Tag: Home loan | Vivek Kaul

19 October, 2016

The Greater Fool Theory of Real Estate

Some regular readers of the Diary have been asking on the social media as to why I have stopped writing on real estate.

Actually, I haven’t, it’s just when it comes to real estate, I have had nothing new to say for a while. But today’s piece is about real estate. Not that this has something very new to say, but the story that I came across was interesting enough to be discussed in detail.

First and foremost, I would like to thank Pune based Ashish Deshpande, Director, Paradigm Wealth Managers, for bringing this to my notice. So here is the story.

On the insistence of a friend, Deshpande went to check out a new real estate development in Wadala in Mumbai.

His friend could only afford the one bed room hall kitchen (BHK) that was on offer. And how much did it cost? Rs 1.8 crore. Deshpande got chatting to the builder’s sales guy and asked him, how many end users were actually buying the one BHK apartments. The sales guy, not surprisingly, answered 90 per cent. I mean, what else could he have said. He is expected to sell apartments not philosophise about them.

Of course, like a good sales guy, he was lying. Deshpande then asked the sales manager to imagine the profile of the guy who would in a position to pay Rs 1.8 crore to buy an apartment to live in it. Let’s do a little maths to get into a little more detail here.

A bank or a housing finance company would finance up to 80 per cent of the value of the apartment. This means a home loan of Rs 1.44 crore (80 per cent of Rs 1.8 crore). Let’s say the individual who wants to buy this apartment goes to the State Bank of India. He takes on a twenty-year home loan at 9.25 per cent per year.

How much does the EMI on this amount to? Rs 1,31,885 per month. How much does a person need to earn per month for the bank or the housing finance company, to give him the required home loan? Assuming around 40 per cent of the salary goes towards the EMI, the monthly salary would have to be around Rs 3.3 lakh. This would mean an annual pay of around Rs 40 lakh.

How many people actually earn that kind of money? Further, the individual would also have to arrange for a downpayment of Rs 36 lakh (Rs 1.8 crore – Rs 1.44 crore). How many people have such a saving? Also, would you expect someone earning as much as Rs 40 lakh per year to live in a one BHK apartment? Would take a very desperate person to do that.

Deshpande offered this logic to the sales manager (not in as much detail). Then the manager let the cat out of the bag and said that most of the people purchasing one BHKs were buying it as a second home. People buy second homes typically to put it on rent to make a regular income, avail of the huge tax deduction that is available or to simply invest money and stay put. Or they simply have some money lying around and they don’t know what to do with it.

Rental yields (annual rent divided by the market price of the apartment) are currently around 2 per cent. So why would anyone in their right mind buy a home to put it on rent? Even after tax returns on fixed deposits, for those in the 30 per cent tax bracket work out to around 5 per cent.

When it comes to saving tax, the strategy perhaps makes some sense. In case of a second home loan (and third and fourth and so on) the entire interest paid on a home loan is tax-deductible as long as a notional rent is added to the income.

But what complicates matters in this case is that the delivery of the apartment is not scheduled up until 2020. That essentially increases the risk given that there are a whole host of under construction properties that haven’t been delivered over the last few years.

Also, the apartment comes with the condition that it cannot be sold before possession is granted. So this basically means that it is a five-year investment and can be sold only by around 2021. So what is a reasonable rate of return for an investor to expect in this case? Deshpande works with a simple rate of return (and not compounded) of 8 per cent per year. This would mean an absolute rate of return of 40 per cent over a period of five-year.

This basically means that five years later the apartment should be worth at least Rs 2.5 crore (actually Rs 2.52 crore to be very precise). If we include stamp duty and other charges (which also need to be recovered) the apartment should fetch at least Rs 2.75 crore in 2021.

A simple rate of return of 8 per cent per year might just work in this case because the buyer is also getting a huge deduction for the interest that he pays on the home loan. But what if someone is looking at least at a compounded rate of return of 10 per cent per year? Then the price of the apartment has to be around Rs 2.9 crore in 2021. And this is without taking the stamp duty into account.

