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Return is king in real estate

In a high-involvement asset like real estate, the 'extra' return on investment should be imperative

Published: Jan 28, 2015 06:58:43 AM IST
Updated: Jan 28, 2015 12:57:00 PM IST

Return is king in real estate Mark Twain is said to have remarked, “Buy land, they’re not making it anymore.” He simply put words to the thoughts of real estate investors. There are several stories of flats/plots from the ’50s which were bought for a few thousand rupees being sold for a few crores today. That is the kind of stuff that keeps the legend of real estate investment alive and kicking.

Is real estate the best investment vehicle compared to gold or equity shares or the perennial favourite, fixed deposits? For starters, it is important to first define “real estate investment”.

Buying an under-construction flat is not real estate investment. You are actually lending money to a developer with the hope that he will deliver a flat to you in the not-so-distant future. You better make a good return when you buy an under-construction flat. Return follows risk, and in the Indian context, the risks of buying an under-construction flat are so high that developers have to provide a price that gives you good returns.

There is nothing wrong in buying an under-construction flat in the quest for higher returns as long as you understand the risks involved. Most people don’t. And those who are otherwise “safety” seeking investors make this investment under the notion that they are investing in “real estate”. Very few investors know that the largest number of pending cases in consumer courts is with respect to developers not delivering on promised flats.

The other mistake people make is the assumption that buying a house to stay in is real estate investment. I would put it more in the category of a consumption item like gold jewellery. You know it has decent resale value but you are unlikely to sell it unless your life is at stake. As an aside, there is a very vocal minority that advocates that it makes no sense to buy a flat for your own residence. They have plenty of charts, tables and rent-versus-buy calculators to prove their point.

I think these rent-versus-buy calculators miss a very significant cost which is that of defying social convention. Buying your own house (even with a fat loan) is considered the sign of having achieved financial stability. The cost of social pressure is enormous and the sense of security you get by conforming to the social norm (of owning your own residence) is way too high to be ignored.

Return is king in real estate
Image: Getty Images
Most people don’t understand the risks involved in buying an under-construction flat in the quest for higher returns

This brings me to why a real estate investment that runs into “thousands” turns into “crores” in just two generations. Real estate investments tend to be lumpy—the thousands invested in the ’50s were pretty big amounts then. Plus, it is not always easy to liquidate a real estate investment unless you are a very active investor. Most investors are not active and this lack of easy liquidity, which is actually a disadvantage, turns into its biggest advantage as the asset continues to accrue and compound returns.

The most crucial bit about these investments are the returns. Let’s assume you have invested Rs 1 crore in a flat in Mumbai in 2015. If you could travel to 2065 and find your grandchild selling it for Rs 117 crore, will you think that you’ve made a great investment? If you are delirious with the result, it typifies the legend of real estate investing.

The actual return on this investment is just 10 percent per annum, and even that is prior to the payment of capital gains tax. The post-tax return will be in single digits. It is a decent return, but not spectacular. This is what I call the ‘law of large numbers’ where the large upfront investment accrues decent compounded returns over very long periods of time (because of illiquidity), resulting in a large value on sale.

We did a small dip stick survey on the real estate market in Mumbai. Ready reckoner values [market value of properties] are available for 24 years since 1990 and we looked at the 10-year moving returns over these 24 years. While the ready reckoner values trail the real prices in most cases, they keep pace with the increase in prices, and hence, the returns calculated using these rates will tend to be quite close to the actual returns.

Return is king in real estate

In the best-performing locality of Colaba, the average 10-year return was 8.07 percent with the lowest being 2.09 percent (1996-2006) and the highest being 14.37 percent (2003-2013). The returns are far more volatile if you take a lower time period of five or eight years.

If you include the returns from investing in under-construction properties, you will notice that over long periods, they are only slightly better than “safe investments” such as fixed deposits. Given the fact that real estate is a high involvement asset, the “extra” return over a bank fixed deposit is a “must have” rather than “nice to have”.

If you look at a comparative return on the Nifty, it is far superior with much lesser volatility. Not a single 10-year return is negative in this case.

But unlike equities, real estate prices are not published on a daily basis and hence, a drop in rates is not publicly visible. Thus, you don’t see panic selling. Because of the illiquidity, the investor also doesn’t book profits prematurely (when prices rise) as in the case of equities. Hence, real estate tends to allow the magic of compounding full play unlike any other asset class even if the rate of compounding is not very high.

