Should you consider real estate while planning your child’s education?
Parenthood is the best experience for all humans. However, it is also true that raising a child comes with huge expenses that can challenge your finances if you are not well-prepared. Education forms a significant chunk of all the costs incurred in raising a child. Thus, planning your child’s education is as crucial as retirement planning for yourself.
Let us see in this article how one should go about education planning and what assets one should explore, and the role of real estate in your portfolio, in accumulating the corpus for your child’s education.
How to plan your child’s education?
Planning your child’s education starts in the early stages of a child’s life. Today, higher education is quite expensive and costs around Rs 20-25 Lakhs for a degree in India.
This number increases further if you are looking for a foreign education for your child. Additionally, the currency depreciation that the Rupee (INR) is witnessing against currencies like the USD adds to the parent’s worry.
While estimating the cost of education and tuition fees, you should look at other costs such as accommodation, transportation, stationery and books, coaching, etc. You can explore EduFund’s unique cost calculator.
Let us now talk about planning your child’s education financially and the steps involved.
Step 1. Estimate the Cost of Education
Parents have to make an active choice for
- Place of education
- Tier of school
- Type of course or field for the child to study in
You will also need to consider whether your child wants to study abroad or prefers a domestic education. The education cost in India is increasing at a high rate.
Beginning from the admission process to the entire school life, parents increasingly find it challenging to meet the increasing fee structure and other costs associated with education.
Inflation in education has led to rising costs. The education inflation trend has been 10-12 per cent over the years, double that of household inflation.
For example –
- A 4-year engineering course costs around Rs. 12 lakh.
- 10-years, the cost will likely increase to Rs. 31 lakh
- By 2038, it would cost around Rs. 61 lakh to get an engineering degree.
Step 2. Decide the time horizon
Calculate your child’s graduation or post-graduation time.
Step 3. Analyze your current assets and liabilities
This helps to know the current financial position to help the parents plan better.
Step 4. How much to save?
Once you estimate the cost of education, decide how much to save in a lump sum or a monthly contribution.
Step 5. Investment planning
Plan a proper asset allocation that is well-diversified and reflects suitable risk-adjusted returns.
For example – Suppose you have a long-term horizon to accumulate the corpus. In that case, you should consider equity as an investment asset class in the portfolio.
As you come closer to the goal, your allocation on debt tends to increase, and distribution inequity reduces.
Step 6. Start investing
Real estate as an asset class
In general, real estate is considered a great investment option in India. The two types of real estate investment options are
- Residential properties
- Commercial properties
Real estate can be an excellent alternative to many investment options that offer lower risks, yield better returns, and diversify.
- Durability: Investment doesn’t come with a fixed maturity plan and has the possibility of creating wealth for multi-generation
- Immobility: Real estate investment is very illiquid in nature.
- Transparency: When purchasing a property, there could be a possibility that the seller is withholding information.
- The cost involved: A significant lump sum is locked in to pay initially when purchasing a property.
Additionally, housing loans help to bridge the gap between the savings and the cost of acquiring a property. Post down payment and a monthly mortgage payment includes a part of the principal and the interest on the loan.
Registration and Stamp duty payments need to be made to the legal owner of the property. In addition, there are various other charges such as preferential location charges, maintenance charges, parking charges, and taxes like Goods and Service Tax, property tax, capital gains tax, etc.
Why is real estate not a good option for a child’s education investment?
One main reason real estate is not a good investment option is its illiquid nature. Because education is a defined event and cannot be pushed further, the parents must be ready with the required corpus before the child is ready for school/college (as applicable).
If an investor is required to sell the property in a short duration, it could lead to distress selling, where the seller faces a substantial loss compared with the current market value.
On the front of the returns, the rate of return does not justify the costs and taxes incurred in property investment after adjusting for inflation. Interest on loan and mortgage payments further reduces the actual value of return received on property investments.
Due to inflation, the return is just a poor single-digit number lost in many years. It also requires more initial capital in the form of a down payment which may be difficult for parents in the initial or mid-stages of their career.
Buying a property vs. systematic investing
Let us consider a case where Mr A buy a house to fund his child’s education after 16 years, and Mr B considers investing in mutual funds via SIP for the same duration.
Case of Mr A
In the first case, Mr A makes a down payment of Rs 10 lakhs (10% of the current property value) and gets an EMI of Rs 79,892 for the period of 15 years. He then sells the property in the 16th year. The real estate growth estimation is at 6.5%.
Case of Mr B
Mr B starts a SIP of Rs 50,000 per month when the child is born for a long-term period of 15 years.
Source: Edufund Research Team
Table showing the investment in real estate vs mutual funds.
Note: Outflow is the total money paid by Mr A and Mr B.
Mr A – Outflow is the sum of the down payment and all the subsequent EMIs.
Mr B – Outflow is the sum of all the SIP.
Source: EduFund Research Team.
Graph showing difference in the outflow and total value of the investment in real estate and mutual funds
The difference in cash outflow (Total EMI vs. Total SIP) is considerable at Rs 53 Lakhs – is because when an individual starts paying EMI, he ends up paying the principal and interest component, both due to which the cash outflow is high.
Further, when we consider the amount accumulated in SIP after 16 years and the amount recovered from the property sale, there is a staggering difference of Rs 40 Lakhs.
Thus, the total benefit in mutual funds over real estate stands at nearly Rs 1 crore.
We see that investing in real estate creates a hole in the investor’s pockets. Moreover, many investors may not have such a substantial initial lumpsum readily available to invest in.
Mutual funds provide the feasibility to start with SIP and increase the amount gradually. But for a housing loan, a minimum down payment is a must.
EMIs for housing loans are like an expense for an individual. Whereas SIPs are like reasonable EMIs where an investor earns interest on their periodical instalments.
Also, mutual fund SIPs have the power of compounding, whereas real estate investments only have an average inflation rate that gets added to the asset value year on year.
To plan your child’s education, you should also ensure that your portfolio has the necessary liquidity. The property sale is a difficult and lengthy process, requiring time-in-hand.
Mutual fund redemption is instant, and the investor receives the funds in 2-3 business days. The properties in a preferential location have a reasonable appreciation rate, but that may not always be the case.
Distress selling takes place in case of an urgent need for money through a property sale, that is, property sold at much less than actual market value.
But in the case of mutual funds, even during emergencies, the investments are sold at the market value. Therefore, transparency and liquidity are more in mutual fund investments.
These points are more than enough for a parent to choose mutual funds or other alternate investment options over real estate while planning their kid’s education.