The obsession with Real Estate
TLDR: Obsession with real estate - history, real returns and alternatives.
We Indians have an unhealthy relationship with real estate. I would go as far as to state that it is more of a obsession and we are sometimes blinded by it. But why is that?
Set your clock back to a hundred years. Every thing is in black and white, you see a farm hand working hard in a field from sunrise to sunset harvesting grain by hand and delivering the produce to a the only palatial house in the village, Waiting for his employer to pay his daily wage for this back breaking work at the end of the day.
The wealthy were called Zamindaars (Roughly translated to owner of the land - Landlord) simply because he or she (who are we kidding, there were no women Zamindaars back then) controlled the land, the employees, the produce and thereby the wealth. So there is strong association of wealth and real estate. It is part of our cultural history and identity.
Land ownership = Wealth
Here and Now
Fast forward a few hundred years, many are still stuck in the old ways of thinking. Wealth and investments options still revolve around real estate which is wrong. Let me clarify. Owning a house (or apartment or villa or farm house) is a dream for many of us. It is part of our identity, an expression of our uniqueness and individuality. So go ahead and buy your house for your stay provided you are doing it within your means and are not purchasing a house in anticipation of your future needs or even worse your future income growth.
Good. Now that you have your own house, let us look at real estate as an investment.
Problems with real estate investment
Poor liquidity - real estate assets are not liquid, selling one in a time of need is very difficult. Sale could take anywhere between a few weeks to a few years.
Mediocre Income generation - except for some farm or commercial properties, the return from rent never really matches your capital outlay. Let’s get there in a bit.
Partial redemption not possible - So you own a property worth 10 million, but you need say 1 million for some purpose, what do you do? You cannot partially redeem.
Lack of future appreciation - historically there might have been significant appreciation in property prices, but those days are behind us. There is a general glut in the market, I don’t expect the future to hold the same level of appreciation as in the past.
Black money - The elephant in the room that everyone sees but nobody acknowledges. Lots of real estate transactions suffer from this problem, even if you have no black money, you might end up having to provide some to the seller. (For the uninitiated - black money is income not declared to the tax authorities, which is a common but big problem in India)
Now come the arguments :
1) “What are you talking about?, I bought an apartment in 2008 for 50 Lakhs ( 5 million) and now it is worth 1 Crore (10 million)”
So your property value doubled in 10 years, good for you. But is it really that impressive?
This translates to
CAGR (Compounded Annual Growth Rate) of close to 7.2%.
An Fixed deposit over that period would have returned around 10 % (minus taxes)
Investment in SENSEX over that period would have returned close to 14.3% (minus transaction fees and brokerage)
Invested in NSE mid cap index you could have had a return of 17.3%. (minus transaction fees and brokerage)
CAGR over 10 years - Nov 2008 to Nov 2018
This doesn’t even consider the miscellaneous costs around maintaining the property, property tax, maintenance fee, bank loan servicing or other expenses that you need to put into the property.
2) “What about rental income? Are you taking that into account? I have a 50 Lakhs ( 5 million) property, which gives me rental income of 20,000 each month”
Let us break this down.
Scenario 1: Assuming that this person bought the house paying 20% cash down and remaining 80% on home loan for a period of 20 years at an interest rate of 8%
Cash down : 10 Lakhs ( 1 million)
Monthly repayment (Mortgage / EMI) around 48,000
Total amount repaid over 10 years: 58 lakhs (5.8 million)
Total interest repaid over 10 years: 18 Lakhs (1.8 million)
Assume you get a tax benefit of 150,000 per year against the home loan (under tax section 80C) , so it is 12,500 each month.
So your benefit is 20,000 (rent) + 12,500 (tax savings) = 32,500 (total)
Your monthly EMI payment = 48,000
Net benefit = 48,000 - 32,500 = -15,500
Also you are ignoring the opportunity cost of the 10 Lakhs (1 million) down payment that you made, which you could have invested elsewhere to make some real returns.
Scenario 2: Assuming the person bought the property with full cash down and no loans. 50 lakhs (5 million)
So a return of 20,000 on an investment of 50 lakhs (5 million) is 4.8%. Which is way less than what you would have gotten from an investment in SENSEX
Scenario 3: Let us add capital appreciation to the mix for an apartment bought with full cash 10 years ago and getting an rent of 20,000 every month, let us assume for simplicity sake the rent has been 20,000 from 2008 to now
So total return = 4.8% from rent + 7.2 % from appreciation = 12 %
This is still lesser than what you would have gotten from investing in SENSEX. at 14.3%
Typically real estate assets like apartments and houses lose value as they get older because of depreciation, but stock investments grow more as time goes on. The peak price of your apartment or house is between 0 to 10 years old. Once you cross the 10 year mark they start to depreciate unless there are other extenuating circumstances.
There are probably many of you who made a killing in real estate because you bought the property at the exact right time, a metro station came up right next to you, a new mall was built next door, a new IT park was within walking distance from your house etc. etc. These are some cases where you might have reaped greater returns than in the given example. But this is more of an exception than the norm and the examples i have used are that - examples. If you think my assumptions are wrong, do let me know.
So is property a bad investment and should you stay away from it? Absolutely not. For a good diversified portfolio you should have a good mix of real and financial assets. Real estate, gold, commodities all should be part of your portfolio mix. But don’t load up on property alone and ignore the other alternatives.
REIT - Real Estate Investment Trusts - are in its infancy in India. I have heard a few rumblings in the news that there might be more of them launching soon. That might be a way to allow real estate investments in India without some of the key drawbacks that I had highlighted above.
So in conclusion, keep your real estate investments real (Man, i am killing it today) and diversify your portfolio across multiple asset classes. Real estate as a portion of my portfolio is currently at 24%. This does not include my primary residence, as I don’t consider my residence an investment, that might be a topic for another day.
What do you think is the right percentage allocation of real estate in your portfolio?
Leave your comments below.
Happy investing - #MyFatFIRE
Title image - Ray in Manila - Flickr