Contemporary Structure of Fixed Monthly Expenses

The article attempts to deal with the dilemma of an investor who is facing the challenge of choosing a product among various available asset classes that provides monthly return on his investments (which is, say, approximately equal to his fixed monthly lump sum amount of household expenses) in addition to capital appreciation of his investments. The author has made an endeavour to compare the age-old practice of building rental income from buying and leasing real estate properties versus investment in structured products in the equity market, which yield fixed monthly income along with a gradual increase in the underlying corpus.

What is 'your' ninja technique to structure a secured flow of fixed monthly expenses? This is a million-dollar question, especially for the mid-life age group of people who are fortunate enough to have accumulated some wealth. The so-called intellectual cult of human beings around us, belonging to old-school thought, often counsels us and fosters their earned wisdom by advocating for building rental income for a secure livelihood as a prescription to our retirement planning. However, a closer examination of this widely accepted wisdom reveals a contrasting reality. When this notion is critically assessed against the harsh truths of contemporary life and evaluated using various parameters, its limitations become evident. To facilitate further, the article has outlined a few such yardsticks in Matrix-1, intended as a reference for readers to explore independently.

Matrix-1: Illustrative list of dark side of reality associated with investment in real estate properties to build rental income to secure monthly household expenses:

• As per the statistical data, the average RoI (Return-on-Investment) on residential properties is merely 3% p.a. pre-tax [reduced to 2.37% post-tax (considering the highest tax bracket of an individual and zero surcharge and 4% cess)]. This rate goes up to a mere 6% p.a. pre-tax [reduced to 4.74% post-tax (considering the highest tax bracket of an individual and zero surcharge and 4% cess)] in case of commercial properties.
• There is an exorbitant amount of stamp duty and registration charges payable on the purchase of real estate properties. These stamp duty and registration charges are in the range of say 6%-8% payable on the published circle rate or the actual sale consideration price, whichever is higher. These charges vary from state to state (as real estate property is a state subject and every state government decides and periodically tunes the applicable circle rate and stamp duty rate, and registration charges rate).
• The instrument of lease (lease deed) is also compulsory, and required to be registered at the office of Sub-Registrar (in case the lease tenure is more than 11 months) and the applicable stamp duty and registration charges are payable based on various factors including the tenure of lease, nature of entity of landlord and tenant, annual escalation in rent, security deposit amount, etc.
• The rented assets remain in physical possession of third-party tenants all the time, which may cause fear psychosis in the mind of the landlord, and sometimes it results in the unpleasant circumstances of trespassing and encroachment of the properties by the tenant.
• The ownership title of the assets may not be free from all defects. The latent and inherent defect in ownership title, if any, travels from seller to buyer even after payment of the entire sale consideration and registration of title documents at the office of Sub-Registrar after capturing photographs and thumb impressions of the parties in the presence of witnesses.
• These assets are not liquid. Sometimes, it takes more than 6 months time (or even more) to translate a real estate asset into a liquid asset, owing to various challenges in terms of finding suitable buyer, absence of established and regulated marketplace for price discovery, time period spent by buyer to pay the agreed sale consideration, time consumed in due diligence by the buyer or the lender bank of the buyer.
• Sometimes, the lender banks are not comfortable extending easy and instant loans against these assets, citing various reasons (excuses) of a complete chain of documents depicting ownership title, location of property, nature and character of assets, possession, physical conditions, difference in prevailing circle rate vs. actual market rate, etc. Thus, the owner may be deprived of liquidity to cater to some emergency requirement or to fetch leverage to meet his business or other pressing needs/circumstances.
• The physical and tangible built-up assets are subject to depreciation and wear and tear over a period of time. It needs regular expenses for upkeeping and maintenance. It also needs expenses every 5 to 10 years for repairs, renovations, and facelifts. The annual municipal taxes and insurance expenses are also required to be paid on real estate properties for the sake of statutory compliance and safeguard against the potential threat of physical damage to the properties. The municipal taxes are as high as 20% of annual rental in case of certain states in India.
• There is a hefty amount of brokerage (ranging from 0.50% to even 5% of the consideration) payable at the time of both purchase and sale of the assets.
• There is a threat of tenants vacating the premises, and the assets may remain vacant and unrented, yielding no monthly income at all. For example, the recently developed culture of WFH (Work-From-Home) in the post-COVID era has indeed caused downsizing the office areas by top-notch IT companies. Additionally, in case of change of tenants, the additional expenses of buffing of the premises and brokerage to the property dealer are also incurred, in addition to the statutory compliance of police verification of the new tenant.
• The inherent nature of the real estate assets is such that it cannot be split into small units and we need to deal with the whole property at a time, e.g. if someone owns one flat worth Rs. 10 crores he cannot sell 25% or say 50% of the flat to meet some immediate needs, if any. Similarly, if he has Rs. 2 crores available for top-up/ addition, he cannot invest it in the same flat, and instead, he will have to look for purchase of some additional property.
• Surprisingly, a huge amount of stamp duty, as high as the quantum of amount which is payable in case of actual sale to a third party, is also payable (in a few states in India), to record a gift of the property, even if the property is gifted to a person in blood relation.
• Needless to say, there is some element of trauma associated with safekeeping the original title documents of the properties.
• As the rental income is subject to GST levy (over the given threshold limit), the landlord has to additionally fulfil the requirement of obtaining GST Registration and monthly/quarterly compliance of the taxation formalities including raising tax invoices, filing of GST returns, collection of GST amount from the tenant, and finally remittance of GST amount to govt. These compliances are to be done every month before their respective due dates to avoid the levy of interest and penalty.

