4 Reasons Why Your Property is One of The Best Forms of Leverage

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A few years ago, my friend bought a two-bed flat in Gurgaon. He had paid 20% cash as down payment, and financed the rest from the bank. The loan repayment period was 20 years. After three years of living there, he decided to sell the house and was able to get a price that was twice his initial purchase price. With the surplus money, he bought another three-bed flat on the outskirts of Gurgaon and was also able to clear the home loan for the previous house. So, in just a span of three years, he owns a three-bed flat using the principle of OPM (other people's money).

What is leveraging?

Leverage is the use of various financial instruments or borrowed capital to increase the potential return on an investment.

Loan against property

Banks and other financial institutions give loans against property, which is a good source of leverage. If you were to take a loan on the basis of your income of say Rs 10 lakh per annum, then, based on your income tax returns, the bank would probably loan you Rs 25-30 lakh. But, if you attach your existing property documents, then the loan amount can be significantly higher.

Ideal long-term investment tool

In India, the appreciation of property is very high and over a long period, the returns are exponential. In 1972, my father purchased a 500 square meter plot for Rs 14,000 in Chandigarh. At that time, the cost of constructing a single-story house was around Rs 76,000. So, the total investment needed was about Rs1 lakh – a large amount for 1972. Of course, my father did not have that kind of ready cash, and he availed of finance from a bank. In 2014, the net worth of this property is Rs12 crore. Had he invested that Rs 14,000 in a fixed deposit at a rate of 12% and reinvested the principle plus interest in the fixed deposit repeatedly, the present day value would have approximately been Rs18.3lakh. This exponential difference in the capital growth for the two forms of investments demonstrates why property is ideal as a long-term investment.

Regular income generator

Let your money work for you. The assets need to be converted into a money-generating tool. Taking cue from my father, in 2012, I planned to construct two more floors. The idea was to rent out the property. The cost of the construction was about 1 crore. Again, I did not have that kind of cash. I took a bank loan with a monthly installment of Rs 27000 for 20 years. I realized that Chandigarh was an educational hub for north India, and there was a huge demand for paying guests. After the construction was complete, the property earns around Rs 1 lakh per month in rent, and I am able to pay the installments comfortably. In fact, the rent even covers other operational expenses.

Income tax benefits

In both of these real life instances, for purchasing a house or adding to an existing property, the loan was taken from a financial institution. If you do the same, then as per Section 80C of the Income Tax Act 1961, you can claim tax benefits on the principle repayment and the interest component (under Section 24 under the Income from House Property head). But these benefits are available only for residential properties and not for commercial ones. Hence, the income tax benefits actually help lower the loan interest rates. "After all, every penny saved is a penny earned."

Disclaimer: Copyright Kotak Mahindra Bank Ltd.

4 Reasons why your property is one of the best forms of leverage

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