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Only in black: This example shows all that is wrong with Indian real estate

I had an interesting conversation with a relative of mine early last month.

This gentleman had bought a flat in the Delhi sub-city of Dwarka sometime in 2002 at a price of around Rs 25 lakh. The area was totally undeveloped at that point of time and hence property was going cheap.

More than a decade later the flat is now worth around Rs 2 crore. The flat had been bought as an investment. My relative planned to sell the flat and use the money to meet the expenses of his daughter's education (she wants to do an MBA/PhD from a good university in the United States) as well as her wedding.

The balance that remained after meeting his daughter's expenses would go into his retirement fund, given that he has no plans of working beyond the age of 63-64.

 Only in black: This example shows all that is wrong with Indian real estate

AFP

During the course of our conversation I suggested to him that it would be a good idea to sell the flat and invest the money into different debt mutual funds. The logic being that Rs 2 crore was more than enough to meet his daughter's education and wedding expenses and at the same time add to his retirement kitty.

So it made sense to preserve the Rs 2 crore that he had managed to accumulate by investing in the flat, rather than look for more gain. Also, by investing in debt funds, the return that he would earn would be similar to a fixed deposit but the after tax returns would much better given that he could take indexation into account while calculating his taxes. Indexation essentially allows the cost of purchase of a flat to be adjusted for inflation.

The after tax returns would be in the range of 7-8% and he could make a decent Rs 14-16 lakh every year, which would further compound, if he stayed invested.

He liked the idea and decided to sell his flat. Given that the flat was in a good society, he got several good offers. But even one month later he has not been able to sell the flat.

He called me yesterday and told me that he hadn't been able to implement the plan I had suggested to him, around a month back. The reason for that was very simple. Although he had got offers from several buyers willing to buy the flat at Rs 2 crore, none of them were willing to pay him the entire amount in white, through a cheque. The buyers typically were ready to pay around Rs 80 lakh in cheque and the remaining Rs 1.2 crore in cash.

As mentioned earlier my relative had bought the flat at Rs 25 lakh, most of which was financed through a home loan. The remaining came from the savings he and his wife had put together. So all the money to buy the flat had been paid in 'white'. He had been lucky given that the builder he had bought the flat from was building his first project and was more interested in offloading what he had built, rather than insist on being paid in black.

The property dealers my relative had been dealing with to sell the flat had clearly told him that if he wanted the entire Rs 2 crore to be paid in cheque, then he could more or less forget about selling the flat. At best, they could get a buyer who would pay upto Rs 1 crore in cheque, the remaining Rs 1 crore would be paid in cash. For someone who has largely lead an honest life, he couldn't figure out how he would go around handling cash to the tune of Rs 1 crore. The brokers had a solution for this as well. They could help him buy gold bars. Or if he was willing to bet his money on real estate again, they could showcase some projects coming up on the outskirts of Gurgaon or on the way to Agra. Maybe he could buy two flats there, they suggested. And if he found all this too risky, he could simply store away the money in a couple of bank lockers. Even that could be arranged for, it was suggested.

My relative's situation is a very good example of all that is wrong with the Indian estate real system as it has evolved. Since a major part of the transaction is in black, the cash that is thus generated needs to be put to use in some way. Just putting it away in a locker isn't really a solution.

Money needs to keep growing. The amount paid in black can also be used to buy more real estate. For a flat which costs Rs 80 lakh, half the money i.e. Rs 40 lakh, needs to be paid through a cheque, and the remaining Rs 40 lakh can be paid in cash, brokers suggested to my relative. This also means that Rs 40 lakh of the Rs 1 crore that my relative had received in white would be put to use and become tax free. The law gives a tax payers two years from the date of the sale to invest in another 'residential' property. If the property is under construction, a period of three years is allowed. The amount invested becomes tax free.

As mentioned earlier Rs 40 lakh of the Rs 1 crore received in black, would be utilised to buy a flat. That means Rs 60 lakh would still remain. This can be used to buy gold. Gold can be easily stored and hidden.

The point is if a real estate investor wants to sell his property, he has to be ready to receive payment in black. If he doesn't want to be paid in black, it will be very difficult for him to sell his property. Once he has sold the property and received the money, he needs to put the 'black' money to use again.

This means buying more real estate in an up and coming location, where the prices are low. And so the cycle of black money continues with investors selling to each other, driving up prices and making real estate unaffordable for those who want to buy a 'home' to live in.

(Vivek Kaul is a writer. He tweets @kaul_vivek)

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Updated Date: Dec 21, 2014 03:09:40 IST