In stark contrast, if we fetch the view of new age Gen-Y sharks, who have already built the corpus pool and sculpted their retirement pension planning at a young age vis-à-vis the Old-Money genre of population who are scripting their annuity scheme at the age of 50+, the difference between their respective story writing is quite evident. The newer generation believes that "the life should be plain, simple and uncomplicated" and in the same wave length they are adopting the cruising tool of autopilot mode which offers pre-defined constant stream of cash flow crediting in their bank account on 1st day of every month without indulging in any requirement to chase-up the remitter and at the same time the said model is tax efficient, online, automated, transparent, liquid and hassle free. Does it sound too good to be true? Calm down, it is not some fiction, and indeed it is happening in real life itself, and the smart species of mankind is deploying this toolkit.

This gadget is not some form of rocket science and instead it is a paradigm shift available in the form of plain vanilla structured investment product in equity market in India itself which ensures steady streak of constant amount of cash flow every month, e.g. Rs. 1 lakh crediting to your bank account on 1st day of every month at the expense of say Rs. 939 (may be read as say Rs. 1000) of income tax, against one-time lump sum investment of Rs. 1 crore. Interestingly, the amount of income tax will be zero in case the desired monthly inflow of Rs. 1 lakh is bifurcated equally in two accounts, say husband and wife (thanks to the Union Budget of the previous fiscal year). Nonetheless, the amount of income tax will be higher in case the monthly target requirement is, say, Rs. 5 lakhs or Rs. 10 lakhs (please refer to the Matrix-2 above for a few cases of tax incidences) as the annual exemption of Rs. 1.25 lakhs ceded by the previous year's Union Budget remains fixed.

Matrix-2: Illustrative list of Income Tax incidences of a few scenarios in case of investment in structured products in equity market:

#Assuming conservative CAGR of 14% (which is even less than the historical rate of CAGR achieved by equity market since its birth). It is, however, subject to market risks.
##Nonetheless, the annual amount of LTCG tax expense will tend to increase in subsequent years owing to the fact that the component of income comprising monthly withdrawals in subsequent years will gradually increase.

Conclusion:

Considering the listed pros and cons of investments in both options of asset classes, a critical assessment can be done by each investor in their own personal cases, amidst the facts and circumstances as applicable in their respective cases. Nonetheless, the readers are advised to personalise and structure their own investments and portfolios in consultation with their long associated Chartered Accountant and SEBI-registered investment advisors only, to rule out any dent or disastrous advice by the mushrooming and newly developed breed of finfluencers who are not authorised by the market regulators.