This is a sample of an oft repeated conversation at any Financial Advisors office:
Client: I am planning to buy a house.
Advisor: Another one?
Client: Yes.
Advisor: Why?
Client: For “investment”.
Advisor: How will you fund it?
Client: That’s why I have come. I want to sell some stocks and Mutual Funds I am holding. I want your advice on which ones to sell. For the balance amount I will take a loan.
Advisor: (wondering to himself) Aren’t Stocks and Mutual Funds investments”
The problem lies in the client assumption that Real Estate is the only asset, which will definitely appreciate, and that too in a big way.
Lets tackle some of the popular misconceptions and issues related to Real Estate.
Real Estate gives huge returns
Many a times we have seen headlines in newspapers reporting big real estate transactions. For instance one such headline came up in 2012 reporting the sale of a flat in Samudra Mahal building at Worli. The sale was made at a whopping rate of Rs.1,18,000 per sq.ft.The effect was enhanced because the purchase was reported to have been made at a price of mere Rs.700 per sq.ft, albeit in 1970. This is a typical showcase example for fans of Real Estate investments.
However, if you work the numbers you would realise that Rs.700 becoming Rs. 1,18,000 in 42 years gives a return of 12.66%.
Not so impressive now, is it?
Lets take another example. An investment of Rs.100 made in 1979 becomes Rs.19,500 in 2013. The return works out to be 16.76%. Incidentally, this is the return your stock exchange index gave over the period.
The return on Real Estate investment looks big mainly due to the large ticket size, but you need to look at the annualized return
Costs involved
Most people when they buy Real Estate especially as second or third homes, they are eyeing the rental income that comes with it. But they would do well to consider the costs of buying and maintaining a property.
Cost of acquisition, which includes stamp duty, registration fees, brokerage and lawyers fees can go up to 10% of the cost of property.
Then comes the cost of taking a loan in terms of processing fees and interest payable on loan. The argument of getting tax rebate does not cut any ice because on every Rs. 100 you pay as interest the maximum tax benefit is Rs. 30. Remember that balance Rs. 70 goes out of your pocket and is an additional cost.
Recurring costs include maintenance costs like repair and painting, property tax and payment of electricity and water bills.
Finally the taxes you pay when you sell the property. If you choose to save tax you are either investing in the low yield Capital Gains bonds for 3 years or are re-investing in some other property. The latter option means you cannot ever cash out.
Other issues to consider
Real Estate transactions are not regulated transactions. The value discovery is difficult and it is left to the individuals entering the transaction. Most of the time it is left to the Builder’s whim or in case of resale the benchmark is the previous known transaction, which may or may not be known.
In an under development project a lot depends on the developer. It is difficult to ascertain whether he has all the requisite permissions. Many a projects are languishing due to misadventures of the builders and the investors are of course the losers.
Lastly when you get into Real Estate you are taking on a huge financial commitment and entails taking loans and committing to EMIs. If there is a sudden job loss or even a scaling down of income due to recession in your industry do consider whether you would still be able to fulfill the EMI commitments.
Most Important issue
In all this hype about making big money by investing into Real Estate, we forget that our focus for investing is to fulfill our financial goals as and when they appear on the horizon.
What is the point of having one huge investment in a flat which is now worth Rs.3 crores, if for your daughter’s higher overseas education you need Rs.50 lakhs, and have to either sell this property or take an educational loan?
In conclusion, I want to say that this article is not about Real Estate bashing neither is there an attempt to prove that equity investing is superior.
People commit huge resources when they are buying their first home and they should. But when it comes to buying Real Estate as an investment, do consider whether it fits into your asset allocation or whether that piece of property is the biggest investment you have. If latter is the case you could have a problem.