We have many clients who have up to 80 percent of their portfolio in real estate. As part of the asset allocation exercise, when we ask them to sell one of their properties, they look at us as if we have asked them to sell one of their kidneys. It is always an uphill battle to convince them.

In conclusion, you should definitely invest in real estate as long as you have a fairly large portfolio and only some portion (up to 30-40 percent) is allocated to this asset class. But don’t delay buying your own home, and understand what you are getting into if you are buying an under-construction flat.

Illustration: Sameer Pawar

(This story appears in the 06 February, 2015 issue of Forbes India. To visit our Archives, click here.)

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  • Dr. Swatantra Kumar

    Mr. Harsh, Really very nice insights about investing. But, see few downsides about investing in other investment instruments as well. - In India investors are of two kinds i.e Active and Passive. For active investors almost every investment instrument works fine in the long run. In case of passive investors, where the majority investing in real estate works well because of these reasons - 1. As Parag mentioned, Real Estate investments can be leveraged. One can get a bank loan to invest in a house. I am not sure if you get bank loans at the similar rates for investing in stock market!!! 2. The leveraged purchase of real estate works great since you get exemptions on interest as well as principal. I am sure stock market investments don't fetch any such deductions. 3. Few refer liquidity as a concern on real estate investments. I feel these days we easily get Loan against property in case of liquidity requirements. I hope that solves liquidity concern as well. The best thing about this is that your property still is used by you and stays with you. I am sure thats not the case with any other investment. 4. As a general rule any investment option can go bad if one chooses a bad unit to invest. Stocks of a poor organisation will never fetch returns. Same remains true with a real estate investment. Invest wisely after carrying out good research about the company from which you are buying. Happy investing.

    on Apr 24, 2016
  • Laxmi

    The real estate sector of Chennai was not as developed as today, where the builders and developers are grabbing land for the gated communities, towers, villas etc. Chennai today is listed in one of the top city to invest in real estate around the world as per Candy GPS report which states Chennai in top 10 cities to invest around the world. I recently invested in Radiance Realty\'s Mandarin at OMR(Chennai) and still the property prices soar high in OMR Thoraipakkam region due the IT sector and its closeness to many other parts of city.

    on Feb 1, 2016
  • Parag Saraiya

    Harsh - while I agree with some parts of your analysis, you have missed out two important aspect of the home buying in India ; 1 You get 70 to 80% of home value as home loan. You can not get the same for equity or any other investment. (Yes there is a dangerous F&O which has caused many to go bankrupt or commit suicide) 2 There is a large tax benefit on home loan repayment - principal as well as interest. And if husband and wife both are earning members and loan is joint then the benefit is larger. So the cost of home loan comes down to 7.5% instead of 10% or so. Once you put this in calculation, the returns will change quite a lot. For an equity investor who starts with 10 Lacs v/s a real estate investor with 10 lac down payment and rest in housing loan. if you do the match over 10 years, you may get better results in some cases in real estate. Since you had given Colaba example, if we take an example of Oberoi project in Malad (East), the return from 2005 to 2015 would be 300% appreciation and equity market have given 160%. But again both investments need patience and good selection with a little bit of luck. Having said that blind faith in anything is bad ! those who started investing in sensex because it reached from 8000 to 16000 in 2 years realized that the same sensex went back to 8000 after 1.5 years. and he may sell after getting frustrated. So a blind investor will fail in any investment except if he is pure lucky. Real estate has been vehicle for wealth creation for many rich families not only in India but globally. You need methodical approach. May be REIT are the right vehicle which will reduce the investment quantum needed to invest but may take away the tax benefits. I have also seen people investing in equities on some rumors and destroyed 90% of their capital. Whether Equity or Real Estate, patient and wise investors will make money; greedy and stupid investors will lose money(I have seen people losing money in fixed deposit also - they went to unreliable smaller banks who have 2-3% more than SBI but a few of them had to close). (Disclaimer - I am a real estate developer but not in any large metro. I don't think 80% of your wealth should be in real estate - and wealth does not include your primary home.)

    on Jan 12, 2016
  • Krishnakanth

    What Harsh Roongta said i agree with him. Now a days people are moving on real estate. If we invest in that we will get profit.

    on Sep 22, 2015
  • Amit

    This is right time to sell flat and invest that money in other investment options. Because in coming years real estate will not be that profitable.

    on Jul 29, 2015
  • Raunak Roongta

    This is a eye opening article at the time when every one is over bought in property without understanding the returns. In India most of the people calculate absolute returns rather than CAGR .

    on Jun 9, 2015
  • Raunak Roongta

    This is a eye opening article at the time when every one is over bought in property without understanding the returns . In India most of the people calculate absolute returns rather than CAGR .