Now, imagine one BHK apartments selling for Rs 3 crore in 2021? These are the numbers we are looking at. What if there are no buyers? As Deshpande puts it: “in the absence of an end user your investment becomes a fixed deposit fetching 2% return annually with principal not in sight or at least at big risk.”

So where does that leave us? It brings us back to the Greater Fool Theory of Real Estate. Or the theory on the basis of which people are still betting on real estate. The expectation is that at the end of the holding period of five years (in this specific case) one will always be able to find a greater fool who is willing to buy real estate at an even higher price. In more general cases, the expectation is to find a greater fool who is willing to buy.

If that is how you like to invest, then all I can say is best of luck. Or maybe you have a lot of black money lying around. And there is still no place better than real estate to launder it.

The column originally appeared in Vivek Kaul’s Diary on October 19, 2016

6 May, 2016

Here’s More Data to Show How Over-Priced Indian Real Estate Is

I know I am kind of going overboard with the analysis of the data released by the Income Tax department last week, but believe me it is necessary, to show how loaded things are against people who actually pay income tax.

Last week, the Income Tax department released some very interesting data-the kind of stuff that it had not released for a while.

It released detailed numbers for income tax returns filed in assessment year 2012-2013. In the assessment year 2012-2013, the income tax returns for the income earned in 2011-2012 was filed.

Let’s look at the income tax returns of individuals in detail. The Income Tax department has provided data for income for individuals under the head-salary, business income, other income, short-term capital gains, long-term capital gains and interest income.

Take a look at the following table:

This table tells us that the average income of individuals filing an income tax return is around Rs 4.40 lakh.

Table 1: Income under the head (in Rs crore)

Salary	6,27,200
House property income	29,927
Business income	4,03,251
long term capital gain	30,479
short term capital gains	3290
Other sources income	1,28,020
Interest income	44,918
Total (in Rs crore)	12,67,085
Total number of returns	287,66,266
Average income	Rs 4,40,476

How do things look if we look at just the salaried class?

Table 2

Salary (in Rs crore)	6,27,200
Number of returns filed	116,76,493
Average income	Rs 5,37,148

As can be seen from the above table the average income of the salaried class in India filing income tax returns is Rs 5.37 lakh. This is around 22% more than the average income of the individuals filing income tax return.

It is important to understand here that most individuals belonging to the salaried class would have an income lower than the average income of Rs 5.37 lakh. In order to understand this, we will have to take a look at the data in a little more detail.

Let’s divide the data in those earnings up to Rs 10 lakh and those earning more than Rs 10 lakh. Let’s consider those earning up to Rs 10 lakh first (See Table 3). As can be seen from Table 2, the total number of returns filed by the salaried class comes to around 1.17 crore.

Of this close to 1.06 crore have salaried incomes of up to Rs 10 lakh. This means around 91% of the salaried class filing income tax returns have an income of up to Rs 10 lakh. Take a look at the following table (Table 3).

Table 3

Salary range	Number of returns	Sum of Salary Income (in Rs crore)
>0 and <=1,50,000	16,00,167	14,956
>150,000 and <= 2,00,000	10,67,300	18,853
>2,00,000 and <=2,50,000	10,24,315	23,120
>2,50,000 and <= 3,50,000	19,18,714	57,075
>3,50,000 and <= 4,00,000	8,06,685	30,215
>4,00,000 and <= 4,50,000	7,54,202	32048
>4,50,000 and <= 5,00,000	6,96,210	33032
>5,00,000 and <= 5,50,000	5,95,298	31190
>5,50,000 and <= 9,50,000	20,23,583	140464
>9,50,000 and <= 10,00,000	1,00,155	9760
Total	105,86,629	3,90,713
Average Income	Rs 3,69,063

The average income of those earning up to Rs 10 lakh is Rs 3.69 lakh. This is significantly lower than the overall average income of Rs 5.37 lakh of the salaried class filing income tax returns. How do things look for those earning an income of up to Rs 5 lakh?

