Market Next

Real Estate Investments

Real Estate Investments
July 04
08:43 2016

What are Real Estates?

Land, residential buildings, shopping complexes, agricultural farms, residential apartments and flats etc. are considered as real estate. They are called real estate because they are visible to naked eyes whereas financial assets are not visible to naked eyes. Traditionally owning landed properties was considered to be essential part of physical wealth as much as gold and silver. Now also real estate contributes a valuable part of one’s physical wealth. Owning a residential flat or building is a dream of every individual and more than one becomes an investment for earning an income.

Investments in Real Estate

Investment in real estate is considered to be profitable when it is done judiciously. Every property may not generate the same rate of return. The return varies according to the type of the asset and the location. The return from real estate represents rent, lease, sale proceeds of crops etc. and so on. The investment in real assets as also the return grows as the years pass. The investment value appreciates due to increase in the land price. A piece of land in a prime locality can bring substantial increase in the investment value compared to that in a remote centre. However, certain centers are growth potential even though they are currently in a remote locality. Hence the real assets can be considered as growth assets.

Types of Real estates

The income from real estate varies according to the type. Certain types of real assets give regular income to the investor. The properties like office buildings, retail properties such as shopping, malls, single shop buildings on the pavement side etc., industrial and leased apartments, villas, hotels, godowns, mini storage, parking lots, seniors’ care housing, private educational campuses, industrial estates etc. are examples of such assets. They give income in the form of rent or usage charges. The demand plays a pivotal role in deciding the income. A property in a prime centre can bring higher return than that in a village. An office property or a shopping complex gives better, higher and stable return than that from villas or residential houses because these buildings consist of more units than in a single villa or house. Hence even if there is some default, the return from other units can compensate the loss.

Characteristics of Real estates

The return from the real estate assets can be inconsistent, though regular, on account of expenses of maintenance, collection and supervision and taxes. The boom and depression in the economy can influence the growth favorably or adversely. A property value goes up during the boom period and the land purchased during that period may not fetch even the same price during the depression period. The changes in government rules also can influence the land prices. The investment in real assets does not have a definite maturity period as in the case of a financial asset like bank deposit. The real assets are tangible in nature and therefore need management. The real asset market is inefficient as people with more information can make higher profits. Physical transfer is not possible in the case of real assets since the transfers are affected through documents executed through legal process which involves transaction cost. One of the major characteristics of real estate is low liquidity. The investment cannot be taken back when the investor wants as in the case of bank deposits, shares or bonds. The quality of tenants is very important in ensuring regular flow of income. As stated elsewhere, the price of the asset varies according to location, price and availability of infrastructure.

Advantages of Real Estate Investments

  1. Investments in real estate give an excellent opportunity to diversify the portfolio risk.

  2. The portfolio return can be increased by including real estate also in the portfolio of investments

  3. The portfolio risk can be brought down by including real estate assets also in the portfolio.

  4. Since the rental income goes up and the capital investment appreciates as inflation goes up, the real estate investments provide an excellent mechanism for protection from inflation

  5. The investor can increase the value of the property by renovating, modifying and providing additional amenities.

  6. The ownership is legally certified by executing legal documents and registering them. The original ownership document is issued by the Revenue Department of the State Government.

  7. The ownership of land and buildings is a status symbol and the owner can feel proud of his investment.

  8. The investments in real estate can enhance the net worth of a person.

Disadvantages of Real Estate Investments

  1. Buying real estate asset is costly because of the stamp duty, registration charges, documentation fee etc. payable for registering the document. Besides payment of periodical revenue taxes, building taxes, irrigation taxes and cost of upkeep and maintenance also increases the cost.

  2. Unlike financial assets, the real assets require management and supervision. Proper upkeep and maintenance on a regular basis is necessary to keep the value at higher level. The maintenance and management involves cost.

  3. Identifying a growth potential area for acquiring real estate asset is a difficult task. Property bought in an area which does not have any growth potential may not fetch a better value than the original investment. Sometimes, even the original investment may also not be received by selling the property situated in such centers.

  4. The investment in real estate is subject to cyclical impact of the market. These cycles are lease market cycle and investment market cycle. While lease market cycle is driven by demand and supply where demand side represents the people who are in search of premises on rent and supply side is the availability of space for rent, the investment side also has the demand for funds from the builders/ owners of buildings and supply of funds by the investors who are looking for good investment avenues. Hence the return varies according to the demand and supply matching.

