Some of these OCIs and NRIs have ancestral property or inherited real estate in India. They end up with cash in hand when they sell these properties, given the prevalence of unaccounted, or ‘black’, money in real estate deals in India. Some take the risk of bringing the cash to the US, even if bringing anything over $10,000 in cash is illegal. Many invest it in another property in India. It is not uncommon for OCIs and NRIs to use their dollar earnings for upgrading their own houses, or those of their parents or sibling(s), in India. Sometimes, they buy a new property for these relatives, while keeping the ownership in their own names. Among the much romanticised positions of these investors is the desire to return home to live in India sometime. Many also see it as a back-up plan for their old age, when their US-born children have begun to work and settle in the States.
Home ownership hassles
Let’s begin with a comparison of the home ownership process in India and in the US. In India, buying a house involves dealing with many entities: real estate broker, insurance agent, lender bank, title and legal process adviser, and government agencies for registration and duties.
As mentioned earlier, black money remains a thorny component of real estate deals even now. NRI and OCI buyers have to execute a power of attorney in favour of a local resident Indian to take care of the processes on their behalf, and open an NRO (non-resident ordinary) or NRE (non-resident external) account to repay the home loan.
In the US, the highly structured administrative process involves the broker and lending banker, who together take care of every step of the detailed process including inspection, legal documentation and registration leading to the sign off on a closing date.
It is relatively easier to reliably buy or sell property in the US, compared to the process in India, which can be fraught with delays and in some cases instances of fraud and malpractice. The liabilities and penalties for such instances are clearly stated and implementable in the US.
Now, consider the financial and tax aspects. It is relatively easy to borrow against property both in India and in the US. In both countries, the credit score, debt repayment as a proportion of income, and the amount of loan as a percentage of the value of property are considered. Both systems enable using the borrowing as a leverage to acquire an asset. The home loan interest rates vary depending on the market situation; but given the lower levels of inflation, they remain lower in the US than in India in general. The combination of higher interest rates and depreciation of the rupee can wipe out a significant portion of the capital appreciation of the Indian property. Many investors only see their equated monthly instalment (EMI) in dollars falling as the rupee depreciates, but fail to see that the value of their investment has also dropped, reducing the dollar value of the capital appreciation in the property.
Significant gap in rental yields
It is easy to use a property based in the US to obtain lines of credit on home equity. This works like an overdraft account against the current value of the property after deducting the mortgage loan, enabling the home owner access to lower cost secured loans as needed. Home owners can also take new loans to structurally modify their properties, or swap out an existing loan for a higher new loan.
Not all of these facilities are available on properties owned in India. Rental yield on Indian properties are low: 3-5% gross yields, further reduced to 1.5- 2% after costs. Most home ownerships in India work on the expectation for capital gains than rental income.
The NRI or OCI investing in India gets a lower capital appreciation too, owing to rupee depreciation. In the US, average rental yields are 7% gross and 4-5% net, higher or lower depending on the location. The NRI or OCI investor pays a higher interest rate on loans than the resident investor. Therefore, investing in India is a high-cost, low-yield proposition for them, resulting in negative cash flows as they repay the loan monthly.
Properties in the US are primarily sought for their income potential, and the positive difference between the cost of debt and rental yield, than capital appreciation alone. The NRI or OCI investor is better off in terms of loan rate, structured process, zero currency risk, higher liquidity and top up loan facilities, and better income and cash flow by investing in properties in the US, than in India.
The tax situation makes the differences in property investments even more stark. While both India and the US offer tax deductions for interest payments, the US also allows a capital gain write-off of up to $500,000 (for a couple filing jointly) on sale of primary residential property. This benefit is not available on the property they buy in India. The interest income is taxable. On its sale, they can take the money back to the US as dollars but pay taxes on the capital gains.
The tax regime in the US makes it specifically lucrative to own not just residential property (primary and secondary home) but also recognises and encourages the acquisition of residential and investment properties.
Dollar income for dollar property
The tax concessions of properties held as investments, beyond the primary and secondary homes, is significantly higher. The mortgage interest is fully deductible from taxable income (without limits that apply to primary and secondary properties) all expenses including property taxes are fully deductible, and the property is eligible for depreciation that can be written off against rental income.
It is tough to beat the benefits of using dollar income and borrowings to buy a dollar property in the US. Property investments by NRIs and OCIs sending out dollar incomes to India to buy property, or borrowing in India and repaying from their dollar incomes, make poor financial sense. Emotional pressure from Indian parents on their NRI and OCI children to invest in property in India fails to recognise this financial reality.
The Author is Chairperson, Centre For Investment Education and Learning