Real Estate Investment: A Right Choice or Wrong Choice…?

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 Real estate. You know what?

I was shocked after knowing a few less-known facts about Real Estate Investments.

1.) Is there any inconvenience in owning a Real Estate Investment?
2.) How do Real Estate Investments perform compared to other investments?
3.) 9 Unique Challenges of having Real Estate in your portfolio
4.) Final Decision

Source: CLSA

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 2022-20234, 50.7% 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?

50.7% allocation by investors clearly conveys to 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 secure feeling as they are investing in a physical asset.

IV. Are there any tax benefits?

For housing loans principal repayment up to. ₹1,50,000 can be deducted from your income under section 80 C for tax exemption.

For housing loan interest payments, up to ₹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 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 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 50.7%.

Will real estate prices also fluctuate or grow steadily?

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 has 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 real estate prices fluctuate noticeably. One such recent economic activity that resulted in real estate prices dropping is demonetisation.

Though it is an unpleasant reality, it is a fact that real estate prices also fluctuate like equities.

1.) Is there any inconvenience in owning a Real Estate Investment?

Yes, because it needs a huge investment initially and the personal effort and time of an investor.

Also,

• 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 that 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?

2.)How do 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, whether the 50.7% real estate allocation given by Indian Investors is justifiable or not.

Here is an estimate of returns that every investment earns over the 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 does not providing that low returns like Fixed Deposit and not that high returns like Equity. Real estate yields an average return with adequate risk.

3.) 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 bodies 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 a 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 a 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 the Stock market is regulated by SEBI, and insurance by IRDA, there is no such regulatory body for real estate.

The property is just registered in the Registrar Office and there are 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?

Most of the people have a thought that Real estate allows you to generate a steady passive income on retirement. But it is absolutely a bad decision. Do you wonder why?

For example: If a person rents a property worth ₹50 lakhs. He will get only around 3% of it as a rental income 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 at two different rates.

Also, the parties involved in one transaction will not know about the price of 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 funds and real estate for a better understanding.

Illustration:

Below is a genuine example of one of our clients.

Mr. Akash (name changed) purchased a flat of 732 sq ft. in Saidapet, Chennai in Feb 2004 for ₹12,44,400. The per sq ft rate is ₹1700.

In Jan 2024, he decided to calculate how much he will earn if he sells the property. The value per sq. ft has been increased to ₹10,750 which gives him ₹78,69,000 for 732 sq. ft. Huge isn’t it?

Scenario 1:

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!

In the same year Feb 2004, if he invested in HDFC equity fund- G ₹12,44,400 he could have got ₹22,974.25 units for a unit price of ₹54.1650.

On Jan 2024, the equity mutual fund value is ₹3,45,30,429 for ₹22,974.25 units (₹1503.0060 per unit).

Amazing right?

If he chose equity mutual fund, now with his ₹3.45 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.

If we had chosen any other investment vehicle, then the return on these investments would be as follows.

Scenario 2:

In the same property and in 2004, instead of investing a lump sum if he could have chosen to invest 20% as a down payment and balance 80% as mortgage loan what could have happened. Let us assume he is going for a 20 year loan.

So, his down payment will be ₹248880 (20%).

His EMI will be ₹9600 per month for 20 years at a 10% rate.

The present value (as of Jan 2024) is ₹78,69,000 which has given him 9.41% 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 ₹248880 (the equivalent of 20% down payment) on Feb 2004 and a SIP of ₹9600 per month (the equivalent of EMI) in HDFC Equity fund. The present value (as on Jan 2024) is ₹2.24 Crore which has given him an XIRR of 17.29%.

Scenario 3:

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.19,900. 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 rents as a monthly outflow from the lumpsum (₹12,44,400) investment made in the mutual fund, then the value of mutual fund corpus at the end of 20 years is Rs.1,88,56,597.

Even after considering the rental expenses (with an annual increase), the mutual fund investment has given an additional return of Rs.176 lakhs.

Therefore, it is clearly proven that equities will beat out real estate in the long run.

Systematic Withdrawal Plan Calculator

4.) Final Decision.

Let us not get deceived by the psychological comfort and wrong perceptions about real estate investments and overexpose ourselves to real estate investments. The 50.7% real estate exposure, given by Indians is 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.

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