Table 4

Salary range	Number of returns	Sum of Salary Income (in Rs crore)
>0 and <=1,50,000	16,00,167	14,956
>150,000 and <= 2,00,000	10,67,300	18,853
>2,00,000 and <=2,50,000	10,24,315	23,120
>2,50,000 and <= 3,50,000	19,18,714	57,075
>3,50,000 and <= 4,00,000	8,06,685	30,215
>4,00,000 and <= 4,50,000	7,54,202	32048
>4,50,000 and <= 5,00,000	6,96,210	33032
Total	78,67,593	2,09,299
Average income	Rs 2,66,027

The average income of those earning less than Rs 5 lakh is around Rs 2.66 lakh. These individuals form around two-thirds of the overall salaried class filing income tax returns.

How do things look for those earning more than Rs 10 lakh per year?

Table 5

Salary range	Number of returns	Sum of Salary Income (in Rs crore)
>10,00,000 and <=15,00,000	5,92,418	71,464
>15,00,000 and <= 20,00,000	2,07,141	35,566
>20,00,000 and <= 25,00,000	1,10,700	24,708
>25,00,000 and <= 50,00,000	1,24,472	41,302
>50,00,000 and <= 1,00,00,000	36,775	25,032
>1,00,00,000 and <=5,00,00,000	17,515	30,661
>5,00,00,000 and <=10,00,00,000	655	4,375
>10,00,00,000 and <=25,00,00,000	156	2,158
>25,00,00,000 and <=50,00,00,000	26	809
>50,00,00,000 and <=100,00,00,000	6	412
Total	10,89,864	2,36,487
Average income	21,69,876

The average income of those earning more than Rs 10 lakh per year comes to around Rs 21.7 lakh more and is significantly more than the overall average of Rs 5.37 lakh for the salaried class.

What do these tables tell us? That the average salaried Indian who files income tax returns doesn’t earn much. As mentioned earlier, around 91% of the salaried class has an average income of Rs 3.69 lakh. Close to two-thirds have an average income of Rs 2.66 lakh.

This basically means that the income of the average salaried Indian filing an income tax return is significantly lower than the overall average salaried income as well as overall average income. At least that is how things were for the assessment year 2012-2013.

A question worth asking here is what sort of a home can individual earning a salary of Rs 3.69 lakh per year, actually afford. An annual income of Rs 3.69 lakh translates into a monthly income of around Rs 30,755.

What sort of a home loan would a bank give against this amount? Typically, a bank works with the assumption that 40% of the monthly income can go towards servicing an EMI and accordingly gives a loan.

In this case that amounts to around Rs 12,300. An EMI of Rs 12,300 at an interest rate of 10% and a tenure of 20 years, would service a home loan of Rs 12.75 lakh. Banks typically lend up to 80% of the official value of the property. This means an official value of property of around Rs 16 lakh (Rs 12.75 lakh divided by 80%). Please take into account the fact that I have used the word official because there is bound to be a black component as well.

What this number tells us is that most salaried class in 2011-2012, were not in a position to buy a home to live in, across large parts of the country. There is no reason to believe that things would have changed since then.

The point is that the demand for real estate is in the below Rs 20 lakh market price segment. But what is being built across large parts of the country is clearly above that price. As RBI governor Raghuram Rajan said in a recent speech: “I am also hopeful that prices adjust in a way that encourage people to buy.”

Let’s wait and see if Dr Rajan’s hope becomes a reality, any time soon.

The column was originally published in the Vivek Kaul’s Diary on May 6, 2016

5 May, 2016

Here is Another Good Joke: New IT Data Shows Only 6 lakh Indians Are Repaying Home Loans

In yesterday’s column I explained that if official data is to be believed India has only 20 lakh individuals who earn an income out of house property.

To put it simply, as per official data, India has only 20 lakh landlords or 19.95 lakh to be very precise. This number can be inferred from the data for the assessment year 2012-2013 shared by the income tax department last week. Income tax returns for the income earned during 2011-2012 would have to be filed during assessment year 2012-2013.

