Real estate returns, like stocks, are determined by a combination of two factors
- Income (lease rentals, like dividends in the case of stocks)
- Capital appreciation
The only difference in the two is that in real estate, the lease rentals are fixed, largely predictable over a period of time and a very significant component of overall returns. In India, rental yields are typically very low in residential areas. Commercial rentals average between 6-9% with an escalation clause that provides for close to 15% upward revision in rentals after three years. This would further improve the returns beyond the existing tenure.
To arrive at a correct and more realistic estimate of returns, an investor should consider the following five factors
Acquisition cost: The buying costs are higher than other asset stocks. For instance, the transfer of property requires registration and payment of a stamp duty. Some of the additional costs involved are
- Stamp duty
- Broker commission
- Miscellaneous costs of drawing up legal documents
Maintenance expenses: While the purchase is a one-time expense, maintenance is an important recurring cost for preserving the value of your investment, maintenance expenses are normally Rs 5-20 per square feet per month for commercial property depending on the quality of the property, and this needs to be factored into yield calculations. Further, each lease contract is structured differently and a contract may incorporate clauses that create some financial obligations for the lesser. To arrive at true it is thus important to look at yields after deducting such expenses.
Taxes: Property tax and taxes on capital gains are the two aspects one needs to familiarize oneself with and consider when evaluating returns and comparing them with those on other asset classes. From the tax point of view, the points to consider while buying are:
- Discount in applicable tax rates, if property is bought by women
- Any rebate is applicable for pre-payment of taxes
- Change in tax slabs due to location, area or built-up of the property
