Should you invest in a second house?

FOR GOOD RETURNS: Independent houses fetch higher rent than apartments.  

OWNING A second home is not uncommon nowadays with rising salaries and easy finance. Many a house-owner considers acquiring a second property purely for investment purposes. But is a house or an apartment that you don't plan to live in, really a good "investment"? Experts say that renting out property as a residence cannot earn you a very high or a lucrative return. But it may be a good idea if you are looking for a stable source of income. You need to be mindful of three factors that can influence rents — the location of the property, the purpose for which you plan to rent it out and the timing of your purchase.

A thumb-rule used by realtors pegs the "fair rent" on residential property at 6-8 per cent a year. That is, the total rent you receive in a year should amount to 6-8 per cent of the market value of the home (This number, that is annual rent divided by market value, is termed "rent yield" in realty-speak).

In reality though, residential flats earn you a much lower rent yield. In today's marketplace, residential property fetches a rent yield of about 4 per cent. In other words, if you pay Rs.2,200 per sq ft to buy an apartment today, expect it to earn a rent of Rs.88 per sq ft for a year (four per cent of Rs.2,200) or Rs.7 per sq ft per month. In Chennai, residential apartments now fetch a rent of between Rs. 8-10 per sq ft a month.

But isn't four per cent a rather measly return on any investment? Not if you really delve into the numbers, points out one expert. "You can today get a home loan at an interest rate of about 7.5 per cent a year. Since the loan is tax deductible, the effective cost of the loan comes down to about five per cent a year, for those in the 30 per cent tax-bracket. A flat you buy today will earn an annual rent of about four per cent a year. So, even if the value of the property appreciates by just one per cent every year, the cost of your buying the flat is covered".

There are also other ways to bump up the rental income beyond the "four per cent" bar. To start with, if you are toying between an independent house and an apartment, it may be wise to settle for the former if you plan to rent it out. An independent house usually fetches much higher rent than an apartment; rents start from Rs.12 a sq ft, compared to Rs.8 a sq ft for flats. If you are keen on an apartment, realtors point out that new apartments developed as a part of a self-sufficient township are likely to command a higher rent than a standalone complex.

Location can make a big difference to the rent that you earn from property. Properties in up-market localities earn you substantially more rent for every rupee invested, than ones in peripheral areas. Buying into upcoming areas is another good strategy; rising demand from a floating population of IT/ BPO professionals has driven up rents in areas such as Velachery and Tambaram, which are proximate to the IT corridor.

With a rising number of expatriates looking for luxury homes in Chennai, rent yields have climbed sharply in exclusive neighbourhoods such as Boat Club, Poes Garden and Alwarpet. A rent of Rs.15-18 per sq ft is not unusual in these localities, substantially higher than the Rs.8-10 per sq ft that is the norm elsewhere. High-end apartments with amenities such as a full power backup, gym, play area and treated water, command better rent. However, such investment opportunities are only for those with the means, as the going rate ranges anywhere between Rs.3,500 - 4,500 per sq ft for purchasing high-end properties.

Whether you are looking to dabble in office space or in family homes, the timing of your purchase can make a big difference to the returns that your property generates. Timing your purchase well may be particularly important for your second home, because rents tend to climb much more slowly than property prices when the market is booming. "Whether for commercial or residential property, rents have simply not kept up with the appreciation in property values over the past couple of years. Rent yields have fallen over the past two years", observes a leading Chennai-based realtor.

So, if you bought a home in Chennai when the real estate market was in the doldrums a couple of years ago, you'd now be laughing all the way to the bank. Rents on residential property have climbed by 8-10 per cent over the past two years. As a result, the annual rent you earn may amount to 6-7 per cent of the initial investment, against the four per cent you will earn if you invest today. An appreciation of 15-20 per cent on the resale value of the home would have been the icing on your cake!

Office space - lucrative market

IF YOU view property solely as an investment, the market for commercial space is more attractive than residential apartments. But this is not for the common investor-buyer as the initial investment could run into at least a crore of rupees. With several mid-sized IT/BPO firms now making a beeline for Chennai, the demand for office space (upwards of 5,000 sq ft) has grown at a fast clip in recent times. While rent yields in the residential market hover at a modest 4-6 per cent, you can expect anywhere between 10 and 11 per cent, when you lease out property for commercial or office use.

Rents for office space range anywhere between Rs.26 and Rs.44 per sq ft a month, depending on location. Dabbling in the commercial property market may call for a minimum outlay of Rs.1.25 to 1.5 crore. Banks and institutions such as HDFC now offer a range of financing options for the purchase of commercial property. They typically fund 60-70 per cent of the property value, with the rest to be put up by the investor. The loan is secured against the future rent receipts from the tenant, which go directly to the financing institution to repay the loan.

The purchase price for commercial property is directly pegged to the rent that the property can fetch. "Commercial property prices are determined solely by location and the quality of tenants who occupy the space," notes Mathew Joseph, who heads the Tamil Nadu and Kerala operations of HDFC.

With the IT corridor witnessing rapid development, areas such as Old Mahabalipuram Road, Porur, Mogappair and Kodambakkam are happening new destinations for commercial property buyers. The Guindy industrial area too is seeing a lot of new development, says Mr. Joseph.