Second Home for Investment Vs Mutual Funds – with Calculator

Suresh & Sumesh are working in the same office. Both of them got a windfall of 10 Lakhs by selling the ESOPs allotted to them.  Suresh is thinking of buying a second house.  He thinks that it is a good idea to buy a second house for two reasons

• Investment purpose as the property prices are bound to increase
• Constant source of rental income

Is he right in his thoughts of buying a second house for investment and rental income? He is consulting his various friends for their suggestions. Everyone had different views and suggestions. Lastly, he came to Sumesh for the advice. Sumesh is the investment expert in his office and is planning to invest his 10 Lakhs in mutual funds.

Sumesh explained the pros and cons of real estate investments to Suresh.

Sumesh asked Suresh few questions.

• How will it impact your other financial goals?
• How much is the property price?
• How much amount you are going to pay for the down payment?
• How much monthly EMI are you going to pay?
• Are you going to invest your rental income anywhere?

Suresh answered these questions one by one.

• Suresh earns a good salary and was well placed with his main financial goals of children education & marriage and retirement. He had a surplus of 10 Lakhs which he wanted to use for investment.
• The property price is 50 lakhs
• 10 Lakhs was the amount for down payment
• He wanted to opt for a home loan of 40 lakhs for which monthly EMI was 35989
• He wanted to invest his rental income in equity mutual funds

Now let us analyze who will have more wealth after 20 years.

Suresh is purchasing a 50 Lakhs property with 10 Lakhs down payment and 40 Lakhs home loan.  The EMI for a 20 year loan at 9% interest comes to Rs. 35,989/-.

Assuming a 6% increase in property value throughout the tenure, the house value will be around 160 Lakhs after 20 Years. He is expecting an average rental income of 15,000 per month from this. After maintenance expenses and taxes, he is planning to invest 10,500 per month in equity mutual funds.  This investment can give him an accumulation of 104 Lakhs after 20 years assuming 12% CAGR.  He is not considering the likely increase in rental income in future years because he is not expecting the property to be occupied for all the 12 months in a year. There can be break in between. Since he is working in private sector and changes job location frequently, he is sure of not getting tenant always.

So, Suresh will have 264 Lakhs (160 +104 =264) after 20 years.  Out of this, 160 Lakhs is in the form of a 20 year old property.

Sumesh invested 10 Lakhs in equity funds and decided to invest 30,789/- per month in equity funds for 20 years.  After all, this is the amount, he is getting more than Suresh.

The investment of 30,789/- per month in mutual funds can create around 305 Lakhs assuming a return of 12%.  The lumpsum 10 Lakhs invested can create another 96 Lakhs after 20 years.

So, Sumesh will have 401 Lakhs (305 +96 = 401)

In this example, Sumesh is the clear winner with an extra of 137 Lakhs (401-264 =137)

Sumesh is thinking of purchasing a brand new retirement home with this 401 Lakhs, close to his retirement, if he feels it better at that time. Suresh will be left with a 20 years old house.

Also, Suresh would be paying around 86 Lakhs in 20 Years, as he is paying monthly EMI of 35,989 for 20 years.

Assumptions in the calculations

Equity mutual funds return is assumed at 12% for the next 20 years which is realistic considering the past returns and the future growth prospects of a growing economy like India.

Suresh feels that the annual appreciation in property can be more than 6%.  Is he right? I don’t think so. With huge unsold properties across the country, even 6% is on a higher side for a long term like 20 years.

Real estate as investment

Real estate is an illiquid asset. If you want to buy it now, it is very easy. But if you want to sell it at a later date to realize its value, it is not an easy job. It may take years to get a genuine buyer.

Purchase real estate, if you want to stay there and don’t purchase it if you want to sell it at a later date for other goals. There can be some exemptions in select pockets in the country, where it is still attractive. But in general, real estate is not an attractive investment option for long term.

2^nd House investment Vs Investment in Mutual Funds Calculator –

You can use this calculator to decide whether to invest in second house or in mutual funds, choice is yours.

2nd house for investment

Keep few things in mind while using the calculator

• Do not take appreciation in house value more than 6%. It would be highly optimistic!
• Do not consider rent per annum as more than 2%-3% of your property value.
• Do not take mutual funds returns more than 12% to be on safer side.

Do not think about all this if you are purchasing your first house where you are going to stay. First house is always an emotional decision but for 2^nd house for investment purpose, take cautions approach.

Keep Investing and Happy Investing!!!