Thanks to urbanization and growing household incomes, India is witnessing a steady rise in demand for residential properties. According to statistics, Bengaluru, Chennai, Ahmedabad, Goa, and Pune are hot property investment destinations for NRIs. Low home loan interest rates are expected to boost the demand for home investments and increase sales by 35-40% in 2021 .

But is it wise to invest in real estate, with the dependency on rental income for wealth creation?
Let’s take a step back to understand the dynamics of investing in a home purely from a wealth-creation perspective.

Cost of the investment
While considering a property for investment, investors tend to evaluate the property’s market value but forget to account for the additional costs involved in acquiring the asset. Costs like registration, stamp duty, home loan interest, purchase of parking space, etc. are often discounted while evaluating the investment cost. These additional incurred costs, although one-time, must be included while calculating the total value of the investment and its probable ROI. In addition, homeowners need to be aware of the investment required to ensure the property is up and running, ready to be leased or rented. Such costs can sum up to a substantial amount adding to the investment incurred to make the property a profitable asset.

Recurring costs
The excitement of finding a distress sale or an excellently located property on the market cloud your judgment on the valuation of the property. Homebuyers must evaluate the recurring costs that accompany an investment in real estate. These include:

• Property Tax
• Maintenance Costs
• Society Charges
• Electricity and water bills
• Agent fees

Such costs increase drastically for properties located in prime areas like city centers or posh gated societies. Get the right picture in terms of the value of your asset; take into consideration the total cost of investment along with recurring expenses over the period of time you intend to hold the property.

Capital Depreciation
Investing in property requires understanding the actual market value of the property you intend to invest in. If you purchase an asset that is overvalued, then the possibility of capital depreciation could be high when you intend to sell or re-mortgage your asset. Besides the macro, other micro factors affect the future value of your asset, from location to surrounding infra development to inventory and more. A typical scenario is a drop in the value of flats where unsold inventory is high in the surrounding place. In some areas, the prices appreciate due to better public transport connectivity like new metro routes, rail, or air hubs. Investing with a keen eye on future possibilities of location-based development and capital appreciation is critical for such long-term investments.

Rental Yield
Homeowners often mistake the absolute value of rental income as returns. Investors need to understand the concept of rental yield to evaluate better the property they want to invest in. Here is how you can calculate rental yield:

Net Rental Yield = ((Annual Rental Income – Property Expenses) / Cost of Property) * 100

Investors must calculate the cost of property and property expenses accurately, considering all of the points as mentioned earlier. Considering the pandemic, one should go one step ahead and account for contingencies and possibilities of non-occupancy. This calculation could be viewed as an average of 1-month vacancy in a given year.

Investing in a home, especially in top-tier cities, can be heavy on your pockets. The value of properties today is exorbitant and usually delivers a low rental yield. The average rental yield across top metro cities in India has ranged from 2.8% to 3.8%. The same investment made in low-risk fixed-income investments could offer approximately 4% to 5% returns post taxation.

There are quite a few factors real-estate investors must keep in mind before investing in a home to diversify their investment portfolio. Investors must undertake thorough research and ask themselves these questions:

Do I have the capacity to hold the investment for the long haul?

Am I ready to invest in the property to ensure 100% occupancy and a higher rental yield?

Would I benefit more from investing in financial instruments instead?