Real Estate is one of the most popular investments in India. People invest in real estate properties not just fort for capital appreciation but also for their rent earning capacity. So, there are many factors that you should consider before buying a property for investment.
Most of the investment properties bought are second properties of the home buyers. You may want to buy a property for either capital appreciation or for rental income. You can either buy a plot, residential villa, or an apartment for investment depending on your requirements. Let us understand what factors you should consider before making a decision to buy a property for either capital appreciation or for rental income.
Factors that influence the Capital Appreciation of a property
If you are buying a property so that you can sell it at a higher price later, then you should always think of investing for the long term. For the real estate asset class, long-term means at least 15 years.
1. Type of Property: For long-term investment, a plot or residential villa is suitable. Apartments are not suitable for long-term investment as the resale value reduces as the property ages.
2. Infrastructure development: Any new projects related to connectivity, transport, road, or transit hub, will boost growth in the surrounding areas of those projects. People will tend to settle around these areas which will lead to more amenities and hence, more demand.
3. Development of locality: The local neighborhood and the social infrastructure such as parks, shopping malls, education institutions, transport also determine the price appreciation of a property.
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Factors that determine the Rent Earning Capacity of a property
Rental income is a passive income and can continue until your life expectancy, and can be left behind as an inheritance. Since you are buying this as an income-generating investment, the obvious factors you should consider are the locality, ongoing rentals in that area, facilities and conveniences nearby, etc.
A property may fetch an assured rent throughout the year if it is attractive to prospective tenants in terms of rent, facilities, and comfort the house offers. Below are some points that can be considered to ensure higher occupancy and higher rental yield for your property:
- Location: While a calm and serene location is usually preferred for a self-occupied property, a location closer to shopping areas, public transport hubs, schools, and colleges fetch higher rent and also, provide a better capital appreciation. But a noisier neighborhood can reduce the demand for the property!
- Amenities: Facilities like gymnasium, supermarkets, daycare, 24-hour security, etc. inside the apartment complex/gated community are preferred by the tenants.
- Size of the Property: A 2 BHK home has a better chance of finding tenants than a 3 BHK house as the occupancy rate is high for 2 BHK. Also, the property taxes will be higher for a bigger property.
- Parking Space: Sufficient parking spaces should be available for tenants and visitors.
- Age of property: New properties fetch higher rent than resale ones. The rent earning capacity of the property reduces as the structure becomes old.
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Financial factors to consider before buying a property as an investment
Buying a property is a high-cost investment and can have a significant impact on your finances. Below are certain factors that can impact your finances when you buy a rental property.
- Approximate budget
Deciding on your total budget for the property purchase and sticking to it is very important.
If you are buying it to get rental income, you will only get ongoing rentals in a given locality, and spending additionally on a property may not translate to an increase in rent.
If you are looking for capital appreciation, the return will be dependent on the real estate growth in that locality only. If you have taken a loan to fund your purchase, then stretching your budget will only result in higher interest outgo.
- Approximate Rental income you hope to get
Rental yield depends on various factors like locality, size of the property, and facilities available. So, check how much rent you can expect to get in the property you have finalized.
The annual rent expected should be at least 4-6% of the total cost of the property.
Be aware that sometimes your property might remain vacant for few months.
- Tax benefits you hope to avail
You can claim tax benefits only if you plan to take a home loan for the purchase. If you plan to contribute a major part of the cost from your own funds, the home loan availed will be less and hence, the tax deductions that can be claimed will also be less.
A deduction of Rs. 1.5 lakh on the principal portion of your Home Loan EMI under Section 80C of the Income Tax Act and a tax exemption of up to Rs. 2 lakhs on the interest component under Section 24B can be availed.
If you are buying the property for rental income purposes, then the rental income is taxable. If you sell the property at a higher price later, then the gains are also taxable.
- Your surplus income
If you plan to buy the investment property on loan, do not always expect the rental income to offset your monthly EMIs.
If there is any rise in interest rates, your EMIs will increase. Also, there is a possibility of the property remaining vacant for few months.
So, ensure that you have surplus income to pay the EMIs in any of the above circumstances.
- Own funds available for the purchase
Even though banks claim to fund 80% of the cost as a loan, it may not be the case always. The loan sanctioned can vary depending on your existing loans, your take-home income, and also on the structural assessment by the bank officials.
Depending on the loan sanctioned, you may have to fund more than 20% of the cost. Also, you have to pay for the registration costs, cost of interiors, etc., and miscellaneous expenses that can arise.
Before buying the investment property, you should also check if you have sufficient emergency funds of at least 6 months of expenses and funds for other important financial goals such as your retirement and children’s education.
It would also be good if you evaluate if the corpus you want to invest in the property would fetch better returns if invested in other asset classes.
- Possession time of the property
If you are buying an under-construction property, then check the approximate possession date committed by the builder.
If you are availing of a loan, then you have to pay the pre-EMI until you get possession of your property.
- Property trends
You should check how the property rates in a locality have appreciated in the last 5-10 years. If you are looking only for capital appreciation, then investing in a property in an already established locality may not fetch you good returns as compared to investing in an upcoming locality.
Maintenance – the most important factor after buying
The maintenance of your property is another important factor that can have an impact on your finances. Even though the tenants are expected to bear the cost of repairs due to regular wear and tear, there will be many other repairs and maintenance work that has to be borne by the property owner. An investment property should ideally have less cost of maintenance and repairs.
