I have made a comparison of Real Estate as an investment option to earn yield via rent, versus a traditional FD and also an index fund.
For this, I am using a 3 to 5 year old 3BHK apartment which is available for sale at 1.4 cr. Assuming no loan, although that may not be the case for everyone, and a home loan will certainly eat into one's yields if they are opting to go for a home loan to buy an apartment, even though there are some tax sops for home loans.
Cost of home: Rs 1.4 crores.
Rent for 3BHK - Rs 50,000 per month
Rent Escalation rate - 5% (conservative, though it can be 10%)
Period
Cash Flow (-)
Cash Flow (+)
Description
Yield
01-June-2023
1,40,00,000
Purchase of property
01 June 2023 to 01 May 2024
Rs 5,50,000
Rent for 23-24
3.93%
24-25
Rs 5,77,500
Rent for 24-25
4.13%
25-26
Rs. 6,06,375
Rent for 25-26
4.33%
26-27
Rs 6,36,693
Rent for 26-27
4.55%
27-28
Rs 6,68,528
Rent for 27-28
4.78%
28-29
Rs. 7,01,954
Rent for 28-29
5.01%
29-30
Rs. 7,37,052
Rent for 29-30
5.26%
30-31
Rs. 7,73,905
Rent for 30-31
5.53%
31-32
Rs 8,12,600
Rent for 31-32
5.80%
32-33
Rs 8,53,230
Rent for 32-33
6.09%
So The total rental yield in 10 years = Rs. 69,17,840
Now if the seller wants to sell this property after 10 years, and assuming conservative property escalation rate of 4% a year, he will get :
Sale proceeds: Rs. 2,07,23,419
So rent over 10 years, the initial Rs 1.4 cr has now become Rs 2.07 Cr (sale proceeds) + 69.17 Lakh (rental yield) = Rs 2.76 Cr
Now instead, if the initial 1.4 Cr is invested in a FD at 8% PA or index fund assuming 10% PA,
The returns are as follows:
Fixed Deposit:
FD Rate 8%
Capital Rs. 1,40,00,000
Period (years) 10
Return 2,88,54,441 (Rs 2.88 cr)
For Index Fund,
Index Fund Returns: 10%
Capital Rs 1,40,00,000
Period (years) 10
Return 3,63,12,394 (Rs 3.63 cr)
So it seems that even a simple FD and also an index fund hands down beats the returns from investing in property, including the rental income.
Are these assumptions and conclusion correct , i.e its better to invest in mutual funds/indices over buying a property as an investment for rental yields?
Under what conditions will a property be a better investment, if one wants to diversify their asset allocation?
A higher property escalation rate like 10% would definitely turn the tables in favor of the property investment, and this can happen in areas where new roads/metros/IT infrastructure corridors are planned. But even if we assume a 10% property escalation rate, I'm skeptical that someone would buy a 10-15 year aged 3 BHK for 3.6 Crores, when there is likely to be new property offerings in the same area at a much more reasonable price?
Edits:
Reinvestment of rent into equity index scheme:
By reinvesting the yearly rental into equity index, this adds to the overall returns of the portfolio.
In this case, I am investing the yearly rent at the end of 12 months into an index fund. Of course, one can do it monthly as well, but for yearly re-investments, the numbers are as below:
At the end of the first year, Rs. 5,50,000 is invested into the index fund.
At the end of the second year, the index fund will have 10% (theoretical) returns from the first year's rent + new corpus of second year's rent. So the fund balance will now be (5,50,000*10%)+5,50,000 + second year's rent (5,75,000).
Overall, for 10 year period, the rental re-investment index fund's balance at the end of the period is: Rs. 1,06,13,326.
Compared with the rent alone (Rs 69.17 lakhs), reinvestment of rent into index brings much higher returns.
Taxation:
I have ignored taxation, as the investor will fall under the top taxation category. Thus, rentals will be taxed every year, and fixed deposit interest will also be taxed every year - thereby both will reduce the compounding effect. However, equity funds taxation will be taxed only on withdrawal.
