A very good day to all of you on this precious day, our beloved Mahatma’s Birthday!
I received several requests from investors and well-wishers to share my views on real estate investments and I thought that I will share my views on this topic.
Indians are passionate when it comes to purchasing physical assets, especially gold and real estate and hence these 2 asset classes form a considerable portion of ones portfolio of investments. Real Estates have a psychological impact on investors and the pleasure of owning properties have resulted in some investors accumulating very high proportions of this asset as part of their overall portfolio. I have met several investors who have over 80% of their assets just in real estate as there is a myth that real estate investments always make huge returns and they have produced several “Crorepatis”.
I personally have quite an amount of experience with Real Estate investments – Land, Independent House and Apartments but haven’t dealt with Commercial property. Very few individual investors invest directly in Commercial Real Estate and hence I am not getting into the details of it.
Among Land, Independent House (house with full share of land ownership unlike apartments where the ownership is on undivided share) and Apartments, the return potential is maximum for residential land, followed by independent house and apartments/ flats. The risks are also stacked in a similar way – highest for residential land and lowest for flats. i.e. Investments in Flats and Independent houses are relatively safer when compared to Land investments. Land investments needs thorough due-diligence as there are several horror stories of the same property being sold to multiple buyers by fabricating documents and the checks and balances in the registrar’s office is below par. Also, usurping of land by local influential people is also quite common.
Real Estate as an asset class suffers from huge black money or unaccounted money transactions and the difference between the guideline value and actual market value is quite significant (excess of 100% in several areas). This is more pronounced in land deals and independent houses and to an extent controlled in flats/apartments. For salaried people it is not uncommon to convert their hard earned money to black money (during purchase) as the seller most of the times is not inclined to take more than the guideline value due to capital gains tax incidence. There are cases where the buyers also try to limit the white component to only the guideline value in order to save on stamp duty and registration charges (8% of sale consideration in Tamilnadu). In my view this huge unaccounted money that moves from one person to another is one of the key reasons why the real estate prices have reached astronomical figures in India.
In Adyar, Chennai, the cost of a 2 bed-room flat of size 1000 sq. ft. is priced at 16,000/- to 18,000/- per sq.ft. Including registration, taxes, car park, corpus, water and sewerage and basic furnishing the landed cost is approx. 2 crores. This is an alarming number and I am not sure how many people can really afford such properties. Compared to this the prices in US where the income levels are significantly higher seem to be very cheap. One of my friends recently bought a 4 bed room independent house (about 2500 sq. ft. constructed area) with 2 car parks, garden etc. for $260,000/- in a prime area in Dallas, Texas. This works out to only 1.55 crores. A similar set-up in Adyar (where 2400 sq.ft. of land costs about 6 crores) would cost anywhere between 12 to 15 crores. Trying to compare real estate investment in Adyar and Dallas is definitely comparing apples and oranges but the point I am trying to emphasis is the affordability factor of Real Estate in prime locations in India.
I would like to illustrate the example of my own investment in Real Estate and its performance now. The flat that I live in Adyar is 1150 sq.ft, 2 bed room flat, purchased in 2002 when the rate was only about 1800/- per sq.ft (before the mega real estate boom in Chennai). Including car park, registration and others I spent about 30 lakhs by the time I took the possession in Aug 2004. The flat is about 10 years old now and I checked the market value (I don’t plan to sell it though) for the purpose of this blog. Based on the going rate and the depreciation the price would be about 12,000/- per sq.ft (or 1.38 crores for 1150 Sq.ft.). The gains is not a simple math of 1.38 crores minus 30 lakhs resulting in 1.08 crores. I would have earned rental returns if I had let it out which was around 9,000/- in 2004 and approx. 25,000/- now. Assuming 25% as maintenance expenses, 9% investment returns from the rent and the taxes that I would have paid on rents received, the sum works out to 16.13 lakhs. If I sell the flat I have to pay Capital Gains Tax which I calculated and works to about 14.33 lakhs (the indexed cost of the 30 lakhs taking the cost of inflation index published by the government of India is 66.35 lakhs and 20% taxation on the net gains works to 14.33 lakhs). I had taken 20 lakhs bank loan resulting in considerable interest charges but I am ignoring it for this calculation for a reason. I would have to pay 2% brokerage when I sell the property and including all these the net value of the property comes to approx. 137.5 lakhs giving me a Return on Investment (ROI) of 14.15%. The caveat here is that I would be able to find a buyer who will pay me 138 lakhs in white (The buyer would have to pay 1.38 Crores plus 8% registration and stamp duty and brokerage making it atleast 1.52 Crores) and no unaccounted money which is rarity.
