Last Updated on February 12, 2022 at 6:15 pm
Rental income is immediately appreciated by one and all as a form of passive income – perhaps the oldest. Real estate has an undeniable charm associated with it and it is quite natural to ask if it can be used as a source of passive income particularly after retirement.
We had discussed how passive income is a crucial part of your retirement plan and how can one build the ideal retirement portfolio that goes beyond money. If you enter a constant source of income that you are likely to receive after retirement – say a pension or rental income – into the freefincal robo advisory template, you can see a dramatic drop in net corpus required and therefore the investment required.
A source of rental income as a component of our retirement basket is certainly welcome, particularly when such income is from inherited property. The question we shall consider here is, “can we invest in real estate to get rental income?”
Such a discussion gets sidetracked towards, home loan interest rates, appreciation potential of the property and rental yields and important aspects of goal-based financial planning is never considered.
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Use a simple retirement calculator to think twice about getting a home loan (for sell occupation or investment). The simple ground reality is we need to invest at least 75% of our essential monthly expenses towards retirement (including EPF/NPS contributions). Then come the future expenses for our children which has much higher inflation. This would leave little money to consider property purchase. I am willing to wager that most people who enter into a home loan agreement have not bothered to think about how it would affect their retirement plans.
(1) The point is, we should consider real estate as an investment only after we start investing enough for our financial goals. Real estate investment is an unnecessary luxury for most retail investors as they do not have enough to invest towards their financial goals.
“Property would always appreciate in value” is an unsubstantiated claim that is doing the rounds even after the visible slowdown in the real estate industry. Even if we agree that property does not get devalued easily and will always increase in value, the rate of appreciation can be small.
In any case, this appreciation is irrelevant because most buyers are reluctant to sell. I personally know of six families with multiple properties, at least one is locked up with no tenant; their liquid net worth is not much to speak of and they are refusing to sell the place!
Appreciation in property value is of no relevance if the buyer does not want to sell. Yes, it is the same as notional gains from mutual funds or stocks. Everyone says real estate is illiquid. What does this actually mean? (1) It refers to our emotional attachment to property (unlike gold or stocks) and (2) even if we do wish to sell, we will find a buyer but not get the price we want. Illiquidity does not mean lack of buyers but a huge gap between asking price and buying price.
(2) If a property is purchased as an investment, rental income is likely to be the only dividend. There is a huge gap between the home loan EMI rate and the rental yield. EMI outgo could be three times the rental income you get from the place. This will continue for a decade until the loan is closed (pre-closure could mean further loss due to time value of money). Rental yields for most properties are comparable to an SBI SB account rate.
Unless the property is sold at a later date for a significant profit, the loan would always mean we lose out. Not to mention the difficulty with getting tenants; increasing rent down the line, recessions etc. There are two unknowns here: we have no idea if we would actually sell the property later on (mindsets change; circumstances change;) and even if we do, we may end up getting a return comparable to a fixed deposit.
Then comes the actual state of the real estate market. It is easier to buy direct equity than real estate. There is no market-determined price; dealings could involve black money and unless we understand ins and outs of construction terms, we are likely to be short-changed. Forget the risk after purchase, the risk in the purchase is simply too high for a regular salaried guy who dreams of real estate investing (based on anecdotal evidence) but does not or cannot do the required research to think the purchase through.
Assuming you have some spare money (after accounting for your goals), a long-time SIP in gilt funds (assuming you do not want equity risk) will help you get reasonable returns with safety and liquidity. The effective return from your real estate investment could be lower than this simple step!
Want to calculate your existing property returns, try this free tool: Real Estate Returns Calculator