The past and future of real estate as an investment
It's time to permanently abandon the myths that surround real estate investments
A couple of weeks ago, while I writing about the success of the black money declaration scheme, I referred to the collapse of real estate as a viable investment option. As expected, this brought a flurry of protesting emails from a lot of people who seem deeply committed--not just financially but also emotionally--to the idea of real estate being not just a great investment but the only viable investment option.
As it happened, I also happened ran into a prominent Delhi-based real estate developer who made the claim that every wealthy person in the city had become rich through real estate. While such a claim is unverifiable and basically rhetorical, I guess it can be argued that rich people buy a lot of property and eventually the price of that property increases. But to say, based on this, that all rich people became rich because they invested in property is hyperbole. It could also be availability bias of who you know. I mean a narcotics smuggler would probably think that everyone who’s rich became so out of the drug trade.
Around the same time, I hosted Value Research’s inaugural ‘Money Hangout’ on Youtube, where participants asked questions about their investment problems. The typical real estate question arose out of the same problem. A lot of people have second apartments, bought as an investment on a loan that is being repaid with some difficulty out of a salary. Now, the apartment is worth some theoretical number of crores but is practically unsellable and the rental yield is a ridiculous one per cent or so a year if one can find a tenant. Obviously, real estate ‘investors’ of this category are asking themselves some uncomfortable questions, even though they are not yet prepared to accept the obvious answer.
The problem here, which is blinding everyone, is that there are plenty of anecdotes of people of earlier generations doing very well out of real estate. Everyone knows some families who owned a house bought 30 or 40 or 50 years ago which, when sold after decades, made them rich.
The problem with getting inspired by this is that the entire model of real estate value creation has changed. Broadly, there are five sources of real estate value creation. One: the legal ‘state change’ from agricultural or unused land to residential or commercial. Two: the creation of a physical environment which makes the real estate usable. This consists of construction and infrastructure. Three: the improvement in actual livability as an area becomes fully populated and eventually comes into the mainstream. Four: Inflation and general economic growth over a period of time. Five: The periodic booms and manias and slumps that inflict real estate.
In the old way of investing in real estate, one bought a plot of land in an area which was substantially underdeveloped and over the next two or three decades one could capture all the value created under numbers 2 to 5 above.
Things have been very different in the last decade when real estate investors have bought apartments. In this new model, stage one and two are completely taken over by the land acquisition agency and the developer between them. However, by creating tremendous hype around real estate, engineering massive price inflation and high-pitched marketing, developers have also captured a lot of the future value accretion that would happen in stage three and four. As a buyer, you are told that one day the area in question would be the next central Delhi or south Mumbai and therefore you should pony up a future price right now. Many did so, and find that they now have a long and uncertain wait. Maybe their descendants will get something, maybe they won’t.
Of course, some of this excitement about the fabulous long-term returns of real estate arises purely from mathematical illiteracy. One of the people I spoke to breathlessly told me about a piece of property in Mumbai that became 100x since the mid-60s. Did that person realised that this was a rate of return of barely 9.7% a year? Probably not.
Happy investing
Source:Valueresearchonline.com
Some comments from various investors on the article ....
Let me share my experience (my not be the same for everyone)I booked a flat in Hyderabad in Feb 2004 and got it delivered in Feb 2005.The total cost of ownership was 12.5 lakhs, at that time.I am paying a 12 year loan (EMI Rs.11,938/ for 11 lakhs loan) to be completed in Dec 2016 (in the next 2 months). Though the idea is to live in the flat,I never stayed there, as I got better opportunities in other cities and roaming around India.If I sell it now,I may get only Rs.28 lakhs (the real estate scenario in Hyd was even worse when compared to rest of the country).I rented it and got a rent starting with Rs.4,000/ in March 2005 and Rs.9850/ now. The house was vacant couple of times in between for 11 months in total (for some modifications,repairs I got done).The repairs costed me around Rs.1.5 lakhs on these two occasions. Considering all this,I don't think it was such a great investment.The only silverlining was, I never had to look for a tenent,as this house is for a small middle class family (not a high end one and hence has good rental demand) and I never had a problem with any of my tenants.
I was making a quick calculation of investing the same in HDFC Tax Saver (which I was aware in 2004,as I was doing tax saving in that fund in 2004).
If I invested Rs.1.5 lakhs lumpsum (the initial corpus for the flat) and continue to invest the EMI from Jan 2005 (when I started my Flat EMI) in that fund, my corpus would have been 54 lakhs and I don't need to pay any tax,if I sell the fund.
Now,I got some tax break by investing in that flat (as interest is tax deducted) and some rent (though very meager, after considering the taxes,repairs/modifications and loss of rent for 11 months during the period I stated).
In all I think,I would have been much richer by investing in an average mutual fund than investing in real estate (the way I did).This is my experience.
The good part is, I was not an aggressive real estate investor and was doing SIP from 2003 (though my means are modest then and improved with time).I made reasonable returns with good funds ( helped by Valuereserach, which was a great source of advice on funds).I am happy and more importantly mentally comfortable with my fund investments,which as on date have clocked 16% pa retun (85% equity,15% debt portfolio).
I think,we all need to think what really works for us and with some experience, we will come to know about it.
My first investment in 1996 was in a plot, which I sold just before the 2008 crisis with a net gain of 10 X my investment amount. I sold it because, I felt that those rates are unsustainable. Although, it dipped during the crisis, but it is still on its way up. But, I have no regrets about selling.
My second major investment was in 2002 in a Independent house, the cost of the land has appreciated some 12 x times in 10Years. This property is for my end use, it doesn’t matter if it multiplies.
So my past experience with real estate has been pleasant. Although, I still have capacity to buy / invest in real estate, I have the following reasons for not buying it:
The property price (what you pay for a flat) is much higher compared to what you pay in Developed Countries (if you could buy there). Even in places like Dubai, that has got excellent infrastructure, the cost of real estate is much cheaper than my place (chennai).
Atleast in Chennai (i think same holds good for most other cities), there is absolutely no infrastructure and amenities to support such a huge growth in high rise buildings. It may come in future but it will take another 5 to 10 years and still you know we are not going to get all what we want as amenities. Even the climate in chennai is so harsh.
The developers take the investors for a ride by the time they handover the flats. What is promised is not delivered and you cannot fight against the developers (who got the time for it).
A friend of mine invested in Hiranandani and DLF projects in chennai worth 1Crore each and he is now being asked to pay almost 20% more than what is agreed referring to terms and conditions. The agreement is always one sided favoring developers. He has got no other option but to pay. Otherwise you end up in court and waste time or shouting in front of promoters house (as seen recently in TV).
It is a nexus between banks, developers and politics. Of course, the political corrupt black money plays a big role in real estate.
If there is a crash, it will hurt many people. But, it may or may not happen in near future. if there is no crash, there could be a time correction and that could suppress the long term returns.
If you are a value investor, you will not invest in it. Well, you may look like fool to others who are investing in it!
Accumulate cash and wait for the right opportunity to buy it and I am sure there will be opportunity in future at some point….
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