Top reasons for selling
- Regulatory changes and price stagnation
- Lower tax benefits on property let out
- Fund children’s undergraduate degrees Shifting into more attractive assets
Dilemmas after selling
- To reinvest in land or property?
- To invest in capital gains bonds?
- To pay taxes and invest in MFs?
When there is a trend to the behavioural pattern of our investors, we like to understand it. The current trend we are observing in our investors and many around us is that people are liquidating their land or property or showing intent to do so. The RBI did provide data on the shift from physical to financial assets. However, the shift in the needle in percentage terms seems so small that you don’t pay serious attention to it. But when you see several pieces of anecdotal evidence all around you and look at the number of properties available for sale in online portals you realize there is indeed a change happening.
I want to summarize the top reasons I came across for people to sell their land or property in the past year or so. Please note that much of these are either through the interactions I’ve had, or our advisors have, with investors or anecdotal evidence from people in the field. However, there is some data from reports that backs such theory.
Why are people selling real estate now?
Regulatory changes and price stagnation: For those who bought a property for investment, the fear that demonetization and GST could turn their property prices unattractive has led to some selling their second homes or their land holdings.
That real estate prices did not move much in most pockets is true. The data below will show that they stagnated in the past 3 years. In fact, a report by Knight Frank India suggests that residential prices have gone down in many cities in the second half of 2017. Pune was hit the most with a 7.5% fall in the second half of 2017 compared with the same period a year ago. The fall was 5% each in Mumbai, Kolkata and Bangalore. Of course, you might wonder why more people are not buying when prices are cracking. But then, people seldom buy on negative sentiments and that’s a separate story anyway.
Coming back, investors woke up to the fact that their investment was not yielding much and that the lack of ‘cash transactions’ could push prices down further. This led them to liquidate their real estate asset. This is especially where it is held as plots.
Tax changes and the impact on let out property: Budget 2017 put an end to the good days of booking unlimited losses on your let-out property. With the Rs 2 lakh-per-year-cap on claiming loss from house property (from no limit earlier), the tax-saving component has significantly come down. While the losses can be carried forward for 8 years, it is possible to claim such losses only if your rental income steeply increases to set off this loss. This is because you must be able to generate sufficient surplus under this head of income in subsequent years to set off this loss.
Let us take an example of a Rs 50 lakh home loan. Even at a nominal 8% interest for 15 years, the interest component for the first 10 years is not less than Rs 2 lakh per year. That means for the first 10 years, you may have some carry forward loss unless your rental income is quite high.
You might want to read an article that we wrote soon after the budget in 2017 on why borrowing and investing in property is unattractive. The poor rental yields on properties combined with this loss of tax benefit appear to be slowly triggering an exit from property investment.
Soaring aspirations of the Y2K babies: From a time when going abroad to do a masters was the ‘in’ thing, it is now about packing bags to a foreign land after Class 12. Hence, the baby boomers of the late 90s and early 2000s are now dealing with the increasing aspirations of their high school children to study in destinations such as US, UK, Australia, or Canada for undergraduate studies. And this does not come cheap – ranging from $30,000 per annum to $ 75,000 per annum (and the higher end is for subjects like fine arts in top colleges!).
Indian parents do not appear prepared for this kind of expense. This has meant dealing with huge outgo and providing collaterals for any loans. For those with a second home or property, it provides the cue to sell the real estate to fund the education.
Increasing investment in other assets: Even as real estate has remained a sluggish performer for the past few years, other options including equity, mutual funds and alternative investments have picked up. Data, at least that of ultra HNIs, suggests that high net worth individuals are shedding real estate as an investment option and instead preferring other assets (see data below). While we do not have data on retail investors’ behaviour, the RBI data suggests that physical savings by households have been on the decrease since FY-12.
What are they doing after selling real estate?
Both the RBI data and the survey on HNIs tell us that people are moving to other asset classes. That is, if they are not using the money towards aspirations like their children’s education.
We too have seen people realizing the need to diversify after the not-so-good experience with real estate prices in the past few years. But what exactly has our experience been with investors who sold their real estate?
People pose the following questions:
- I have money from the sale of real estate. Should I pay taxes or reinvest in another property? Is it a good time to invest again?
- Should I save capital gains tax by investing in Capital Gains Bonds?
- Should I pay taxes and invest in mutual funds?
(A few others who have used up the money for their children’s education, of course, ask us how to save for their retirement.)
The answer to questions 2 & 3 is easier than question 1. A simple calculation will tell you that you that a 5.75% capital gains bond locked for 5 years will give you 3.95% annualized return after considering the tax on interest (yes interest on capital gains bonds is indeed taxable!) at the 30% slab. See tables below for an illustration.
|Cost of property (FY-10)||30L|
|Market value in FY-18 with returns assumed at 11% annualised||62.28L|
|LTCG for tax purpose||7.15L|
|Tax on LTCG (20%)||1.47L|
|Gains invested in 5-yr Capital gains bonds|
|Interest paid out annually (5.75%*)||1.86L|
|Tax on interest annually||0.58L|
|Total interest for 5 years||9.28L|
|Total tax for 5 years||2.9L|
|Total interest net of tax for 5 years||6.39L|
|Maturity after 5 years||32.28L|
|Returns post tax||3.95%|
|*Current interest on CG bonds|
|Post tax capital gains invested in debt funds|
|Return on debt funds*||8%|
|Value after 5 years||45.27L|
|Indexed cost (at 6% annual inflation)||41.23L|
|LTCG for tax||4.03L|
|Value post tax||44.44L|
|Returns post tax||7.6%|
|*Based on past 5 years returns of short-term debt funds|
You will see from the table that the tax you pay on your property gains and from selling the debt fund investment (which you don’t even have to sell) is lower than the tax on bond interest (Rs 2.9 lakh).
We assumed the property was purchased in FY-10 but if you purchased the property 2 years ago or before that (for indexation of long-term capital gains), the returns in debt funds would be higher than the bonds.
So, the answer is simple. You should not lock into capital gains bonds for the sake of avoiding capital gains tax. You don’t really save any tax.
To answer question 1, we need to understand why you wish to buy real estate. Is it for investment? Or did you just sell the only property you had and are looking to buy one for self-occupation? If you intend to occupy then the economics of affording an EMI (if you must take a loan as well) and other considerations kick in.
If it is for investment, you need to be aware that return on investment (rental yield) is low and that the tax benefit of interest on home loans is significantly reduced. We will, through a separate article, elaborate the responses and calculations we have shared with many of our investors when it comes to utilising the sale money from real estate.
The bright side of the present selling trend to me is that, knowingly or unknowingly, people have diversified their asset allocation. For most middle-class Indians, real estate accounts for 70% or more of assets because of the sheer high value of the asset. This is slowly set to change, and such diversification is good if only to absorb the volatility.
Some asset classes break our notions of their safety a bit late. Gold, post-2012, is a classic demonstration of asset volatility and poor returns. Real estate too has shown that and more importantly proved its true illiquid nature in a down market, especially post demonetization. Demonetization itself has proved that the king with the cash can become a pauper overnight. Bank scams and NPAs provide some fear for the safety of deposits.
Equity, thankfully, has always demonstrated sufficient volatility and not hidden its true nature of being risky in the short term. If this is not enough indication to highlight the importance of diversification, then what is?