What to look-out for in a property for rent

A lot of investors buy property on the basis of back-of-the-envelope calculations of rental income. Unfortunately, many of the assumptions they use are not realistic. If you are also planning to buy property to rent out, make sure you do not make the same mistakes.

The first assumption is that the property will earn rent throughout the year. The calculation can go awry if you are not able to find a tenant. This is especially true if the property is in a far-flung and sparsely occupied locality. You might also have to shell out 15-30 days' rent as brokerage if you find a tenant through an estate agent.

To earn an attractive rental return, buy the apartment in a service or manufacturing hub. "You may buy the apartment at some distance from the employment hub, but it should be well-connected. You may then get the flat at a lower price and be able to earn a higher yield of 6-7%," says Ashutosh Limaye head, research & REIS, JLL India. He cites the example of Old Madras Road in Bangalore, which is well connected to Whitefield.

Another flawed assumption is that the rent received will be net return. Rental income is eligible for a 30% deduction but the balance 70% is added to the income of the owner and taxed as normal income. If you are in the highest 30% tax bracket and earn Rs 20,000 as rent from your property, the post-tax income will be only Rs 15,634 a month.

It's a bit easier if you have taken a loan, because under Section 24b, the interest paid on the loan can be deducted from your total income. It certainly brings down the cost of the loan. Here again, keep in mind that the interest portion of the EMI keeps coming down every month. So, the tax benefit will dwindle with every passing year.

Residential or commercial property?

Investors are also swayed by the greater demand for residential property. True, such property has a higher demand, but the prices push down the rental yields. "Rental yields from residential property are very low at 2.5-3%," says Limaye. On the other hand, commercial property offers rental yield of 6-9%. "However, buyers of residential property are compensated by higher capital appreciation," points out Sanjay Sharma, managing director, Qubrex, a Gurgaon-based real estate consultancy.

There are other advantages as well. It is easier to find tenants for a residential property. However, an investor must also take into account the legal implications if the tenant refuses to vacate the property.

Also consider the tax implications of owning a house. If the house is lying vacant, you have to pay tax on the deemed rental from it at marginal tax rate after 30% deduction. Owners of vacant residential properties also have to pay wealth tax at the rate of 1% of the amount by which the combined value of your assets exceeds Rs 30 lakh. Commercial property is not included in the computation of wealth tax.

Source: The Economic Times