Investment real estate

Investment real estate is a type of investment in real estate to get regular returns. Therefore, a second home qualifies as an investment real estate, so does investment in an office unit.

Why invest in this fashion?

Interest on deposits with banks and other business enterprises appear to be much higher than income generated by investments in real estate. Therefore, such investments do not appear to make much sense. However, there are two components of returns on investments in real estate. The monthly rentals are the smaller component. The capital appreciation is the larger component.

The reasons such investments make sense are:

  • The capital appreciation is taxed only when the real estate property is sold.
  • This capital appreciation continues to compound at a rate much higher than inflation, effectively defeating inflation. Unlike this, the interest earned on deposits or bonds is consumed and there is no ploughing back. Therefore, over a period, returns on deposits do not suffice to meet regular expenses.
  • Rentals increase annually, and are effective means to tame inflations impact on monthly budgets.
  • In emergencies, the real estate properties may be mortgaged to raise some funds.
  • These properties may be mortgaged to raise funds for consolidating costlier debts. Such mortgage loans carry lower interest rates because the underlying security continues to appreciate over a period, effectively providing cover to lenders principal as well as interest. Moreover, these loans are repayable over longer tenure, in smaller monthly installments, unlike other unsecured loans.
  • The investor can also get loan on prospective rental receipts from some banks.
  • If and when the investor finds himself with some additional funds, he or she can make additions to the property, thereby increasing its value. Such value additions can be made with smaller amounts as well, as adding a swimming pool, or developing a garden, etc.
  • The interest paid on mortgage loans is deductible from annual income, for arriving at taxable income.
  • Unlike gold this investment cannot be robbed. Nor does it require specific safety measures for preventing theft.
  • Unlike shares, the values of investment real estate properties do not witness a great deal of volatility.

    • How is investment real estate financed?

    Like all real estate properties, investment real estate properties are also very costly. It does not make any sense in pouring in all savings to purchase such properties, because parts of the returns materialize after several years. Taking mortgage loans for purchasing such properties is the best way. Part of the purchase costs may, however, be paid through savings, or borrowings from friends and relatives. Many banks, credit unions, financial institutions, and private lenders offer long-term loans on mortgage of investment real estate. These loans are generally repayable in monthly installments. There are some creative options in these loans, such as ballooning and moratoriums, quite like the home loans. However, not every bank or lender offers such finance options. Interest rates also differ from bank to bank, from lender to lender. So investor must shop around and find a lender who offers the best terms and conditions.

    Interest rates on loans granted by lenders for purchase of investment real estate are slightly higher than conventional home loans. This is because the governments subsidize such interests on first time home loans. Since investment real estate is an investment and not a necessity, the governments do not extend such subsidies to this type of property purchase. The other reason for such interest rates being higher is the fact that the ratio of defaulters is higher in this category. Therefore, the banker or lender attempts to recover the loaned amounts at faster rate, to mitigate risks of future defaults.

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