Wherever I go, I see a flex or billboard stating property for sale, buy flats, land for sale etc. Even I was so surprised when I saw there was a separate channel on TV for real estate. These tempted me to take a step to know more about the Real estate. You know what?
I was shocked after knowing a few less-known facts about Real Estate Investments.
- Is there any inconvenience in owning a Real Estate Investment?
How Real Estate Investments perform compared to other investments?
9 Unique Challenges of having Real Estate in your portfolio
Recently, I read a research data about, ‘Where Indians Invest and How much they invest?’ It says that most of the Indians invest in Real Estate.
In 2017-18, 53.9% is the exposure given by Indian investors for real estate investments. We have a very strong preference for Real Estate investment.
Why so? Is it worth investing in real estate? Let us explore.
Why there is always a tremendous demand for real estate?
53.9% allocation by investors clearly conveys us that people have more psychological comfort towards investing in real estate.
What factors have contributed to this psychological comfort?
I. Do you feel that it is easy to understand real estate investing?
Investing in real estate can be much easier to understand than investing in the stock market or mutual funds. Because it involves the purchase of a physical asset.
You and I can see the real estate asset, touch the asset and feel the asset. This definitely contributes more to our psychological comfort compared to mutual funds and shares.
II. Do Investors earn higher returns?
When compared to Gold and Fixed Deposits, real estate has the potential to deliver better returns. Real estate is one among the very few asset classes which has the potential to beat inflation.
III. Secured Feeling
The major benefit of investing in real estate is that it provides investors with a secured feeling as they are investing in a physical asset.
IV. Is there any tax benefits?
For housing loan principal repayment up to Rs. 1,50,000 can be deducted from your income under section 80 C for tax exemption.
For housing loan interest payment, up to Rs. 2 lakhs can be deducted from your income under section 24 for tax exemption.
When you sell a property after 2 years, you need to pay a long term capital gain tax of 20% after adjusting for indexation.
V. The sense of Pride
Unlike the other investments like fixed deposit, PPF, and mutual funds, investors tend to take a lot of pride when they buy a real estate asset. It is considered as a social symbol in their family circle and social circle.
Most of them buy for self-occupancy or to pass it on to the next generation. So it obviously gives them a sense of pride.
VI. Easy availability of loans
Compared to other assets, for buying real estate, you can easily avail loans from banks. This is also a reason for more allocation by investors towards real estate.
All the above reasons seduce investors to invest in real estate to the extent of 53.9%.
Will real estate prices also fluctuate or grow steady?
Perception: Real Estate prices go up steadily.
Reality: Real Estate prices will fluctuate
There is a reason for this perception. There is no mechanism to track the daily prices of real estate transactions.
Everyone knows that the share prices fluctuate. Because share transactions happen online and through the stock exchange in a very transparent way. So on a daily basis, we know how the share prices are moving. We could see the fluctuation in the share prices through media and online sources.
However, the real estate market is not evolved enough like a share market to track the daily transaction prices. If we come to know the real estate prices on a daily basis through some mechanism, we will realise the fluctuation it goes through.
Also, if we do a bit of research, we can also realise some major economic activities also make the real estate prices fluctuate noticeably. One such recent economic activity that resulted in real estate prices drop is demonetisation.
Though it is an unpleasant reality, it is a fact that real estate prices also fluctuate like equities.
Is there any inconvenience in owning a Real Estate Investment?
Yes, because it needs huge investment initially and personal effort and time of an investor.
- It takes a longer period i.e. weeks or months or even longer to sell a real estate investment.
- The transaction costs are very high, i.e., while selling the real estate we have to pay a commission of around 5-6% + Stamp Duty + Registration Charges.
- Real estate property which is used or unused requires maintenance.
i.e., investors have to pay maintenance charges for the building which are kept idle or building which is in use.
It is very important to think before you make any real estate investment decisions. Like, if I invest in this real estate investment, is it manageable to meet all the expenses?
How Real Estate Investments perform compared to other investments?
If you and I understand what are the rates of return given by different asset classes, then we can see, the 53.9% real estate allocation given by Indian Investors is justifiable or not.
