Nuggets of Wisdom

Chapter 6

Power of the EMI

How to use EMI to your advantage, especially when circumstances are favourable

The Indian Economy in 2003 was humming along with moderate inflation and great growth rates. The economy had set itself for the boom period. It was in these times when my friend Mahesh, began to look at different properties to make his first investment in real estate. He had a home of his own and this search was for investment purposes. It was the beginning of his eventful journey.

The turn of the century was a time when a large portion of working India began to
discover the power of the EMI (Equated Monthly Instalments). The EMI enabled a number of young Indians to be able to afford homes without having to drum up the entire capital requirement upfront. It did have its pitfalls. The sudden flush of liquidity into the real estate space due to EMIs was one reason why prices began to climb steeply over a period of time.
It created huge demand without the supply side of the equation being worked out. Overall however, it was a great enabler and people who made good use of it benefitted immensely.
Take the case of Mahesh. He narrowed down on the available choices and bought his first home in the year 2003. The rental he was getting initially barely covered the EMI. To begin with the EMI payable did stretch his budget, yet the time at which the property was acquired, was a masterstroke. The economy began to gallop and wages saw huge increases year on year. This caused a significant increase in his rental income and by the year 2005, his new property began to pay-off its EMI on its own. Moreover during this period, in terms of the capital invested, the value of the property appreciated significantly. Additionally,
Mahesh also benefitted with an increased pay. He was back in the market hunting for his next property.

In the year 2005, Mahesh bought his second property. The EMI again, was a stretch.
The properties in 2005 had gone up in price significantly since 2003. Mahesh, in any case, was optimistic. As luck would have it, it was an encore. The economy galloped further, wages increased and the rentals rose again. To Mahesh’s credit, it must be said, he had bought into a fast growing micro-market in the city with great potential for rising rentals.
Again, the rentals began to pay off the EMI and Mahesh was sitting pretty. His salary had risen further; not only had his property values appreciated, but they had also become self-supporting, paying themselves off.

Mahesh was on a roll and in 2007, he was back on the market buying his third
property. The prices were a real stretch but he persisted based on his experience. He carried a huge EMI burden to acquire his third investment. However this time, he was not so lucky.
By 2008 there were shocks in the global economy and he lost his job. The rentals did not rise as much as he had hoped and his EMI became a huge cannon ball chained to his leg. He was still scraping from his savings to pay for his EMI when I last met him. Moreover, he could not easily dispose the property because of the market conditions. The property had become illiquid and a white elephant.
Nevertheless, it is a story of the power of the EMI. In a humming economy and rising market the EMI often allows you to lock in the price of a property and pay for it over a period of time. One is at an advantageous position if the economic conditions are just right.

What does happen is that while the EMI is fixed, the wages and rentals would rise over time, thus, with time this would enable one to comfortably payoff the dues of the property. In addition, the property price could appreciate in value giving handsome capital returns. Moreover, if the property does undergo significant capital appreciation it may be possible to renegotiate the EMI on more favourable terms, based on the improved collateral to loan ratio.

One needs to be cautioned that it may not always pan out this way. One of the most important things to be sure of; is the micro-market. If the micro-market or local pocket where one bought the property grows, one could benefit from rising rentals and good capital appreciation. However, if the purchase is hurried and is made without weighing the location and the microeconomic conditions, one may neither be able to get the expected rentals, nor would one be able to easily dispose the property, thus, leaving one in a very sticky situation. What Warren Buffett says about stock is equally valid for real estate.

He said “It is better to buy a wonderful stock at a fair price than to buy a fair stock at a wonderful price.” When one applies this wisdom to real estate, it can be said that properties should not be bought just because they are cheap or discounted. Further, one needs to check the rentals the properties would fetch and the potential increase in rentals by gauging the scope for future economic activity in that location.

Another caveat is, if prices are ahead of fundamentals and one pays an exorbitant
amount for the property; then one would need to be prepared for a lengthier wait to reach the state of comfort. It could take longer and one may need to stick it out.
Also, it’s important to be prepared for shocks in the economy and on the personal
front before taking the plunge.
The best timing is when one judges the economy right and there is an upward trend in the economy. Then one would be able to ride the tailwinds and exploit the factors going in one’s favour, as Mahesh did. Locking in a good interest rate and driving a hard bargain from builders in crunch time is part of the game. So do use the ‘Power of the EMI’ to your advantage.