this case the rents would become Rs.10,500 per month, which means the yield would be 5.04% (10500 X 12 divided by Rs.25 lakhs).

Remember that increase in rental income will happen gradually over a period of time which will boost your yields. Moreover, if you hold the property for a longer time it can serve as a regular income stream in addition to your salary and other sources of income. For people who bought properties a few decades ago, the rental income is sufficient for them to live on for the rest of their lives.

2. Price Appreciation

People also buy property expecting prices to move up in future. For instance properties which were in the range of Rs.25 lakhs on the outskirts of a city are now worth more than Rs.40 lakhs based on current market prices. In most of the metro cities there are hardly any properties within the city limits below the price of Rs.3000 per SF. In some cases even the land area or plots are worth Rs.3000 per SF.

Mr. Prasad bought a property on the outskirts of Bangalore in Whitefield during the IT boom in 2006. At that time Whitefield was a distant suburb were the individual house was available for Rs.25 lakhs. Today the price is double that amount.

This is a superb appreciation within a matter of just 5 years, despite a cycle of recession during 2008 and 2009. Although property prices get affected by economic and market forces, in generally prices move up gradually over a period of time.

Given the price appreciation and rental income which keeps increasing over time, property is said to be an investment which moves in tandem with inflation. Equities also exhibit this feature over a longer time frame. So why invest in a home? – for the added benefit of price appreciation

3. Tax Benefits

Why invest in a home? There are tax benefits. People who take a home loan for a self occupied property get a tax deduction for the principal paid as tax deduction. Similarly there is an additional deduction for interest payments. This means your EMI payments towards your housing loan will give you significant tax savings which can use for your expenses or additional investments. Since tax laws can change over time try not to base your investment decisions based on tax advantages as the main factor. The tax benefits you get should be viewed as an additional ‘good to have’ although the advantages are significant. For more information on tax savings on home loan payments please consult with your tax advisor.

4. Annuity or Reverse Mortgage Option

This is one option that gives the ability to use the property to generate a regular income or annuity. For instance there are people who built a property, paid their loans judiciously over the years and continue to live in the same property in their old age too. After retirement their income and earnings may not be significant but they have a property to live in. This is a typical situation faced by senior citizens and retirees.

Lets take an example of Mr.Prasanna Bhat who has been living in Mangalore for decades in his own house.He is now a senior citizen and has some savings to cover living expenses of himself and his wife. Given the situation where price of essentials are going up, medical expenses on the rise, etc he feels that he either needs to sell his house, which is practically difficult.

Renting some portion is an option but since the design of the house is orthodox this is not possible and will involve higher costs and time for redesigning and construction. Finally, a banker advised Mr.Bhat to mortgage the property and get an annuity against it. What this means is that Mr.Bhat will mortgage the property to a bank. Here the property is owned by him without any loan or encumbrance. So he can reverse mortgage the same with a bank and get annuity payments every month against it.

This generates a stream of income (say Rs.22,000 per month) for the couple. This will help them cover the inflation in their regular expenses as well as to meet any unforeseen emergencies. Even in a case where one of them dies in future, the other person can continue to live in the house. After the expiry of both the bank will give their legal heir two options –

  • Settle all outstanding dues and retain the house (or)
  • The bank sells the house used the proceeds to settled the outstanding loan and pay the rest if any to legal heirs

Advantage for you:

You are able to covert an illiquid asset in to an income stream although after your death it is going to be sold. Even though the property is attached to the loan, the value of the property will be higher than the loan in all probability baring a few exceptions. You don’t have to face the embarrassment selling your house or moving to another accommodation which is more expensive.

Advantage for bank:

The bank gains because they are able to use your property as collateral and provide credit and earn income out of it. This is a secure loan with minimal risk for the bank.

Why invest in a home?

There are various other advantages when investing in a residential property. This can include:-

  • Passing on assets to the next generation
  • Option to add additional units or expand (applicable for individual houses)
  • Option to sell or rent out partially (applicable for individual houses)
  • Option to have a shop/retail outlet (applicable for individual houses)
  • You can set up a home office
  • Family members staying together can save on housing and living costs

This list can go on and on depending on the individual benefits one can get out of it. For instance if you want to expand your house by building a two bedroom unit on the first floor, you need to take in to account the cost and investment involved first to see if it is within your budget.

The best real-estate investments with the highest yields are in working-class neighborhoods, because fancy properties are overpriced ~  Jane Bryant Quinn

The next important step is to also check the rental rates and trends to see how much of income can be anticipated from rents. Based on these factors you can decide on whether to expand or not. Its not a one time decision because you can review and reassess the situation if market rents move up making investment attractive.

Conclusion – Why invest in a home 

We have seen several ways in which property investing can be beneficial. Its no wonder why the rich and famous still invest in property.


About the Author

Sridhar is a financial analyst and his work experience spans areas of financial analysis, modeling, valuation and research on companies, specific sectors, etc. Sridhar is an MBA graduate with Finance major from Maharishi Institute of Management.

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