    on Jun 9, 2015
  • Rajan

    The whole real estate market is a shark.If it goes down,it will take many more things with them. real estate. .One has to be very very cautious when investing in real estate.You may get regular income from the investments but it may take a very long time to recover the investment.

    on May 21, 2015
  • Bikash

    Instead of avoiding our behavioural biases the author is recommending buying into the asset class in a price agnostic manner and still managed to gets the shallow article published in Forbes India. Sad state of affairs of personal financial advisory space.

    on Mar 21, 2015
  • Sumeet Modgil

    Hi Could Harsh please confirm how the return percentages change if we include rental income and dividend income. It wasn\'t clear from the analysis how dividends are rental incomes contribute to the total return from these two assets A very good article notwithstanding

    on Jan 31, 2015
    • Harsh Roongta

      The graphs of the returns do not include rental income just as the index figures do not inlcude dividend income which more or less cancel themselves out on a post tax basis. We will soon put in a calculator on the site where you can do the rent versus buy your self and you will find that in most cases if you take a 10 year figure and even after taking rental saving into account as well as tax breaks on home loans , thye rent will still win out off course without taking the social costs of renting into account.

      on Jan 31, 2015
      • Mohan

        Rental yield is normally around 3 to 4 percent compared to about 1 to 2 percent for dividend yield. But flat has depreciation and maintenance expenses which can be much higher. So have you considered the resale price of an old flat or have you compared the cost of a new flat.

        on Feb 8, 2015
  • Thamarakkannan

    When it comes to real estate, we are a country in denial. We used to maintain similar lofty notions about gold until recently. Everyone who is buying an apartment likes to fondly quote anecdotes relating to other apartments in the same block being resold to fetch fat profit. Apartments are expected to double in their worth every two years until the end of humanity and possibly beyond. One who is above 30 and lives in a rented apartment is scoffed and scorned at, and is generally deemed as insane. In spite of 95% of our family\'s worth being in real estate (inherited ancestral land including), my mother still wants me to buy a piece of land. The very mention of \"stock market\", is met with a look of incredulity. I was recently chastised by an aunt, who thought that I had kept about xx lakhs in the \"stock market\" (whereas we in fact have around 6-8 times the amount exposed to equity) and while I tried to reason with her mentioning that it is mostly funds, she cut me off saying that funds are even worse. While the game (that of real estate boom) is being dragged out endlessly, we may not have as yet figured out how the last few tricks will be played, but the slam that was bid won\'t be made. The consumer will be end-played.

    on Jan 30, 2015
  • Rajesh Patel

    Very good article on real estate versus equity investment , most of us are obsessed with safety of investments in real estate and gold , which is not true proves this article

    on Jan 30, 2015
  • Pradeep

    Soon Indian real estate will collapse. Real estate bubble burst can happen any time.. since 2001 real estate is growing, and price become 3- 5 time in last 15 years... Currently buying house is not possible for most of the Indians as price is too high. Only super rich buy and sell property, its not gonna happen for long time.. as day by day unoccupied apartments/ house are increasing, as per recent news - it already touched 1 million mark in many places.. common people are away from market because house is not affordable to them....

    on Jan 29, 2015
    • Harsh Roongta

      My 2 bits :-). I would not use words like \"collapse\" lightly. In high priced markets (with large investor driven inventory) such as Mumbai we will probably see price softening or a prolonged period during which the price stays static. In the other markets which are largely driven by people actually buying houses to stay in we may actually see positive returns.

      on Jan 31, 2015
  • Vignesh

    Very nice article Harsh, this kind of dispassionate analysis of Real Estate is increasingly becoming rare. Good to see this and cannot agree with you more. Due to its nature, this is the only asset class where people stay invested for longer period. While in Equity and MF we tend to get itchy to sell when it gives 40-50% return. Could not fathom your recommendation to buy if it is for own use in your closing comments though. Are you recommending buying irrespective of price levels if it is for self use and hence it will be for consumption rather than as an investment?

    on Jan 28, 2015
    • Harsh Roongta

      Thanks Vignesh. I thought i made it clear that buying for own stay has \"returns\" way beyond simple increase in the price of the house. Please do see the paragraph on the \"social costs\" of not owning a house being quite significant. So yes I am recommending that you buy your own house to stay in irrespective of price levels. Off course you need to buy a house (and not lend money to a developer which is what buying an under construction house is) and needless to add it needs to fit your budget.

      on Jan 31, 2015