Investing in a second home

PERSONAL FINANCE AND PROPERTY

Most people put aside some money for their retirement by investing a regular amount into a Systematic Investment Plan (SIP) of a mutual fund or buy a pension plan from an insurance company or regularly invest in a bank recurring deposit or government backed instruments such as PPF and NSC, etc. Some of them also opt for a pension scheme.

But there is another very effective means to build a sizeable pension corpus - that of buying another house for the purpose of earning rental income as well as long-term capital appreciation.

Here’s how...

This can be illustrated with an example.

Prabhat Varma has the ability to pay a down payment of Rs two lakh and can service an EMI of Rs 6,000 every month (in other words he is able to save Rs 6,000 per month).

This means that he can invest in a house worth Rs 11 lakh for which he will be able to get a loan of around Rs nine lakh. The EMI for this 20-year loan at 9% is around Rs 8,100 per month, which Varma will easily be able to pay from the rental income (estimated around Rs 3,000 per month), clubbed  with the existing savings of Rs 6,000 per month. Even if we assume a rather conservative 10% pa capital appreciation the property will be worth Rs 74 lakh at the end of 20 years. Thus the easy availability of home loans even for residential property bought for the express purpose of renting it out effectively turns this investment into a SIP into real estate. 

Things to keep in mind

While Varma crystallises his plan for another house purchase, he should keep few of these things in mind:  

This is not about the house that you are staying in, the house in question here is purely for investment purpose. 

An investment horizon of at least 10 years is needed for this to be effective. This is not for you if you are already above 50 years of age and are planning to retire by sixty.

This is much riskier than a bank fixed deposit (the expected returns obviously are higher to compensate for the higher risks) and so if your risk appetite is low then this investment is not for you.

A meaningful real estate investment will require much larger initial investments as also much larger continuing investments. Also the flexibility to miss an regular investment instalment is not available since the continuing investment is by way of loan repayment.

From a rental perspective

It is not important that whether you would have yourself liked to stay in that house or not. You should buy from a rental perspective. In fact buying a house in smaller towns that you have some knowledge and connection with, might be a great decision given the fast pace of growth that is likely to be experienced by smaller towns and might give good returns over a long period of 20 years.

Investment in real estate is a relatively high maintenance investment in terms of dealing with societies, finding and dealing with tenants, etc.

Though state and local laws are fast changing tenancy laws in some states and property taxes in some cities make renting out a property a non-viable option. So avoid investment in such areas.

Such an investment proposition is ideal for the likes of Varma who like saving regularly in traditional assets such as real estate.

(The author is the CEO, apnapaisa.com)