Real estate gives moderate returns and should be a hedge against inflation
Property and gold are the darlings of Indian investors. But, today, in many cities, there are “ghost flats” or towers of unoccupied flats where most of the units are empty.
Here are some of the top myths about real estate that misled people, who ended up paying a heavy price for it.
Myth #1: Property prices always rise
: The table tells us that it is not enough if property prices keep rising. They need to rise at a healthy rate.
Otherwise, the opportunity cost of owning the property is huge. A low rate of growth is worsened by the fact that people take loans for buying property.
Suppose Ravi bought a flat worth ₹1 crore with a ₹80-lakh home loan at 10 per cent interest for five years ago. Today, the flat is worth ₹ 1.20 crore. If you subtract interest cost on the loan of ₹40 lakh, he would be left with negative returns of ₹20 lakh.
If Ravi had invested ₹20 lakh in down payment initially and had instead parked that in a fixed deposit at 8 per cent, he would have made ₹9 lakh.
Therefore, Ravi has already lost ₹29 lakh on this investment over five years. This is a minus 150 per cent return on his investment (minus 29*100/20)!
Myth #2: If it’s not appreciating, you can always get rid of it:
Real estate is one of the most illiquid assets that individuals can invest in. Yet, one does not consider the liquidity factor till one has a need to sell. It normally takes three-six months to sell a property.
It is also difficult to find the right buyer at the right price with the right payment terms within six months. Sometimes, it can take more than a year. And meanwhile, if one has loan repayments, then the cash flows can get really squeezed.
I have not invested much from my savings; I have taken a loan:
The above example of a leveraged investment shows that if you take a loan to buy property, your opportunity cost is higher.
Financial leverage helps you get a higher return on your equity (investment) when the asset appreciates, but it is a double-edged sword. Leverage actually worsens your situation if the market or asset price goes down.
You can touch and feel a property, unlike shares
: It is true that property is a “real” asset that you can touch and feel compared to stocks or bonds. Property ownership generates emotions of pride and satisfaction.
Sure, for your own home, one should have emotional bias. But in choosing investments, one should be objective.
What matters are returns, risk and liquidity. India has a robust set of financial regulators who ensure that the common investor’s interests are well protected in financial products.
In fact, the trend now is that more and more Indians are preferring financial assets (mutual funds, insurance and shares) over real assets (land and gold).
When you buy land, a government project (or factory or highway or airport) will come up near it and the price will quadruple
: This is a very common tip given by family and friends. Maybe it is true that some people have made money like this. But such returns cannot be systematically replicated time and again.
Moreover, the risks in this approach are never explored or discussed. Often, given India’s local laws and municipal/panchayat rules, there are legal hurdles in recovering the sale proceeds when land gets acquired.
Overall, real estate is a good asset to invest in and here’s how you should approach it: First and foremost, invest in a home to live in. After that, if you have surplus, ensure that the investment is legally safe and rent-producing.
Do not expect miraculous returns. Expect real estate to be a hedge against inflation and a safe asset, giving moderate returns — slightly over inflation. Do not over leverage. Rental returns should at least cover your interest and maintenance of the property.