The Rising Cost of Money
Increasing inflation is the first factor that inhibits the profitability of a real estate investment. While investing in any kind of property, one should always consider what the overall earnings would be worth at the point in time one wishes to liquefy them.
If one fails to plan for the inflationary effect, further property purchases may be out of reach – rendering the whole concept of real estate investment an exercise in futility.
A simple method of establishing whether inflation will erode one’s real estate investment is to determine if the interest rate earned on one’s savings is less than or equal to the rate of inflation. If it is, it means that your real estate investment too will suffer because of inflation.
One needs to establish whether the average price for property rentals in the location one wishes to invest in will remain higher than the rate of inflation in the long term. If it does not, there is not much point in investing in that location.
Death and Taxes
Property taxes are yet another aspect that can negatively influence property investments. While buying a property with the intention of reselling it for a profit or renting it out, one should remember that profits arising from both the sale of a property and monthly rental income generated are taxable.
The yardstick here is not how much one earns from one’s property, but how much one manages to keep after the taxman has taken his cut. It is very unwise to invest in a property without first consulting with one’s chartered accountant or an experienced real estate professional.
While there is no way of avoiding property taxes, it is certainly possible to make the taxation scenario more realistic. This calls for current knowledge of property taxation laws, which often change without warning. One needs to determine one’s post-taxation cash flow in order to know just how valuable one’s property investment will be in the long run.
Fate – Your Constant Silent Companion
Finally, there is also always an aspect of free-floating risk attached to property investments. For instance, buying a property with the intention of selling it at a profit afterwards always involves a degree of uncertainty and chance of loss.
One can judge the current appreciation value of a certain location with a fair degree of accuracy, but there is no way of anticipating all developments:
The location may fall out of favor with buyers
- There may be unsuspected litigation attached to the property
- Though superficially sound, the property may be legally untenable because it has substandard construction or does not conform to required earthquake-resistance parameters
- The Government may decide to acquire the land the property stands on at the minimum rate for infrastructure development
- The investor may need to sell the property at a moment’s notice – and at a loss – to cover other urgent financial commitments
- There may be a natural calamity such as a flood, rendering the entire location unmarketable
To minimize one’s risk while investing in real estate, one needs to know:
- Exactly how much profit will accrue from the property in a given time frame
- How much it will cost to make the property marketable
- How long it will take for it to attain its highest possible market value
- What the state of the market is now, and what it will be in the near and distant future
- What the possible losses could be with regards to all applicable variables
- If the potential profit of buying a property outweighs the various implied risks
- If the current cost justifies future earnings (via sale in the short term of rental income in the long term)
- If one has sufficient financial soundness to invest in the property now, or if it would be more prudent to wait until financial circumstances improve.
The author, Karun Varma is Managing Director – Bangalore & Kochi, Jones Lang LaSalle Meghraj