7 Common Mistakes To Avoid

In bad times, informed investors, too, end up making mistakes in the real estate market. Here's how to avoid the pitfalls.

The wheels of fortune for the real estate, especially the residential property market, have turned since the stockmarket crash in January this year. The sector, which was already battling with high interest rates and high cost of property that were, to an extent, keeping homebuyers away from the market, received a death blow in terms of the negative sentiment. The global economic turmoil in the later months only increased the intensity. While homebuyers are deferring purchases to catch the bottom, real estate speculators, who invested in property purely for gain, are finding it hard to pull out at their desired price points.
Whether you’re a home-buyer or an investor, the present scenario is the perfect setting for inducing wrong calls. We list the commonest ones—and ways to avoid them.
Money Mistake 1
With prices likely to cool off in the short-term, there is no point in holding on. I should pull out of the investment.
This is the first thing most of us do when we get bad news about any asset class. When it comes to real estate, the worry is aggravated if there’s a home loan involved. With home loan interest rates climbing steadily since 2004, your tenure is now longer (or EMIs heftier). Capital values, too, are down, especially since January this year. As a result, you are paying more (in terms of interest payout) for an asset whose value is decreasing. Experts believe that the prices of residential units will go down by another 15-20 per cent in the short term.
But is that reason enough to pull out? No. If you can hold on to your investment, do so. The reason is simple: In the long run, returns from real estate are second only to that from equities. Further, with the large gap between demand and supply for residential units in the country, long-term prospects still look good.
Pull out of your investment only if you find it difficult to hold on. But be ready for three major hurdles—finding a buyer when most of them are trying to catch the bottom; clearing paperwork if there’s a mortgage; minimising the tax impact on sale proceeds.
Money Mistake 2
While selling the property, I should stick to the price at which the neighbouring flat was sold six months ago.
While real estate as an asset delivers good returns in the long run, exits are not easy, compared to some other asset classes. In the present scenario, your problems will be further compounded because, even if you find a buyer, he will know fully well that you are making a distress sale and, hence, will drive a hard bargain. To get an idea of the price you may realistically expect, investigate the sale of similar properties in the area over the past month or so. Property portals will also give a fair idea of the going rates.
Money Mistake 3
I have surplus funds. I should go ahead and increase the EMI on my existing home loan.
The home loan is the cost of acquiring the house while the interest on it is an expense you incur to get the asset. An ideal situation would be to get the loan at the cheapest cost. However, rising interest rates increase your cost of acquisition. If you have surplus funds, instead of increasing the EMI you should part-prepay the principal. This way your principal outstanding will go down, which will, in turn, reduce your tenure. In other words, your interest outgo will reduce.
Also, most lending institutions do not levy any pre-payment penalties if the part-prepayment is made through one’s own resources. For those who don’t have extra funds, use this time to arrange for it.
Money Mistake 4
Real estate developers are promising returns on investments in their advertisements. I think I should invest in them.
Most developers have been looking at individual investors to bail them out of the cash crunch. Advertisements portraying real estate as an investment with assured returns of around 11-12 per cent were a common sight till very recently. Don’t fall for such gimmicks: these are merely evidence of their efforts to get cheap funds for ongoing projects. When private equity funds invest with real estate developers, they typically expect rates of return above 20 per cent. So, if you have funds, park them in safer instruments like bank fixed deposits—which are anyway giving returns of around 10 per cent.
Money Mistake 5
The developer is giving a car free with the every booking. Good idea to book with them.
This is again an attempt by developers to maintain their cash flow. With banks reducing their exposure to real estate, negative sentiment at the bourses and private equity coming at a high cost, giving freebies is a way to boost sales, which will, in turn, keep the cash registers ringing.
Earlier, developers promised waivers of stamp duty or parking charges to woo customers. But, with most homebuyers not getting lured by such offers, developers have become more desperate. Rather than reducing their basic sale price, they are introducing ever more attractive freebies, such as a car free with a home booking, or even buy-one-get-one-free deals.
If you are seriously tempted, be very clear about what’s on offer. For example, if it’s a buy-one-get-one-free deal, find out who will pay the stamp duty, parking, maintenance and other related charges of the second house.
Apart from high costs (both of real estate and home loan), genuine homebuyers are discouraged by the prevailing negative sentiment. So, if volumes do not increase in the short term, developers will have no option but to reduce rates.
Money Mistake 6
Prices are expected to cool further. I should wait to enter the market when prices hit a new low.
A slump in the fortunes of any asset class provides an opportunity for rich pickings. However, don’t try to time the market. Remember that the real estate arena is not homogeneous and price falls/corrections will vary across markets and properties. So, if you find a good property that suits you by way of location, amenities, construction and other factors within your budget, go ahead and invest. However, under the present circumstances, buy only in ready-to-move-in properties. If you plan for the long-term, you’ll never go wrong with real estate investments based on informed decisions.
Money Mistake 7
Since my EMIs have moved up, I should increase the rent to set off my EMI burden. Also, there is no point in getting any work done on the house as prices are falling.
Most investors see situations like the present one opportune to increase rentals. Your property broker will be happy to know that you expect higher rentals as it will increase his commission. However, it is best to be reasonable while increasing the rent; it shouldn’t be so high that it scares away a good tenant. It makes more sense to have a good tenant at slightly lower rent than a bad one at a higher rent.
So far as home improvements go, basic additional work like kitchen woodwork, a coat of paint and checking of electricity connections will increase your rental income by more than

10 per cent.

