In the current market conditions, sales are muted in both primary and secondary residential real estate segments. The primary market has its own set of problems such as delivery risk. The resale market does not have this risk, as the properties are ready to move in, and yet sales are down here too.
In fact, there are many sellers who have been holding their investment properties for a few years now, hoping for the prices to revive. A common way out, which many sellers take when they need to sell a house, is to reduce the asking price for the property. And as is the nature of this market, if the asking price is sufficiently reduced, a buyer can be found fairly quickly.
Another approach is to put in more money in the property, and improve its value so that a buyer may prefer it over another one in the same area. Expenses on advertisements and property portal listings can also be seen as similar investments.
This is a buyers’ market and sellers have to walk the extra mile. However, many sellers may not have a clear idea on how low the asking price can be, after accounting for all the expenses and costs of maintaining and selling the property. Without this knowledge, a seller may, in fact, end up incurring a loss, without even realising it. Of course, to sell at a loss is also an option, specially when the future of real estate for the next 5 to 7 years looks bleak.
The faulty way of calculating returns
Typically, many people tend to calculate returns on real estate in absolute terms, that is: purchase price minus the selling price. For instance, if a property was bought at Rs60 lakh in September 2011 and can be sold now for Rs1 crore, then the return is assumed to be Rs40 lakh (Rs1 crore minus Rs60 lakh).
That works out to be an absolute return of about 67% over the 5-year period (2011 to 2016). Looking at this figure alone, a seller may want to lower the asking price substantially assuming that a good return on the investment will still be made. However, unlike other asset classes, the true returns on real estate investments are not so simple to calculate. One needs to take into account other cost heads. Consider the transaction cost: on an average, it is about 10% of the property’s value. Stamp duty is 4-8% of the property’s value, the registration fee is about 1% of property value. And both the buyer and the seller may have to pay 1% brokerage each, if the transaction is being mediated by a broker.
Then there is the interest, if the property was purchased with a loan. It costs money to maintain the property and there are costs associated with selling it too.
The better way of calculating returns
Continuing with the above example, suppose that the Rs60 lakh property was bought with a down payment of Rs15 lakh, and a loan of Rs45 lakh. The rate of interest on the loan is 9.5% per annum and tenure is 20 years. Other charges include stamp duty, registration fee and brokerage.
After calculating all the transactions costs and other costs, assuming a sale price of Rs1 crore, the absolute return on selling the property would be a meagre Rs12.43 lakh (see table). After 5 years of holding the property, it is safe to assume that most sellers will not want to bargain on the Rs1 crore asking price.
The above costs do even not take into account all the blood, sweat and tears that go into buying and selling the house.
This is why many financial planners warn investors to think twice before investing in real estate. “Real estate is cumbersome to acquire, cumbersome to maintain and cumbersome to liquidate," said Gaurav Mashruwala, a Mumbai-based financial planner.
Coming back to the point, before you think of lowering the sale price, make sure that you have a clear idea of the returns.
Having said that, offering a discount may not always be a losing proposition. A seller who wants out of paying the monthly payments on the house, may want to sell the Rs60-lakh house for much less than a crore. One has to evaluate the, “loss of interest on the income that a seller could have generated by reducing price by, let’s say, Rs2 lakh; versus holding the property for few more months in the expectation of price rise in near future," said Ankur Dhawan, chief business officer-resale business, PropTiger.com. It also matters “how long the property has been on the market and how many prospective buyers have seen it," added Dhawan. In the primary market, developers tend to offer freebies to lure homebuyers. But, “the opportunity to offer freebies is very limited in the secondary market," said Sumit Jain, national director, residential services at Colliers International India.
“Buyers in the resale market are worried primarily about the price that they would be paying for the property, and are not influenced by freebies," said Dhawan. However, the seller can offer payment flexibility, which is equivalent to a freebie, said Dhawan.
Don’t cut corners
Sellers may be tempted to cut down on some costs, such as those for upkeep of the property, to improve their margins. However, as this is a buyers’ market, the seller can’t cut out all the overheads.
The house may need to be jazzed up, to make it more saleable than another property in the neighbourhood.
“Sellers have to make the property salable by getting broken parts fixed, cleaning the property, maybe a fresh coat of paint if it’s too old," said Dhawan.
Spending on advertisements in newspapers and real estate portals would add to the costs, but they may still need to be incurred.
“Advertising...will cut short the timeline of finding a buyer," said Jain.
Also, bypassing a real estate agent in the current market may be difficult. Intermediaries play a major role during the slump periods. A good broker can advise you on how to position the property in the market, and what price and what strategy can be used to sell the asset within a specified timeline, said Jain.
If you are planning to sell your house, you don’t have much elbow room in this buyers’ market. But by correctly calculating the costs of selling your house, you can at least be sure of how much real returns you can make on the sale, and then decide how much you want to lower the asking price on your property, if you don’t want to hold on to it any longer.