Retirement Planning – How Good Is Property As Investment

Can a property investment guarantee comfortable retirement?

Yashpal, 40, is going to retire after 20 years. Like everyone, he too wishes a comfortable retirement life and for that he wants to make an investment that would fetch him big money. He is certain that the realty sector would do well in the years to come, so instead of going for conventional financial tools like FD and mutual funds, he is considering investing in a property. He believes that he will receive adequate funds by selling the property upon his retirement that will be sufficient to take care of his post-retirement expenses.

Whether Yashpal is right or wrong, we will know only after a detailed analysis of the both pre-retirement and post-retirement conditions, for which we will use the following diagram.

What is the total amount needed by Yashpal post retirement?

Yashpal wants to accumulate funds to meet his post-retirement expenses which are basically going to be in two forms – monthly and lump sum. Let us, therefore, consider both of them separately.

Monthly expenses
Let us assume that Yashpal's monthly expenses are Rs 28,000 (approx.) at today's prices. If there is an annual increase of 5 per cent in the inflation rate, the monthly expenses for Yashpal post retirement would be as follows:

Lump sum expenses
The possible lump sum expenses of Yashpal, in terms of today's prices, can be broken down as follows:

Therefore, the lump sum expenses adjusted for inflation when Yashpal retires at the age of 60 would be

= Rs 7,30,000 x (1 + 5%)²⁰
= Rs 19,36,907

Total expenses
To calculate the total amount needed by Yashpal to finance both his monthly as well as lump sum expenses, we make the following assumptions:

• Funds will be required for 20 years after retirement as Yashpal's expected life is 80 years
• The return on post-retirement funds to be at 9 per cent p.a. with Yashpal striking a balance of safe and aggressive investments (earning 4 per cent above the inflation rate of 5 per cent p.a.)

After calculation, the amount needed on retirement by Yashpal will be:

Investing in a property

We saw that Yashpal needs a total amount of Rs 1.44 crore on retirement (60 years). This amount is to be generated by a property investment. This means, a house Yashpal will buy today should be worth Rs 1.44 crore at the time of its sale (at Yashpal's retirement age).

• Time for investment � 20 years
• Property appreciation � 5 per cent p.a. (at inflation rate)
• Funds needed for retirement � Rs. 1.44 crore

We assume that Yashpal invests in a property worth Rs 50 lakh today. Now, let us analyse the kind of investment it would mean for him given the following facts:

• Yashpal takes a home loan to buy Rs 50-lakh house, after making a down payment of Rs 10 lakh (approx.)
• Loan duration – 20 years; rate of interest – 9 per cent p.a.
• Maintenance charges for the house – Rs 2,500 per month
• Yashpal rents the house till retirement at Rs 25,000 per month
• Increase in rental – 5 per cent p.a. (at inflation rate)

Is it a profitable investment for Yashpal?

Let us compare Yashpal's initial investment with the value of the house after 20 years and check out whether the investment was a profitable one for him.

Initial investment

Yashpal's initial investment would be the down payment of Rs 10 lakh (at 40 yrs.) he makes to buy the house.

The above table shows that Yashpal needs to continue investing in the property only till the 9th year, after which he will start getting positive returns.

Final property value

After 20 years (at Yashpal's retirement age), the final property value calculated at an appreciation rate of 5 per cent p.a. is going to be

= Rs 50,00,000 x (1 + 5%)²⁰
= Rs 1.33 crore

But the funds required by Yashpal on retirement are Rs 1.44 crore.

Therefore, the funds generated through this property investment are insufficient (a shortfall of around Rs 11 lakh) to meet the post-retirement expenses of Yashpal. So given his requirement, Yashpal should

1. Invest in a property of a higher value today if he expects the appreciation rate to hover around 5 per cent p.a.
2. Make aggressive investments from the proceeds of the sale of the property to earn higher returns
3. Find additional sources to fund his post-retirement expenses

Can the investment be turned into a profitable one?

Let us now see how different scenarios will impact Yashpal's investment.

Scenario 1: Appreciation rate is higher than inflation rate

If we consider that the property rate appreciates at 6 per cent p.a. instead of 5 per cent p.a. assumed earlier, the final property value at Yashpal's retirement age will be

= Rs 50,00,000 � (1 + 6%)²⁰
= Rs 1.60 crore

In this case, the return is more (Rs 16 lakh excess) than the required retirement funds of Rs 1.44 crore, which is enough to take care of Yashpal's expenses after his retirement.

Scenario 2: Annual saving of Rs 25,000 during his service

We have already seen that an increase in the property value at 5 per cent per annum (initially assumed) means Yashpal requiring another Rs 11 lakh to meet his targeted retirement funds. But, if he manages to save Rs 25,000 per annum and invests this amount in equity components, his investments will grow to Rs 11.44 lakh at 8 per cent p.a. in a period of 20 years. So, it will serve his purpose for his retirement expenses.

Summing it up

• If possible, Yashpal must look for the ways to decrease his monthly expenses in the pre-retirement period. This will boost his retirement funds.
• Property value of houses in good localities rises higher. Thus Yashpal should buy a property in such a locality or invest in a house only if he expects the annual appreciation rate to be around 6 per cent or more, i.e., the property value should rise faster (1-2 per cent) than the rate of inflation.
• If he invests in a house whose property value appreciates at 5 per cent per annum, he needs additional efforts like saving Rs 25,000 or more per year and investing the same in equities, expecting a growth rate of 8 per cent p.a., to fill Rs 11-lakh shortfall in his retirement funds.