Here is an estimate on returns that every investment earns over a long term,
- Fixed Deposit: Inflation plus 1% returns which is very low.
- Gold: Inflation plus 1.5% returns.
- Real Estate: Inflation plus 3% returns which is medium.
- Equity: Inflation plus 7% returns which is high.
From the above, Real estate is not providing that low returns like Fixed Deposit and not that high returns like Equity. Real estate yields an average return with adequate risk.
9 Unique Challenges of having Real Estate in your portfolio
There are a few challenges faced by investors when they have real estate in their portfolio. These challenges are often overlooked and underestimated. Let us see them in detail.
I. Do you incur a huge cost when you buy Real Estate?
Real estate has a huge transaction cost as compared to other investments. Real estate charges more on entry and exit of investment like the commission to brokers, stamp duty, registration charges etc.
II. Real estate brokers are not professionals?
If one needs to be an agent of insurance or mutual fund or stockbroking, he can’t just like that become an agent. He needs to go through professional training and pass the certification organised by the respective regulatory body like IRDA, SEBI.
However, in real estate, there is no such certification. Anyone and everyone can become a real estate agent. So there are very less professional, knowledgeable and matured players in real estate.
So it is difficult to find a trustworthy real estate agent.
III. How liquid is your real estate investment?
Many investments are highly liquid and can be bought and sold for a profit in a fraction of second. But real estate has very low liquidity.
To encash the property, it takes weeks, months and years. If I need to withdraw my investment amount in equity funds, it takes me four days maximum after all the formalities. Also, it can be done online.
But to withdraw my investment amount in property, it takes me weeks and months. Also, it cannot be done online and has a series of formalities to be followed before withdrawal.
To liquidate your property, you need to invest time and effort consciously.
IV. Can I start investing with smaller amount every month?
Real estate investment needs a huge investment to start up. There is no concept of starting with less amount. It is not like a mutual fund or other investment where we can start with a smaller amount. i.e. I can even invest with a minimum of Rs.500 every month in Mutual funds
V. Regulatory Body
There is no regulatory body for real estate transactions. Like Stock market is regulated by SEBI, insurance by IRDA, there is no such regulatory body for real estate.
The property is just registered in the Registrar office and there is very less trustworthy players. So, there is a possibility of fraudulent activities like bogus documents, selling the same property to multiple people…
VI. Can I invest in real estate for retirement?
For example: If a person rents a property worth Rs. 50 lakhs. He will get only around 3% of it as a rental income in which he has to pay expenses such as property tax, water tax, maintenance etc. So real estate investment is not a very good investment for retirement.
However, if you have enough money for your retirement corpus and in addition to that you want to buy a property and leave it to the next generation, then you can go ahead and do it.
VII. Is there a proper mechanism to discover a real estate price genuinely?
There is no proper price discovery mechanism in the real estate market. On the same day, two identical properties can transact in two different rates.
Also, the parties involved in one transaction will not know about the price for the other transaction. There is no transparency.
Stock exchanges act as a platform for shares to discover the price based on demand and supply. So there is a fixed rate and no negotiated price.
As real estate transactions happen in isolation, there is no way to arrive at a genuine market rate. Negotiations are inevitable.
VIII. Not easy to revamp
If you are investing in shares or mutual funds, when they underperform, it is easy to revamp them by redeeming and reinvesting.
However, in real estate, it is difficult to revamp because of the high entry and exit costs.
IX. Partial Withdrawal
Other investments mostly have the facility to withdraw or liquidate them partially. However, mostly, it is not possible to do a partial withdrawal or partial liquidity in real estate.
