Return is king in Real Estate

Mark Twain is said to have remarked, “Buy land, they’re not making it anymore.” He tried to put a thought in minds of Real Estate investors. There are several stories of flats/plots which were bought in 1950 for a few thousand rupees were sold for a few Crores today. This is something that keeps Real Estate investment alive and kicking. 

Is Real Estate the best investment vehicle compared to gold, shares or fixed deposits? Here it is important to first know what is “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 might make a good return when you buy an under-construction flat. But Return follows risk, and in 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 are of developers not delivering 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 jewelry.

You know it has decent resale value but you are unlikely to sell it unless You are in real financial mess. Than there is a very vocal community 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 as a sign of having achieved financial stability. The cost of social pressure and the sense of security you get by owning a home is too high to be ignored. 

This brings me to why a Real Estate investment that was in “thousands” has turned into “Crores” in just two generations. Real Estate investments tend to be lumpy—the thousands invested in the ’50s were pretty big amounts then. The most crucial bit about these investments is the return. Let’s assume you invest Rs 1 Crore in a flat in Mumbai in 2015. Travel to  2065 and visualize your grandchild selling it for Rs 117 Crore. You will  think that you made a great investment? That typifies the legend of Real Estate investing. 

But let’s try to see what actually is the return on your investment. It 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.

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 year in this 10-year period had shown negative return in this case. 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 comparatively low liquidity , the investor also doesn’t book profits prematurely (when prices rise) as in the case of equities. Hence, Real Estate allows the power of compounding   to play its full role unlike any other investment instrument.

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 something very precious to them. It is always an uphill task to convince them.

In conclusion, you should definitely invest in Real Estate & up to 30-40% of your portfolio should be allocated to it. But shouldn’t delay buying your own home, and understand what you are getting into if you are buying an under-construction flat.