CAN RENTAL HOMES BECOME AN INVESTABLE PRODUCT?

Anjana Mohan

| 17-01-2024



CAN RENTAL HOMES BECOME AN INVESTABLE PRODUCT?


In the last 15 years, rapid urbanisation and exponential growth in employment have enhanced the rental housing domain. Compared to the stock market or even blockchain, real estate has traditionally been a non-volatile asset to invest in over the years. Real estate is always a favoured investment due to its long-term return from appreciation in asset value over the years, with minimal losses. More importantly, it is a physical, finite asset with a steady supply and a high value.

Despite the stagnating phase of vacant homes post-pandemic, by mid-2022, there was a resurgence in rental housing that saw up to a 45% increase in demand for rental homes, with improved rents in Bangalore Central Business District (CBD) areas and suburbs, too, that was at one point considered 'too far off'.

It only drove realtors to keep pace, giving rise to improvised and innovative rental realty, such as co-living, serviced apartments, and BTR (Build-To-Rent). These new-age models are paving new avenues for investments in rental homes. For instance, the BTR concept is betting on improved rental yields by building rent-ready homes that catalyse the tenant-home fit.

1. THE INDIAN CULTURE OF BUYING/ INVESTING IN 2nd OR 3rd HOMES

For Indians, purchasing a home is an emotional investment or a positive sentiment. Unlike any other financial asset, it is tangible. It satiates the buyer's human psyche, driven by a sense of security from living in their homes.

Whether an established businessperson, a young entrepreneur or a salaried employee, acquiring a residential asset has always been a priority for Indians. Owning a home has become a means of rental income and financial growth, making it a longstanding method of monetary investment with long-term returns.

Hence, home investments attract a large set of buyers for secondary homes, giving them a sense of a better lifestyle, social status, and financial security by renting or leasing these secondary homes. These investments draw a steady cash flow and reap several tax benefits associated with income through house rent.

In a fluctuating but resilient economy, such as India, and with the culture of joint families and an average of at least two children per family, it is customary to invest in homes to secure their family financially. This legacy continues to the next generations.

Today, millennials with better jobs and disposable income have a growing awareness and inclination for financial growth through passive streams. The career-focused millennials don't want to be dependent on just salaries but are riding the wave of change by dabbling aggressively in Crypto, Stocks and other futuristic products. Millennials consider investing in homes but are discouraged due to high prices, the hassle of maintaining a property, the longstanding challenges of investing in typical rental inventory, and associated disorganisation and malpractices in the real estate business. It pushes them to channelise their investing capacity into other financial products.

2. TYPICAL CHALLENGES WHILE CONSIDERING SECONDARY HOMES AS AN INVESTMENT & WHY OWNERS FEAR RENTING THEIR FLATS, INCREASING HOME VACANCIES

Buying a home, leave alone a secondary home, isn't something one does every other day. It requires severe considerations and financial planning. There are several hindrances a home buyer faces – finding a well-located property, the lump sum down payment, unpleasant negotiation with demanding owners selling, the horrid task of paperwork, and running pillar to post in government offices. After purchasing the home, an investment product must be made rent-ready. It involves the extended ordeal of finding tenants, furnishing and maintenance, and the corresponding paperwork for tenancy. Deliberations of a prospective home buyer are:

It comes at a hefty price: 

Homes require financial preparation and funds availability much in advance. A few years into their career, someone may have the liquid cash flow but may not be in a secure position to undertake the financial burden of buying a home, including 25% of the total value of the property, as a down payment. Hence, millennials may see it as something other than a realistic investible option in the early years of their career.

Cost of borrowing:

The overall affordability drops for the buyer decreases with the interest rates of loans at 7.5% to 9%, directly impacting the buyer's budget. Against such high-value loans, borrowing becomes a long-term commitment, with the additional stress of paying higher EMIs monthly for a shorter borrowing period. Even when renting out a bought house, the rental yield would be about 1-2% of the total property value, which is still lower than half of the loan's interest rate, making it a stressful uptake. 

Immovable assets:

A home could become an obligation, given the mobility of people and their jobs. One has to be sure of being anchored to a specific place. Otherwise, they buy a home in one city and move to another if the job demands. The asset alternatively becomes an option to give their house on rent to draw a passive income.

Value Depreciation:

Rental incomes may drop as newer properties with modern specifications and facilities come up in the neighbourhood. Depending on where their rented homes are situated (usually away from their primary residence), owners must find ways to manage and run their rental homes remotely or through third parties. Timely renovation, maintenance and repairs, and payment of taxes, to name a few, all of these add to the maintenance overheads, impacting the overall value of the acquisition. On the other hand, secondary homes, majorly bought as a means of investment and secondary income streams, come with their set of pain points, leading to intermittent, if not extended, vacancy periods.