For this, I am using a 3 to 5 year old 3BHK apartment which is available for sale at 1.4 cr. Assuming no loan, although that may not be the case for everyone, and a home loan will certainly eat into one's yields if they are opting to go for a home loan to buy an apartment, even though there are some tax sops for home loans.
Cost of home: Rs 1.4 crores.
Rent for 3BHK - Rs 50,000 per month
Rent Escalation rate - 5% (conservative, though it can be 10%)
Period
Cash Flow (-)
Cash Flow (+)
Description
Yield
01-June-2023
1,40,00,000
Purchase of property
01 June 2023 to 01 May 2024
Rs 5,50,000
Rent for 23-24
3.93%
24-25
Rs 5,77,500
Rent for 24-25
4.13%
25-26
Rs. 6,06,375
Rent for 25-26
4.33%
26-27
Rs 6,36,693
Rent for 26-27
4.55%
27-28
Rs 6,68,528
Rent for 27-28
4.78%
28-29
Rs. 7,01,954
Rent for 28-29
5.01%
29-30
Rs. 7,37,052
Rent for 29-30
5.26%
30-31
Rs. 7,73,905
Rent for 30-31
5.53%
31-32
Rs 8,12,600
Rent for 31-32
5.80%
32-33
Rs 8,53,230
Rent for 32-33
6.09%
So The total rental yield in 10 years = Rs. 69,17,840
Now if the seller wants to sell this property after 10 years, and assuming conservative property escalation rate of 4% a year, he will get :
Sale proceeds: Rs. 2,07,23,419
So rent over 10 years, the initial Rs 1.4 cr has now become Rs 2.07 Cr (sale proceeds) + 69.17 Lakh (rental yield) = Rs 2.76 Cr
Now instead, if the initial 1.4 Cr is invested in a FD at 8% PA or index fund assuming 10% PA,
The returns are as follows:
Fixed Deposit:
FD Rate 8%
Capital Rs. 1,40,00,000
Period (years) 10
Return 2,88,54,441 (Rs 2.88 cr)
For Index Fund,
Index Fund Returns: 10%
Capital Rs 1,40,00,000
Period (years) 10
Return 3,63,12,394 (Rs 3.63 cr)
So it seems that even a simple FD and also an index fund hands down beats the returns from investing in property, including the rental income.
Are these assumptions and conclusion correct , i.e its better to invest in mutual funds/indices over buying a property as an investment for rental yields?
Under what conditions will a property be a better investment, if one wants to diversify their asset allocation?
A higher property escalation rate like 10% would definitely turn the tables in favor of the property investment, and this can happen in areas where new roads/metros/IT infrastructure corridors are planned. But even if we assume a 10% property escalation rate, I'm skeptical that someone would buy a 10-15 year aged 3 BHK for 3.6 Crores, when there is likely to be new property offerings in the same area at a much more reasonable price?
Edits:
Reinvestment of rent into equity index scheme:
By reinvesting the yearly rental into equity index, this adds to the overall returns of the portfolio.
In this case, I am investing the yearly rent at the end of 12 months into an index fund. Of course, one can do it monthly as well, but for yearly re-investments, the numbers are as below:
At the end of the first year, Rs. 5,50,000 is invested into the index fund.
At the end of the second year, the index fund will have 10% (theoretical) returns from the first year's rent + new corpus of second year's rent. So the fund balance will now be (5,50,000*10%)+5,50,000 + second year's rent (5,75,000).
Overall, for 10 year period, the rental re-investment index fund's balance at the end of the period is: Rs. 1,06,13,326.
Compared with the rent alone (Rs 69.17 lakhs), reinvestment of rent into index brings much higher returns.
Taxation:
I have ignored taxation, as the investor will fall under the top taxation category. Thus, rentals will be taxed every year, and fixed deposit interest will also be taxed every year - thereby both will reduce the compounding effect. However, equity funds taxation will be taxed only on withdrawal.