Leveraging Strategy

In the simplest of sense this means taking a loan to fund your real estate purchase. But there is much more to this, especially assumptions and rules that must be complied with. There is not much room for deviation. With a loan in the picture, the financial situation can change dramatically. Here is an illustration:

1. Consider the property cost being Rs 50 lakh inclusive of purchase and registration cost.

2. You will need to put in about 20 per cent i.e. Rs 10 lakh of your own money and balance 80 per cent will be bank funded. Implicit assumption is that you are eligible for getting 80 per cent funding.

3. Consider a floating rate loan. We assume calculations based on property providing a capital gain of about 15 per cent p.a. while the loan interest rate at about 11 per cent p.a.

Profit Scenarios

There are various profit scenarios at your disposal depending on which one of the following option you may want to consider.

Here are 3 examples explained in detail:

1. Do nothing: Just keep paying your loan. The advantages are:

a. Right from month one, you are better off and start making profits. Profit being market value of property minus cost of property along with interest paid till date of calculation.

b. Profit expectation (approximate): At end of 10, 15, and 20 years — Rs 1, Rs 3 and Rs 7 crore respectively.

c. How does this happen? Rate of return on property is higher than the interest cost.

2. Earn a rental income @ 4 per cent p.a. of the capital value of property. If you can earn more, it is even better. Assume post tax rental invested into a recurring deposit @ 8 per cent p.a.

The advantages are:

a. Right from month one you are better off and start making profits. Profit being market value of property minus cost of property along with interest paid till date of calculation.

b. Profit expectation (approximate): At end of 10, 15, and 20 years — Rs 1.4, Rs 3.8 and Rs 9 crore respectively.

c. How does this happen? Rate of return on property is higher than the interest cost plus rental income with tax deduction at 30 per cent - if you pay lesser tax the situation is even better.

3. Earn a rental income @ 4 per cent p.a. of the capital value of the property. If you can earn more it is even better. Assume post tax rental invested into a recurring deposit @ 8 per cent p.a. Make a little prepayment each year - say 2 per cent of the outstanding loan amount. The advantages are:

a. Right from month one you are better off and start making profits. Profit being market value of property minus cost of property along with interest paid till date of calculation.

b. Profit expectation (approximate): At end of 10 and 15 years — Rs 1.5 and Rs 4 crore respectively. But loan finished in 15 years and Rs 24 lakh of interest is saved as well.

c. How does this happen? Rate of return on property is higher than the interest cost plus rental income with tax deduction at 30 per cent — if you pay lesser tax the situation is even better. Also prepayment planning helps you save huge amounts in interest cost.

Even more options: There are more options to consider such as;

4. Rental + little prepayment + little investment

5. Rental + little prepayment + lumpsum investment

6. Rental + large lumpsum investment

7. Large lumpsum investment, spins off more options depending on risk level chosen for investments

8. Depreciation benefits

9. Depreciation + investment

As you can see the list is endless, so are possibilities and their inherent advantages. Situation is specific to each family's circumstances.

All said and done this is a strategy that has high risk associated. Risk here may emerge from various standpoints and one cannot predict the timing and impact. Thus many things need to be balance concurrently viz., your cashflows, budgets, investments, financial plan, job security, asset base or networth. Do this for sure but tread with caution.