In fact, there was another interesting data point, in the column. This means some amount of repetition from yesterday’s column, but kindly bear with me. I am repeating this point because of two reasons—a) I thought, it sort of got lost in yesterday’s column. b) I think it is an equally important point which people need to know about.

As per the data for the assessment year 2012-2013, there were only around 26.01 lakh individual assesses who had shown some income from house property. Of this, around 6.06 lakh (or 6,06,046 to be very precise) had shown a negative income.

This negative income amounted to around Rs 3,298 crore in total. This works out to an average negative income of Rs 54,418 per individual. The term negative income is actually an oxymoron. But what it essentially means is that instead of earning any money from a house, the owner is actually spending money on it.

This happens when someone has taken a home loan to buy a home and is paying an interest on it. The Income Tax Act allows the interest paid on borrowed capital (i.e. a home loan) to be deducted while calculating taxable income.

For 2011-2012, in case of a self-occupied home, a maximum amount of Rs 1.5 lakh could be taken as a deduction for the interest paid on a home loan. Individuals in such situation would end up having a negative income from house property.

For a non-self-occupied home, there was no upper limit to the amount of interest that could be taken as a deduction, though a notional rent would also have to be taken into account, if the house hadn’t been put out on rent.

If the interest to be paid on the home loan was greater than the rent earned or the notional rent, then the income from house property would turn out to be negative. Such individuals would also end up having a negative income from house property.

The surprising thing is that the number of such individuals in total is only a little over six lakh. Does this mean that India has only six lakh people who have taken on a home loan to buy a home? The official data seems to suggest that.

But this is simply bizarre. Some simple mathematics clearly shows us that. The Reserve Bank of India (RBI) puts out sectoral deployment of credit data. During 2011-2012, scheduled commercial banks gave out home loans worth Rs 41,907 crore.

Multiple newsreports point out that in 2012-2013, the average home loan financed by banks was Rs 10 lakh. I couldn’t find an average home loan number for 2011-2012, and hence will have to work with this.

Let’s assume that in 2011-2012, the average home loan financed was 10% lower at Rs 9 lakh than in comparison to 2012-2013. This essentially means that just in 2011-2012, around 4.66 lakh homes (Rs 41,907 crore divided by Rs 9 lakh) were financed by scheduled commercial banks.

Over and above banks, housing finance companies also give out home loans. Hence, it is safe to say that just in 2011-2012, more than six lakh home loans would have been given out.

Further, home loans would have also been given out even in years before 2011-2012. Hence, how is it possible that only around six lakh individuals have a negative income from their homes, as data from the income tax department suggests?

Something doesn’t really add up here. In fact, as I had pointed out in yesterday’s column, the number of home loan accounts with scheduled commercial banks in 2011 had stood at 47.32 lakhs.

Hence, the data from the Reserve Bank of India is completely at odds with the data from the Income Tax department.

Typically, when people do not declare details to the Income Tax department the idea is to hide income and save on tax. But in this case nothing of that sort is happening. If an individual does not declare in his income tax return that he is repaying a home loan, then he does not get the interest paid on the home loan as a deduction.

One explanation for this might be that many salaried individuals are declaring their home loan details to their employers, getting a deduction, and then not filing their income tax returns.

But that can at best be a very small explanation because the difference between six lakh people declaring a negative income from their house and 47.32 lakh home loan accounts with banks, is huge. And if we consider home loan accounts with housing finance companies, the number is even bigger. Also, the same logic will not work for the self-employed individuals.

So what is a possible explanation for this? One explanation that I can possibly think of is that the home loan has been taken on only as a bridge loan. This essentially means that people have used black money to pay a substantial part of the price of the home and have financed the remaining through taking on a home loan. This logic applies more to the self-employed individuals rather than the salaried class.

By not declaring the fact that they are paying an interest on their home loan, the hope is not to attract attention on their rather expensive home in comparison to the home loan amount that has been borrowed. But then in this day and age of big data, it shouldn’t be so difficult for the Income Tax department to figure out, who has taken a home loan and is not declaring it.

I don’t know if this explanation is correct, but this is something I can think of at this point of time.