  5. There is no benchmark measuring tool to assess the performance of the investment in real estate.

Legal Issues in Real Estate Investments

All real estate transactions are subject to compliance with the legal formalities. The transfer of title of property is subject to compliance with the requirements under the provisions of the Transfer of Properties Act 1882. In 2009 the Act was amended to bring in the provision for foreclosure in the case of mortgage property. The Central and State Governments are empowered to acquire the land for public utility purposes by giving appropriate compensation to the owner under the provisions of Land Acquisition Act 1894 which was amended in 1962. The Real Estate (Regulation and Development Act) in March this year and has come into effect immediately. Many states have enacted Rent Control Act for the purpose of protecting the interests of both the landlord and the tenants.

Regulatory Issues in Real Estate Investments

The parliament has now passed the Real Estate Regulatory Bill in early this year. The Act empowers the state governments to establish a Real Estate Regulatory Authority in the respective states for rederessal of grievances of buyers of real estate against the sellers. The Authority has the power to regulate the deals in both commercial and residential properties. The provisions of this Act make it mandatory on the part of the developers to park 70 per cent of the funds in a dedicated bank account which will ensure that the developers are not able invest in more number of properties using the money collected at the time of booking the flat. The developers are required to submit all information’s such as the project plan, lay out, government approvals, land title status, sub contractors to the project, schedule of completion etc. with the State Real Estate Regulatory Authority and also make this data available to the consumers. The law defines the carpet area clearly and protects the consumers form sales on the basis of ambiguous super built up area. The Act requires the builder to give compensation to the buyers of flats at the rate of 11.2% per annum on the advance paid if the completed flat is not handed over on the agreed date. Under the provisions of this Act a developer who violates the order of the appellate tribunal is punishable with a jail term of maximum of three years with or without fine. The Act gives right to the buyer to demand after sales service within one year of taking possession if any deficiency is observed. A developer cannot change the plan of the building already sold without the consent of all the buyers. The Act made it mandatory on the part of all real estate developers running projects admeasuring 500 sq. mtrs. or more than 8 apartments to register with the State Real Estate Regulatory Authority. These initiatives have made the deals between the developers and consumers more transparent and ensure protection to the consumers from any malpractices on the part of developers. Every person buying a real estate should be aware of these protection measures available to him/ her.

Besides these statutory measures, the Confederation of Real Estate Developers’ Association of India (CREDAI) has brought out code of conduct among its members. CREDAI is a non-statutory voluntary regulatory organization established under Section 25 of the Companies Act. Established in 1999 CREDAI has 11500 members spread over 23 state chapters and 162 cities in India. They ensure that their members follow the CSR initiatives. The CREDAI members have established well established systems for waste disposal, water management, power management etc. in the residential apartments and shopping malls built up by them. Besides, CREDAI the credit rating agencies like CRISIL provides rating to the projects based on the promptness of completion and handing over on the stipulated dates. Many developers are now obtaining ISO certification from reputed agencies to establish quality of their projects.

Scope and Potential for Real Estate Investments in India

Real estate sector is a growing area which is now preferred by most of the investors. A recent study reveals that Kochi is the next preferred area for real estate investments. The survey points out six reasons to support its findings. Firstly, Kochi is one among the 20 top cities identified by the Ministry of Urban Development under the Smart City Mission. Secondly Kochi has all potentials to develop IT and employment generation. Thirdly, the commissioning of Metro Rail will ensure inter-city and intra city connectivity in Kochi. Fourthly, The Cochin Port and the Vallarpadam Container projects ensure growth of commerce and industry in and around Kochi. The newly built international terminal in Cochin International Airport will give more opportunities for international flight operators. Finally, Kochi has a well developed tourism and hospitality industry. It is expected that there will be an investment of Rs.2076 crore in Kochi for area and infrastructure development. The tax benefits announced the latest budget can boost the real estate investments. The recent 23.5% hike in the pay scales of the Central Government employees throws open wide scope for investment in real estate sector in India.

Some Essentials of a Real Estate Deal

  1. The locality and the surroundings where the property is situated should be matching to your tastes, preferences and living style.