I tried to compare this with investments in some well-known equity mutual funds and the results were quite interesting.
|Scheme/Index||NAV on 1 Apr 2003||NAV on 26 Sep 2014||Returns||Value of 30L|
|Franklin Blue Chip||23.0826||315.5640||25.55%||₹ 410,13,230|
|Franklin Prima Plus||23.1948||373.1597||27.34%||₹ 482,64,227|
|HDFC Equity||23.4600||440.1260||29.05%||₹ 578,15,463|
|HDFC Top 200||17.4726||322.7530||28.88%||₹ 554,15,851|
|ICICI Pru Dynamic||10.3442||177.0158||28.02%||₹ 511,79,375|
|Reliance Growth||30.1308||699.5247||31.46%||₹ 696,48,801|
|UTI Equity||9.0600||91.4349||22.27%||₹ 302,76,457|
|BSE 100||878.8800||8,021.0000||21.21%||₹ 273,79,165|
You would notice that even investing in Sensex would have given me 1.2 Crores more than my flat and there is no challenge of black or unaccounted money. I don’t need to go around hunting for the right buyer and there are several such advantages.
Let me now illustrate another example of a property transaction, a flat in Velachery (prime location and from a premium builder) which was bought for 65 lakhs (925 sq.ft. 2 bed room) in Feb 2012. Two and half years later the situation is that the value of the flat is not more than 70 lakhs as the prevailing rate is only about 8000/- per sq.ft. and since the property is 2 years old, the value per sq. ft. would be approximately 7250/-. When you buy a new flat you are quoted only the base price and the additions like registration, car park, corpus etc. works out to another 10 to 20%. When you sell it this gets discounted. The registration has to be done for the entire sale consideration (8% of 70 lakhs vs 8% of 15 lakhs, which is the cost of Undivided Share) and not just the undivided share (UDS), which is an advantage if you are buying a new flat. So, the second hand buyer discounts the price to that extent. If we calculate the rentals received for 2 years and deduct the maintenance and taxes, the value would go up by another 1.5 lakhs which probably would be lost in brokerage which has to be paid to sell. The principal amount of 65 lakhs with a simple interest yield of 9% itself comes to about 77 lakhs which means there is a notional loss of 7 Lakhs on this real estate investment!
So, the point is that you don’t always make money or profits in real estate investment and it has its own risks. People may argue that if this property investment is held for a longer period of time, the losses can be recouped and some gains can be made. This holds good even for Equities which is riskier for periods of 3 years and less while the risk reduces considerably beyond 3 years and upwards, making it safe as a long term asset class.
To summarize my views:
- Real Estate as an asset class gives a comfort feel to people. But the percentage exposure should be appropriate in one’s overall asset allocation. Returns from real estate do beat inflation in the long run.
- Real estate investments are marred by liquidity concerns, black money and usurping
- It’s a myth that real estate investments are safe and always give positive returns
- Ensure that your real estate investment is accessible to you on a regular basis or there is a trusted care taker for the same.
- If you are not comfortable dealing with black money, restrict your exposure to real estate, possibly just your home to live.
REITS (Real Estate Investment Trusts) is another way to take exposure to Real Estates and SEBI had just released the guidelines. The minimum investment amount is about 2 lakhs per investor and REIT is similar to a Mutual Fund. Please remember that REITs are mainly focused on commercial properties and their main income would be from commercial rentals. 80% of the REITs should be investment in completed properties and only the rest 20% can be in land and other assets. REITs are expected to hit the market shortly and I will get into more details of it at a later point in time
Please do send me your comments to firstname.lastname@example.org and share your views on my blog. I would also request you to send me some interesting topics that you want me to blog on and if it’s an area of my expertise, I will definitely take it up
<Blog # PenguWIN 1014 – Allure for Real Estate>
Good analysis. infact the returns are alarming. it would be prudent for a common man to invest in mutual funds rather equity/real estate. the best part seen here is ease of liquidity, as stated in the blog. Very much practical.
Comments are closed.