To conclude, the Income Tax department needs to look at this anomaly in greater detail. The answers will be very interesting.

The column originally appeared in the Vivek Kaul Diary on May 5, 2016

4 May, 2016

Here’s a Good Joke: New Income Tax Data Shows India Has Only 20 Lakh Landlords

In yesterday’s column I had mentioned that only around 26 lakh Indians (to be precise the number is 26,01,777) filed for income from house property under the individual category, for the assessment year 2012-2013.

During the assessment year 2012-2013, income tax returns for the income earned during the year 2011-2012 had to be filed. A total income of Rs 29,927 crore was declared under this category.

Of this around 6.06 lakh individuals showed an income of less than zero from house property. This would primarily include people who have taken on a home loan to buy a house and are repaying it. During the financial year 2011-2012, an interest of up to Rs 1.5 lakh, paid on a home loan, in case of a self-occupied house, could be set off while calculating taxable income.

This meant that an individual repaying a home loan on a self-occupied house, could show a negative income of up to Rs 1.5 lakh when it came to income from house property. These are the individuals showing negative income against their house property. This negative income could be set off against taxable income and the taxable income could bethus brought down.

Further, the limit of Rs 1.5 lakh applied only to self-occupied property and not on other homes that a tax payer may choose to buy by taking on a home loan. Any amount of interest paid on such home loans can be claimed as a deduction as long as a “notional rent” is added to the income.

We all know that over the last few years the “rents” have been very low in comparison to the EMIs that need to be paid in order to repay the home loan. The rental yield (rent dividend by market value of the home) is in the region of 2-3%.

Even after deducting a notional rent, the interest component tends to be massive during the initial years. Hence, the difference between the notional rent and the interest paid is negative. This essentially means income from house property is negative. Such individuals who own more than one home financed through a home loan, also earn a negative income from their house property. This negative income helps people with two or more homes, claim huge tax deductions.

Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling and thus prevent a faster fall in home prices.

Getting back to the point, there were only 6.06 lakh individuals in the assessment year 2012-2013 who had an income of less than zero or a negative income from house property. As I said, these are people essentially repaying their home loans. The interest they pay on their home loans can be set off against taxable income.

It is worth asking here that does India have less than 6.06 lakh individuals living in self-occupied homes on which home loans are being repaid? Something just doesn’t add up here. Honestly, this is bizarre.

As a newsreport in The Economic Times points out: “In 2011, the number of accounts was 47.32 lakh, which went up to 47.78 lakh in 2012, with the disbursed amount also increasing from Rs 2.5 lakh crore to Rs 2.6 lakh crore.”

If the banks had close to 47-48 lakh home loan accounts in 2011 and 2012, why are only around 6.06 lakh showing up in the income tax data?

Also, around 19.95 lakh people declared an income from house property in assessment year 2011-2012. This is another extremely low number. What does this mean? It means that the number of individuals in India who are earning a rental income from their homes (real as well as notional) is around 20 lakh. How is that possible? It means is that there are around 20 lakh landlords in the country, if the data from the Income Tax department is to be believed.

It is worth recounting here something that Akhilesh Tilotia writes in The Making of India based on the 2011 Census data: “India’s households increased by 60 million to 247 million from 187 million between 2001-2011. Reflecting India’s higher ‘physical’ savings, the number of houses went up by 81 million to 331 million from 250 million. The urban increases is telling: 38 million new houses for 24 million new households.”

This means India had 331 million or 33.1 crore houses in 2011. Now compare this with the fact that there are around 20 lakh individuals earning a rental income from their homes. This comparison clearly tells us how low the 19.95 lakh number, really is.

There are two things that become clear here. One, is that many individuals are just buying up homes as an investment and not putting it up on rent. Anshuman Magazine, chairman and managing director of CBRE South Asia Pvt. Ltd., in a 2015 article wrote that “around 1.2 crore completed houses” are “lying vacant across urban India”.

Further, this is a clear indication of the fact that most landlords are getting their rents paid in cash and not paying any income tax on it. It also leads to the question where did these people earn the money to build these houses in the first place?