Real Estate Vs Equity Mutual Funds
Let us compare both equity mutual fund and real estate for a better understanding.
|BASED ON||REAL ESTATE||EQUITY MUTUAL FUND|
|Liquidity||It takes a minimum of 3 weeks to a maximum of 6 months to sell the property. Immediate encashment is not possible.||It takes only 4 days to redeem the invested amount.|
|Transaction||Buying and selling only through offline (direct or agent)||Buying and selling through offline and online|
|Entry cost||The cost varies from state to state and from transaction to transaction for stamp duty, registration and brokerage commission.|
i.e.Stamp cost in Tamilnadu may vary from Andhra Pradesh
|There is no such entry cost.|
|Tax||Short –term capital gains tax as per the income slab if held for less than 2 years.|
Long term capital gains tax of 20% with indexation if held for more than 2 years.
|10% tax has been levied on the long term capital gains and 15% on short-term capital gains.|
|Risk and Returns||Higher returns with higher risks||Higher returns than the Real estate with calculated and regulated risk.|
|Partial Withdrawal and Re-investment||No Partial withdrawal.|
Only complete liquidation.
Reinvestment is not that easy.
|Partial withdrawal and reinvestment can be done whenever required.|
|Expected returns||Inflation + 3%||Inflation+7%|
|Genuine Price / Negotiated Price||Price is negotiated||No negotiation on price. Price is market driven and genuine.|
|Regulation||There is no regulatory body. The possibility of frauds and scams are high.||There is a very strict regulatory body (SEBI). Very less possibility of frauds and scams.|
|Minimum Investment||The minimum investment will be high. Usually starts in lakhs.||The minimum investment is as low as Rs.500.|
Below is a genuine example of one of our clients.
Mr. Akash (name changed) purchased a flat of 732 sq ft. in Saidapet, Chennai on Feb 2004 for Rs.12,44,400. The per sq ft rate Rs.1700.
On Feb 2019, he decided to calculate how much he will earn if he sells the property? The value per sq.ft has been increased to Rs. 9000 which gives him Rs.65,88,000 for 732 sq ft.
Huge isn’t it?
Instead of investing in that property if he could have chosen to invest in one of the good mutual fund schemes, what could have happened?
Which one do you think will yield higher returns? Let’s Check!
On the same year Feb 2004, if he invested in HDFC equity fund- G Rs.12,44,400 he could have got 22,974.25 units for a unit price of Rs.54.1650.
On feb 2019, the equity mutual fund value is Rs. 1,38,41,271 for 22,974.25 units (Rs.602.4690 per unit)
If he chose equity mutual fund, now with his 1.3 crores, he can decide to buy a 4-bedroom flat. But as he has chosen real estate he needs to settle for a 2-bedroom flat of 732 sq ft.
We underestimate and overlook the returns provided by equity mutual funds.
In the same property and in 2004, instead of investing a lump sum if he could have chosen to invest 20% as down payment and balance 80% as mortgage loan what could have happened. Let us assume he is going for a 15-year loan.
So, his down payment will be Rs. 248880 (20%).
His EMI will be Rs. 10700 per month for 15 years at a 10% rate.
The present value (as on Feb 2019)is Rs. 65.88 Lakhs which has given him 12.74% XIRR.
Instead of investing in the property if he chose to invest in equity mutual fund what could have happened…
He is investing a lump sum of Rs. 248880 (the equivalent of 20% down payment) on Feb 2004 and a SIP of Rs.10700 per month (the equivalent of EMI) in HDFC Equity fund for 15 years.
The present value (as on Feb 2019) is Rs.84.38 lakhs which has given him an XIRR of 14.77%
Let us add rental expenses in the equation. Let us reconsider scenario 1. In 2004, the rent was Rs.7500 and it increases by 5% to 6% p.a. The present rent is Rs.16000. As we are considering that Akash is not investing in flat and investing in Mutual Fund, he will be staying in a similar rented house, for which he needs to pay the above rent.
If we consider these rent as a monthly outflow from the lumpsum investment made in the mutual fund, then the value of mutual fund corpus at the end of 15 years is Rs.90.87 lakhs.
Even after considering the rental expenses, the mutual fund investment has given an additional return of Rs.25 lakhs.
Therefore, it is clearly proven that equities will beat out real estate in the long run.
Let us not get deceived by the psychological comfort and wrong perceptions about real estate investments and overexpose ourselves to real estate investments. The 53.9% real estate exposure, given by Indians are not justifiable.
By investing in equities you can generate much better returns in the long run.
So we can limit our exposure to real estate investments consciously and logically.