For those who have experienced the economic depression and the dip in Real Estate during 2008-09 global financial slowdown, investing in the real estate sector must be a fear-inducing thought, to begin with. Today yet again, we are face to face quite literally with coronavirus pandemic and all the businesses, jobs, projects everything has come to a standstill. However, real estate has once again emerged as the safest investment option, as the ownership of a house brings with it an unmatched sense of security. So, in this week’s blog let’s focus on how to make money through real estate and cover both basic methods that haven’t changed in centuries, as well as specific opportunities that have arisen relatively recently.
Appreciation
Appreciation or the rise in home prices over time is how the majority of the wealth is built in real estate. The most obvious source of appreciation is the development of the area surrounding your property, and as the neighborhood around your home evolves, adding transit routes, schools, shopping centers, playgrounds, and more, these changes cause the home’s value to climb. Home improvements can also appreciate the value, constructing an attached bathroom, and remodeling the kitchen are a few of the ways property owners use to increase the value of a home.
Property appreciation combined with leverage has a huge impact on your ROI. For example, you bought a property for Rs.20,00,000 and it appreciates to 22,00,000, your property has made you a 10% return. Now, you have borrowed money from a bank/lender, and let’s say you had to pay a 10% of down payment i.e. Rs.2,00,000; this means you have doubled your investment with 100% return.
Real Estate Income
Residential property income
- Rent: When you take a loan to buy real estate, typically you will pay it back with the rent money from tenants. Initially, the majority of the payment is going towards settling the interest account, and slowly when enough time passes a good chunk of every payment comes off the loan balance, and wealth is created in addition to the monthly cash flow. the part is, it’s your tenant paying this off for you, not yourself. Paying off your loan is another way real estate investing works to grow your wealth passively, with each payment taking you one step closer towards financial freedom.
- Buy and Hold: This is one of the most traditional ways of earning income in real estate. Most commonly people buy a single-family home and rent it out; buy a multi-family home and live in one of the units while renting the others—ideally to cover the mortgage and your housing expenses.
- Buy – Renovate – Sell: Also known as forced equity, here you find a property that needs upgrades and you buy such property below market value. Now, with basic renovations like adding appliances, new flooring, paint, etc. you improve its condition and eventually move the selling price above market value. The key is to look for properties with less than the ideal number of amenities, and then add what they are lacking to create the most value.
Commercial property income
Apart from basic rent commercial tenants pay a premium for contractual options like the right of the first refusal i.e. the tenant will have a contractual right to enter into a business transaction with a person or company before anyone else can.
Inflation
Inflation is a huge reason why real estate creates wealth so powerfully over time. Let’s understand how inflation affects real estate prices. An annual inflation rate of 10% means that your Rupee can only buy about 90% of the same goods the following year. It’s not uncommon to hear about how Rs.3 would get you a movie ticket, or a Maruti 800 could be purchased for an Rs60,000. While it’s easy to take for granted, it’s an incredibly powerful wealth-building tool when harnessed appropriately.
The key to using inflation to build wealth in real estate lies in the fact the majority of your big expenses (mortgage, property taxes) stay fixed for the majority of the time you own the property. When you combine this with rising rents and home values (due to inflation), you start to see big results.
Depreciation
Apart from tax exemptions that you can claim on interests (section 24) and principal amount (Section80C) repayment the most powerful tax benefit of investing in real estate is depreciation.
Allowable depreciation gives you the ability to write off part of the value of the asset every year, this significantly reduces the tax burden on the money you make and, in this way, real estate protects your wealth while growing it.
REIT – An alternative real estate income source
Real-estate investment trust works on a system that is similar to that of mutual funds. REIT generates money through investments from individuals, companies, or institutions. This money will be invested in commercial real-estate (IT parks, SEZ, Hotels, Malls, Office spaces). The REIT earns profits in the forms of income through rent or by selling a property; this profit is then distributed amongst the investors in the form of dividends. This is Equity REIT where rental income is the main source.
The other type is Mortgage REIT, here the money is generated similarly as above but the REIT does not directly buy the properties but will give loan to some other investor buying a real estate. Here the main income is interest and these are returned to the investors again in the form of dividends.
Here are a few advantages of REIT
- Low entry point and high liquidity – Minimum investment is Rs.2 Lacs and with a good number of buyers and sellers in the market, makes selling and buying pretty easy.
- Diversification – Risk exposure is very low and the market is not as volatile as the stock market, thus regular capital appreciation and rental returns infuse constant incomes. Additionally, the investments are made in multiple properties and different types of commercial spaces spread across multiple cities, this prevents losses due to economic slowdown in one particular region.
- Good and stable returns – Commercial rentals yield 7-10% returns in addition to property appreciation and is much more stable as compared to volatile corporate profits and stocks. Many people in the US, where REIT is an established concept plan their retirement money (pension) thru REITs.
- Lesser risk – as compared to an under-construction property where delay in time for project completion is a huge risk, also if it is a commercial property you will have to manage and take care of it. Also, 80% of your money will be invested in income-producing properties thus further reducing the risks.
- Transparent – All information is available online where they share average rent on a time to time basis, occupancy level, the profile of tenants, buying and selling rates, etc. But just like any other investment model, you have to beware of fraud agents in the market.
- Funds are Professionally managed just like mutual funds, a proper market study is undertaken before investing or taking any rental decisions. Gets you free from hassles to manage tenant and maintain property which is inevitable if you directly invest in a commercial property.
There are several proven strategies for making money in real estate, but not everyone understands them. Hope this explains the reasons why investing in real estate can grow your wealth so effectively.
Author – Sagar Sohani
Home Constructions | Renovations | Interiors
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