Here is another interesting data point—Of the 19.95 lakh who have some rental income, around 14.55 lakh have an average rental income of around Rs 60,000 per year or Rs 5,000 per month. This number is very low as well.

The point being a major part of the black money in India continues to be generated in the real estate sector. The general impression we have had up until now is that black money is generated when real estate is bought and sold. Nevertheless, with this new data it is very clear, that black money is generated even when real estate is rented out.

The column originally appeared on the Vivek Kaul Diary on May 4, 2016

1 March, 2016

Budget 2016: Does the extra deduction of Rs 50,000 for home-buyers really help?

In the budget speech finance minister Arun Jaitley made yesterday he said: “For the ‘first – home buyers’, I propose to give deduction for additional interest of Rs 50,000 per annum for loans up to Rs 35 lakh sanctioned during the next financial year, provided the value of the house does not exceed Rs 50 lakh.”

How much will this help? Let’s understand it through an example. Let’s take the case of a man borrowing Rs 35 lakh from the State Bank of India at 9.55% per year, repayable over a period of 20 years. The EMI for this works out at Rs 32,739.

Every time an EMI is paid, a part of the principal is repaid as well. And the remaining part goes towards the payment of interest. Hence, with every EMI paid, the principal amount of the loan that still needs to be paid comes down. This means with every EMI, the interest component of the EMI keeps coming down, and the principal repayment keeps going up.

In the first 12 EMIs, a total interest of around Rs 3.32 lakh is paid. Currently, only a deduction of up to Rs 2 lakh is available while calculating the taxable income on, when it comes to the interest paid on a home loan for a self-occupied property. Now a deduction of upto Rs 2.5 lakh can be taken to the condition the loan is upto Rs 35 lakh and value of property is not greater than Rs 50 lakh. Hence, this is a good move to that extent. For those in the top income-tax bracket of 30.9%, it means a tax saving of Rs 15,450.

Assuming the interest rate continues to be the same, how will things pan out. In the second year, the interest paid amounts to around Rs 3.26 lakh. The extra deduction of Rs 50,000 will continue to be available in the second year as well.

How many years is this extra deduction likely to be available? It will be available until the interest part of the EMI continues to be greater than Rs 2 lakh, the deduction which is already available, assuming the government continues with this provision in the years to come.

How long will this last? This will go on for 13 years. After that the interest being paid will fall below Rs 2 lakh per year and hence, this extra deduction of Rs 50,000 will be of no use. Given this, the tax saving will turn out to be reasonably good over a long period of time.

This move will help many people living in cities, which come after the metropolitan cities. It will also benefit those living in cities who are comfortable living on the outskirts.

Will it provide a fillip to the real estate industry? I am not so sure about that. Lack of money is not the only reason that people have stayed away from buying real estate. High prices continue to remain a huge issue. Another major reason is the inability of the industry to deliver a home on time. Further, a few builders have disappeared after taking on money from prospective buyers. All these reasons have kept the home-buyer away.

Also, it needs to be pointed out here that the finance minister could have done the cause of people looking to buy a home to live in even more good, by plugging a huge loophole in the Income Tax Act, when it comes to home loans.

On the self-occupied property, an interest of up to Rs 2 lakh can be claimed as a tax deduction. This limit applies only to the self-occupied property and not on other homes that a tax payer may choose to buy.

Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income. We all know that these days “rents” are very low in comparison to the EMIs that need to be paid in order to repay the home loan. The rental yield (rent dividend by market value of the home) is in the region of 2-3%.

Even after deducting a notional rent, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.

This “deduction” has been used over the years by well-paid corporate employees to bring down their taxable income. Further, individuals who use this deduction benefit on two fronts—tax deduction as well as capital appreciation. Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling.

While offering a tax deduction on a self-occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “deduction” needs to be plugged immediately as it encourages speculation.

Jaitley could have done the cause of the prospective home buyer even more good by plugging in this loophole. But sadly that did not happen.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column was originally published on Firstpost on March 1, 2016