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Avoid your own financial crisis

Most investors have been too psyched out by the mayhem in the global financial markets and its crippling impact on their investment portfolios to take note of the lessons that the crisis holds for them—that poor decisions can land anyone, from large organisations to individuals, in a financial mess, and that this doesn’t take long to happen. For individuals, financial crisis can result from excessive borrowing, living beyond one’s means, poor asset allocation, under-diversification, medical emergencies, or even loss of employment. And it’s in deteriorating market conditions such as at present that individuals are made to pay dearly for such follies. Ergo, it’s important to work out a plan to stay in control and avert a financial crisis. Here’s what you should do.

Know your debt

We all need debt at some point. It can be a loan for a house, an automobile, education, or for other personal needs. But debts can be good, bad or ugly. Home loans are considered good debts as they are used to build useful assets. A home loan makes more sense if you want to switch from a rented to an owned house. And, the lesser the difference between your EMI (equated monthly installment) and rent, the more sense it makes to acquire a home. Says Sanjay Matai, Promoter, The Wealth Architect: “From the need perspective, it is prudent to borrow only for good loans and not to exceed certain limits.” Personal loans are “bad” debts, which should be availed of only in dire circumstances. Ugly loans include credit card debts that are used to finance consumption or luxuries. Both these loans come with high interest rate liabilities and should be avoided at all costs.

Borrow sensibly

Financial planners suggest that one should remain as debt-free as possible. If it’s entirely necessary, then one should borrow only to the extent one can comfortably. Says Viraj Ghatlia, Head, Financial Planning & Wealth Advisory, ASK Wealth Advisors: “When you borrow, you must compare the period for which you take the loan and its repayment schedule with future cash inflow projections. The inflows should always be far greater than the outflows since there can be other expenses besides servicing the loan.”

Normally, the size of down payment and EMI determines whether one can afford a loan or not. If you are taking a home loan, then look for a property for which you can make the down payment, which is usually 15 per cent of the cost of the property. Thus, you can go for a Rs 50-lakh home if you can pay Rs 7.5 lakh. Also, the home loan EMI should not exceed 40 per cent of your net take-home pay. In case of personal/credit card loans, the EMI should not exceed 25 per cent. When buying a home, you should ideally keep aside three months of funds (including EMIs and expenses) as a back-up.Says Gaurav Mashruwala, Certified Financial Planner, ACE Financial Advisory Services: “Do your own personal net worth calculation to keep track of your financial standing. This can be obtained by dividing the sum of all your assets such as money in savings or current account, NSCs, EPFs, property value, car value, stock value, etc., with total debts such as home mortgage, credit card balance, etc. Your total principal liabilities should not be more than 50 per cent of your assets

Don’t over-leverage

According to Mashruwala, overleveraging is a high-risk, low-return game. When you borrow for investment purposes, your net income depends on the returns generated from that asset class minus the interest paid. For example, X and Y invest Rs 5,000 each in a stock. While X invests his own money, Y borrows the same amount at the rate of 10 per cent annum. Let’s assume that over the next three years, the stock generates returns of 40 per cent. After three years, the net income for X will be Rs 7,000 – Rs 5,000 = Rs 2,000, but for Y, it will be Rs 7,000 – Rs 6,500 = Rs 500. Agrees Amar Pandit, Director, My Financial Advisor: “Borrowing to invest is a strict no-no.”

Watch your spending

Eliminating unnecessary expenses and saving prudently are the keys to sound financial health. To illustrate the virtues of saving, if you save an additional Rs 5,000 every month and invest it in a debt instrument that gives 8 per cent annual returns, it will grow to over Rs 17.5 lakh in 15 years. Says Pandit: “To reduce expenses, one can keep a check on entertainment expenses, cut down on the extra phone and look for bargains and offers while shopping.” Other ways of cutting expenses and increase savings are keeping interest payments on credit cards to the minimum, and even scaling up one’s income.Invest wiselyRegular saving and investing makes all the difference between hitting and missing financial goals. Says Himanshu Kohli, Founder Partner, Client Associates: “Every investor should balance wealth creators (equity and real-estate) and wealth preservers (debt) in line with his financial profile, investment objectives, risk appetite and time horizon. Try to put your money in investments that can earn you higher returns than the rate at which you are borrowing. This will help generate positive cash flows for you while servicing your loan.” You will be better off if you have emergency funds the size of 3-6 months of your monthly expenses to deal with unforeseen contingencies. Last, but not the least, buy mediclaim, accidental insurance, permanent disability and professional indemnity policies.

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