When buying an investment property, some points are below to ensure a low cost of maintenance:
- Always choose properties with simple construction. A property with typical 4-cornered construction with standard fittings is easier to maintain than a property with a complex structure with delicate fittings.
- Ensure the property has easy access to plumbing and electrical systems for any maintenance work.
- The doors and windows should be of good quality and long-lasting.
- Avoid fancy wall finishes, intricate woodwork, and texture paint for the walls in rental properties.
- Ensure that the property is relatively safe and strong to tolerate any natural calamities like floods, earthquakes, etc.
Taxes – A factor you should never ignore
Taxes are something you can never avoid. Since most of the investment properties bought are second or third properties of the home buyers, the tax rules applicable are different under each scenario.
If you buy a property either for rental income or for capital appreciation, you have to pay tax on the income or on the gains made. Let us understand how taxes work out under different scenarios.
I. Tax if a property was bought on loan
The IT Act provides tax deductions as below for buying a property on a home loan:
A deduction of Rs. 1.5 lakh on the principal portion of your Home Loan EMI under Section 80C of the Income Tax Act and a tax exemption of up to Rs. 2 lakhs on the interest component under Section 24B can be availed.
Tax Benefit on Principal Payment: Even if you have multiple home loans, the deduction limit of Rs.1.5 lakhs towards principal payment of home loan are applicable under Section 80C.
Tax Benefit of on Interest Payment: Deduction for interest payment is available under Section 24. In case you own only one house, you can claim a maximum deduction of Rs 2 lakhs on interest payment. From Budget 2019, you can consider your second house as self-occupied. So even when vacant, it cannot be deemed let out.
Let us consider home loan tax benefits under two different conditions.
- The first home is self-occupied, and the second home is vacant:
The second home cannot be deemed let out and both the houses will be considered as self-occupied. You can claim a maximum interest deduction of Rs.2 lakhs on both houses.
2. The first home is self-occupied, while the second is on rent:
You have to declare the rental income of the second property under Income from House Property. You can deduct a standard deduction of 30% of the rent and municipal taxes paid from the rental income.
You can claim a maximum interest deduction of Rs.2 lakhs on both houses but any loss above Rs 2 lakhs can be carried forward for the next eight assessment years.
II. Tax if bought by selling an existing residential house
If you sell a residential house and make a capital gain, you can claim tax exemption for the gains by investing in another house within 3 years from the date of sale.
Under Section 54 of the Income Tax Act, an individual or HUF selling a residential property can avail tax exemptions from Capital Gains if the capital gains are invested in the purchase or construction of a residential property.
You should purchase a residential house either 1 year before the date of sale/transfer or 2 years after the date of sale/transfer. In case you are constructing a house, you will get an extended time, i.e., you will have to construct the residential house within 3 years from the date of sale/transfer.
With effect from Assessment Year 2020-21 corresponding to FY 2019-20, a capital gain exemption is available for the purchase of two residential houses in India. However, the exemption is subject to the capital gain not exceeding Rs 2 crore. Also, the exemption is available only once in the lifetime of the seller.
III. Tax if bought for rental income
Rental income is taxable under Income from House Property. The rental income is added to your income and taxed according to your applicable IT slab rate.
You can deduct a standard deduction of 30% of the rent and municipal taxes paid from the rental income. Even when your let-out property is vacant for few months, you have to pay tax on the deemed rent.
IV. Tax if bought for capital appreciation
If you sell your property for a profit within 3 years of buying it, it will be treated as a short-term capital gain. The gains made will be added to the income and taxed according to your applicable IT slab rate.
Also, if you sell your property within five years of the end of the financial year in which it was purchased, the tax deductions claimed for the principal repayment, stamp duty, and registration under Sec 80C are reversed. The total amount is added to the income and becomes taxable in the year of sale. Only the deduction of the interest payment under Section 24B is not reversed.
If you sell after three years, the profit is treated as long-term capital gains and taxed at 20% after indexation. Indexation takes into account the inflation during the period for which you owned the property and accordingly adjusts the purchase price, thereby reducing your tax burden. Expenses incurred on repairs and renovation can be added to the cost of acquisition of the house while computing long-term capital gains. Also, the interest paid during the pre-construction period of the house can be added to the cost, if not already claimed as a deduction earlier.
V. Tax for plot
If you have bought a residential plot as an investment, you cannot claim any tax deduction if you have taken any loan for the purchase.
If you sell the plot within 3 years of purchase, it is treated as short-term capital gains. The profit/gains are added to your income and taxed according to your tax slab rate.
If you sell the plot after 3 years, it is treated as long-term capital gains and is taxed at 20% after indexation.
Some tips for buying an investment property
- If you are availing of a loan to finance your purchase, first check your loan eligibility and your cash flow to service the EMIs before you look for a property.
- Ensure you have sufficient funds to pay for 20% of the value, registration, and basic interior costs for the house.
- If you are buying a resale property, conduct due diligence on the property records, structural assessment, and taxes due.
- If you are buying a resale property, don’t buy anything more than 5 years old.
- Be aware that your property can remain vacant for few months.
- Be aware that interest rates can change over a period of time.