Inventory is not relevant: 

With progressive changes in the new age tenant's mindset and lifestyle preferences, the owner faces a gap in his expectation of a tenant (for instance, renting to bachelors or spinsters is still a limitation with traditional homeowners, who expect a family to move in). Vice versa, the renter may need help finding it satisfactory to rent an older property with restrictions when other relevant housing options are available.

Rental laws and contract terms:

Pro-tenant contracts keep the owner on the back foot, intentionally keeping houses vacant. Fixed margins on rent amounts, fixed tenant occupancy duration, and tenant-owner disputes are seemingly pro-tenant, further discouraging the owner. 

Difficulty in liquidating: 

A rental property is undoubtedly a reliable source of income, but it is slow and depends on several socio-economic and consumer trends in the long run. Homes are illiquid assets that cannot be sold quickly and liquidated to cash. Due to this inherent risk, and growing rental competition, some owners need help to rent out the house or find a buyer to sell it to at an agreeable price.

3. THE NEW AND GROWING INVESTABLE FINANCIAL PRODUCTS FOR THE MILLENNIALS

With the surge of digital platforms or financial tech, millennials today are well-informed on futuristic products and disruptive digital assets. Over the past 2-3 years, decentralised finance (DeFi) has slowly made its presence felt in India. Apart from real estate and gold, here are some of the trending financial products:

NFT: 

Non-fungible tokens (NFT) are digitally investible assets based on cryptocurrency's blockchain technology. These 'tokens' can be anything digital; an artwork, a photograph, a tweet or even a scan of one's brain. NFTs allow the buyer to own something unique in its original form that cannot be replicated.

P2P (Peer-to-peer) lending:

It is a simple format of financial tech that connects lenders and borrowers directly, allowing them to borrow or lend money without going through a bank. P2P platforms allow users to create accounts and lend money to borrowers depending on their high/low-risk return factors. Its advantage is higher interest rates than banks, regardless of the borrower's credit score. 

Crypto: 

This is an intangible virtual currency also based on blockchain technology. Crypto derives value from various influential factors such as its limited supply, creating a higher advantage of exclusivity, its growing acceptance as a transactional currency by several companies, and drastic surges and falls that make the chance of much higher returns.

Futuristic products: 

Metaverse and Web 3.0 are gaining popularity, pushing companies like Spotify and Meta to create digital collectables for investing in the form of NFTs and crypto stocks. Metaverse is a booming virtual universe driven by blockchain that comprises digitised virtual assets such as augmented, virtual reality collectables and even crypto.

4. THE NEW AGE CONCEPT OF BUILD-TO-RENT HOMES IS PROVING TO BE A LUCRATIVE INVESTMENT, PRIMARILY FOR MILLENNIALS,   AND A GREAT PASSIVE INCOME SOURCE

For the new age investor, savings equates to growing their money. Instead of saving a lump sum in a bank account or fixed deposits, the millennial is a savvy retail investor who keeps a keen eye on financial trends. Unlike the previous generation of investors, the new-age tenant is willing to take risks to diversify their spread of investments and sources of passive income.

Last year saw a downhill crash in the crypto market, urging many of its young investors to be more judicious in their choice of investments. Owing to the uncertainty in these markets, the millennial is looking for a low-risk and long, rewarding investment that feels safer to bet on and helps build a long-term passive income without facing the need to sell the asset. Modern rental homes can do this for them since millennials today prefer renting to buying homes.

With this approach, Build-to-Rent properties become a low-hanging fruit for millennials who want to invest in rental realty and reap stable rental incomes. BTR homes gradually become inventory positive (50 to 100 flats or units), which allows its investors scalability, generating rental yields of 5-6% every month, with an annual increment of 3-5%, increasing their rental income significantly.

BTR homes are built specifically for rent, not for sale, promising a greater property and tenant fit - a core differentiator. Therefore, the asset is up-to-speed with new-age tenants' preferences, not only in terms of the design features of these homes but also in terms of amenities and services that ensure optimum tenancy, making the investment cash flow secure.

The beauty of BTR is that although buying into a rental home, the investor doesn't have to be involved with the hassle of renting. The BTR company handles it entirely (from finding a tenant, the paperwork, rent collections, and property maintenance). The investor must only invest and wait for the returns.

5. BTR EFFECTIVELY CATERS TO THE NEED FOR ENVIRONMENT-FRIENDLY AND SUSTAINABLE HOUSING INFRASTRUCTURE

"Green growth" or "Green buildings" is a rising need of the hour, becoming a priority in real estate. Environment-friendly and sustainable living has become more relevant than ever, making organisations and investors conscious about doing business and purchasing. The BTR concept embraces this need through conscience planning and development by integrating technology to reduce impact by monitoring lighting, air conditioning, elevators, and other utility systems.

The BTR model stays ahead by implementing sustainable practices such as integrating a digitised platform that helps eliminate waste from using paper and power. Additionally, with the advantage of developing ground up, BTR homes can remain up to speed with renovations that help maintain a building up to and over sustainable standards.



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