  2. All the title deeds including prior documents for the last 30 years together with the non-encumbrance certificate, possession certificate, land tax receipt, building tax receipt etc. should be got verified by a legal expert before confirming a deal. If you are availing finance from a bank or housing finance company, they will take care of this part.

  3. Enquire about the ongoing market price in the area. This may sometimes be different from what is shown in the documents.

  4. As far possible negotiate and confirm the deal with the owner directly. The middlemen can cheat you in many ways.

  5. It is better to discuss about the deal in front of all family members in the case of family properties.

  6. Start negotiations from a lower point quoting the negative points keeping in mind a justifiable price.

  7. Find out why the seller is disposing of the property. If the seller is in urgent need of funds, that will be an advantage on your part to negotiate for a lower price.

  8. Once the deal is fixed, register an agreement of sale in stamp paper with appropriate value and pay the advance amount by way of cheque or demand draft. If the funds are transferred, quote the NEFT reference number given by the bank in the agreement.

  9. Ensure that the seller has cleared all the statutory dues and liabilities in respect of the property and collect the latest receipts for these payments before confirming the deal.

  10. Ensure that there are no mortgages or liabilities or charges on the property before confirming the deal.

  11. Ensure that at least one person known to you who knows the seller also signs the agreement/ final sale deed as witness.

  12. Ensure that the agreement of sale clearly states a validity period within which the final sale deed has to be executed.

  13. Ensure that all legal owners are physically present and signs the documents at the time of executing the final sale deed. In case of Power of Attorney holders, the original PA has to be obtained and verified.

  14. If there are minors in the legal heirs, ensure that the minors’ share of the sale proceeds is deposited in scheduled commercial bank for a period not less than the period with in which they will become major and the details of bank, receipt number, amount, minors name, guardian’s name etc. are mentioned in the document executed.

  15. If the pathway to the property is shared by the owner of the adjacent property, ensure that the title deeds specifically state the easement rights to you.

  16. Collect the title deeds from the sub registrar’s office on the scheduled date along with all the previous documents, tax receipts, non-encumbrance certificates etc. If any loan is availed from a financial institution, they will directly collect all these documents. In such cases a copy of these documents should be obtained and kept with you.

  17. Immediately on receipt of the documents from the sub registrar’s office, submit the same to the Village Office under the jurisdiction of which the property is situated and ensure that the change in ownership is recorded in their register. Obtain a possession certificate in your name and also remit the tax, if not already remitted by the seller and obtain the tax receipt in your name.

  18. As soon as the transaction is completed, occupy the property immediately. In the case of land, start some construction work like fencing, construction of shed, planting crops etc. to establish your ownership rights on the property. In the case of independent houses, villas and flats conduct a house warming function inviting few of the neigbours and stay in the house for one or two days.

Tax Implications on Real Estate Deals

The real estate deals require payment of income tax on the capital gains. The tax is to be paid by the seller. The capital gain is computed by multiplying the price paid at the time of buying with the cost of inflation index and deducting the original price from the computed value. The Income Tax Department has published the inflation index in their website. If the full amount paid is not shown on the documents to save stamp duty, the income tax department can acquire the property by giving the value shown in the document. This is a risk to the buyer. The revenue department of the State Government can also initiate legal action for hiding the original price and avoiding stamp duty. The capital gain has to be added to the current year income and tax should be paid at appropriate rate if the taxable income goes above the prescribed limit. The income from real estate by way of rent, lease etc. is also taxable under the Income Tax Act. However, the income from agricultural property is exempted from payment of tax. Hence the buyer should study the tax implications of each deal before entering into any real estate deal. The Income Tax Act permits the owner of a house property which is used for dwelling purpose to deduct a maximum of Rs. 2 lakhs by way interest of housing loan from the taxable income. Besides the installments paid during the year can be claimed under Section 80c deductions within the overall limit of Rs.150000. These deductions are available only against one house. If the property is given on lease or rent, the municipal taxes and the interest paid on capital borrowed for purchase, construction, repair, renewal or reconstruction can be deducted from the rental/ lease income. In addition to this the Income Tax Rules permits a deduction of 30% of the annual value under Section 24 (a).

About Author

Dr. Sasidharan K

Dr. Sasidharan K

Related Articles