Have you been listening to these amazing stories from your father and uncles about flats or plots of land bought for a few lakh rupees decade ago which got sold off for crores? Haven’t you? These are the stories that have been ingrained into our minds and make us believe that “Property ownership = wealth + prosperity”. And this wealth is expected to continue growing with time.
Living in your own residence (even though bought with a fat loan) is considered to be a sign of financial stability. This societal pressure is too high to be ignored. And to top it, if you own properties beyond the house you live in, it simply means you have comfortably secured your and your family’s life.
Now before we discuss how good real estate is, as an investment class, let us first see what is not a real estate investment
People make the mistake of considering the house they live in as a real estate investment. It is a consumption asset like gold jewelry and most people do not sell it unless they are in dire need of money or buy another residence.
Why so much obsession over it?
Indians often have an emotional connection with real estate and gold investments because of the belief that the value of these assets will always grow with time or remain intact. This emotional bias often comes in the way of investors making rational decisions.
The illusion of great returns: Stories of big returns from our elders have also made most Indians think that holding real estate for a long term will reap exponential gains without getting into the real math behind it.
Another reason behind this obsession is that one can save on the capital gains tax incurred from selling a property for profit by reinvesting all the sale proceeds in another property.
The easy availability of real estate loans and attractive financing schemes have also made it easier to fund real estate investments
Problems with real estate investment
Poor liquidity – makes selling property very difficult because of the large ticket size of the investment.
Mediocre income generation – most real estate investments do not have a great return outlay and their high absolute values fool us into believing we are making money while alternative investments over the same horizon perform better. (We shall discuss this in detail below)
Lack of transparency- real estate prices are not listed often and one cannot always ascertain the actual value of their property as they can for equity or other financial investments.
Let us break the MYTH
Case 1: So, what if your property value more than doubled in the last 10 years. Doing simple math would reveal that the actual CAGR returns are nothing more than 7-8%. This doesn’t even consider miscellaneous costs associated with real estate purchases like maintenance costs, property tax, interest costs on bank loans, etc.
This is much less than 10-12%+ returns one would have generated, had he invested in Nifty 50 over the same period.
Case 2: Rental income earned on the property
| Value of Property (Rs.) | 1,00,00,000 |
| Loan Amount (Rs.) | 80,00,000 |
| Interest on Loan | 8% |
| Loan tenure | 20 years |
| EMI (Rs.) | 66,915 |
| Rent on the property (Rs.) | 35,000 |
| Tax savings on loan (Rs.) | 12,500 |
| Net benefit each month (Rs.) | -19,500 |
Even if we assume that rent increases by 10% every year, the total net benefits comes to around Rs. 50 lakhs over 20 years. This is much less than the opportunity cost of the initial down payment of Rs. 20 lakhs which could have been invested elsewhere and generated a return almost double the net benefits.
In short, returns on real estate investments are not as attractive as believed to be.
There are of course some exceptional cases where you would have made bumper gains because you bought the property at the exact right time, a mall, commercial office, or metro station came up right next to it. In such cases, you might have reaped returns much more than what we have calculated above. But, mind you, these cases are more of an exception than the norm.
So, is Real Estate investment bad?
Certainly not! For a well-diversified portfolio, one must invest in a mix of natural and financial assets. However, these investments should be well distributed to avoid any concentration risk.
There are also alternative ways to gain exposure to real estate through REITs.
REITs – Real Estate Investment Trusts – are companies that own or operate income-earning real estate including commercial buildings, malls, hospitals, residences, and other prime real estate properties. Investing in real estate through these REIT funds is more liquid, provides greater diversification, and potentially higher total risk-adjusted returns.
Ideally, an investor should buy property only if they have a vast portfolio that is well diversified in such a manner that buying an expensive property will not result in a portfolio imbalance. One should keep asset risk and return in mind before making big-ticket real estate purchases and not get carried away by emotions.
Disclaimer: This write up is solely for educational purposes.
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