scorecardresearchBusting 5 common myths around real estate investment

Busting 5 common myths around real estate investment

Updated: 21 Apr 2022, 03:01 PM IST
TL;DR.

The perception of real estate investment being a safe investment emanates from the fact that investor owns something tangible in their hand. While in most of the financial instruments, it is the paper, except gold, that they own. Here are the common misunderstanding people have when it comes to Real Estate Investments

Busting 5 common myths around real estate investment

Busting 5 common myths around real estate investment

Whenever I interact with people, I notice one thing in common amongst all. It is about the perception of high risk in equity investment whereas real estate is considered a low-risk and better investment avenue.

The perception of real estate investment being a safe investment emanates from the fact that investor owns something tangible in their hand. While in most of the financial instruments, it is the paper, except gold, that they own.

Common misunderstanding people have when it comes to Real Estate Investments

  • Real estate prices never correct
  • Real estate provides good rental income
  • No one has ever made a loss in real estate investments
  • Home loan is an advantage due to tax savings on principal and interest paid
  • Property prices go up because of scarcity of land

What people do not consider/conveniently forget?

  1. Real estate investment is not very liquid. This is witnessed when you try to sell a property. The quoted price in the market is seldom matched when we try to sell the property. It is just the opposite when we try to buy a property. It all depends on who is in need.
  2. One can’t sell a part of the real estate investment. It has to be a complete entity. Unlike in Mutual Funds or the stock market, where we can sell as low as one unit of stock, we will have to sell the entire property in the real estate. This makes it a very rigid transaction.
  3. If the home loan is at floating rate and interest rate is going up, it certainly pinches.
  4. Registration of property, maintenance, property tax and society charges are critical factors to decide the returns but are commonly overlooked
  5. It requires constant vigil especially if it is a piece of land, like an independent bungalow.
  6. Real estate prices have crashed in the past: most recent being 2008 and prior to that in 2000. We witnessed a ‘V’ shaped recovery in 2008 but in 2000, was a decline that lasted for couple of years. It was almost stagnant during the last decade and started picking up recently.
  7. The property prices also go up because of black money invested in the sector. In many locations, esp. in Retail Real Estate, the impact of black money is declining due to various state government making efforts to bring the circle value or ready reckoner rate or guidance rate close to the market price. The registration of the property has to happen at the ready reckoner rate or market rate, whichever is higher. In Maharashtra, this ready reckoner rate is reviewed every year. However, in many states, there is a significant difference between market rate (very high) and ready reckoner rate (very low). This becomes a ground to generate or use black money.
  8. The transparency in the sector is almost negligible and in many cases “might is right”. The RERA is a powerful tool that buyers have got esp. for new under-construction properties. But then this has not been completely implemented in many states.

Grandpa purchased it in just 1.7 lakh, today worth 3 crore

One more common issue around property market is quoting the historical price v/s the current market price. When the historical prices are considered they always appear very small. These are always considered without the right perspective.

We would quite often hear from our grandma that this property was purchased by grandpa in just 1.7 lakh and today it is worth 3 crore. But the perspective is to add income levels and time duration. When the property was purchased in 1.7 lakh, grandpa’s income was not even 25,000 in a year. Today, even driver is earning more than 1.50 lakh in a year. So 1.7 lakh and 3 crore have no correlation.

What is CAGR and why it is important?

To get the right perspective, we should see the returns in the CAGR terms. CAGR is Compound Annual Growth Rate. It is the annual rate of return that would be required for an investment to grow from its beginning balance to its ending one.

One can calculate the CAGR from any financial websites like https://investinganswers.com/calculators/return/compound-annual-growth-rate-cagr-calculator-1262

Let’s see some examples of the properties from different locations purchased in different timelines and what is the CAGR they generated? These are actual examples. However, the returns for others could vary as mentioned in this article due to variety of reasons.

Location Purchase year Purchase price Today’s price 

CAGR 

(Annual returns) 

Ahmedabad 1974 01.75 Lacs 3.30 Crores 11.53% 
Bangalore 1990 03.00 Lacs 1.25 Crores 12.36% 
Pune 2003 05.00 Lacs 40 Lacs 11.57% 
Lucknow 2010 50.00 Lacs 77 Lacs 03.66% 

These are some of the examples from different cities of the real estate prices and how they moved. There can be variations due to variety of reasons for others. The property market works very differently. The prices of two properties just diagonally opposite locations could give very different returns. But if we consider it broadly and in general terms, we realize that property returns are more or less in line with the rate of inflation with some added returns.

Now the next question is can we improve our property returns too?

When is the right time to buy?

We should buy the property when we find that it is giving us an opportunity to buy at a reasonable price or in distress. Something similar to what we do with other investment avenues. This helps to maximize our returns.

But the million-dollar question is how to identify if it is at a good value or distress value and not a “Hot” market.

Here are a couple of parameters that you should think about before taking a decision:

Rental yield - It’s one of the important parameters. The gross rental yield is rental income divided by the price of the flat. The net rental yield comes after we remove the property maintenance, property tax, society charges, brokerage charges or any other payments that owner of the property has to make to put the property on rent. For a retail real estate, the Gross rental yield should be close to 4-5% and the Net rental yield should be close to 2-3%, more the merrier. If the rental yields are lower than this range then it does not make a sense.

Rise in income levels – If the income levels are rising then it leads to purchases of real estate properties. We have witnessed how the salaries of software professionals went up during Covid period especially in 2021 due to sudden spurt in their demand. In addition to this, the software professionals were working from home and that was giving them a benefit of additional savings and led to the start of momentum in purchasing real estate properties across India. This was one of the reasons why we considered Real Estate sector as an opportunity play which was in down cycle during the last several years. The other reason was a significant consolidation in the players. Few players many a times offer better investment opportunity.

Stagnant prices - one more parameter to keep in mind is stagnation of the real estate prices. If prices have not gone up, in fact gone down compared to the peak price for at least 5-7 years period, then also it can give an opportunity.

Property auction - If we find an increasing trend in property auctions, we might get a good opportunity to buy a property. What is a property auction, and how it is relevant? Whenever buyers buy property by taking a home loan from the banks or financial institutions, they will have to mortgage the property to that institution. If the buyer defaults on loan, then the financial institution auctions such properties. If more and more properties are coming in the auction, people cannot repay their home loans. In India, buyers have an emotional attachment with the property. They rarely do they willingly want to take it to the auction. If properties are coming in the auction, they put more pressure on real estate prices.

How should we find the details of properties in an auction?

There is an Indian Banks Auctions Mortgaged Properties Information (IBAPI) portal which is an initiative of Indian Banks Association (IBA) under the overarching policy of the Department of Financial Services (DFS), Ministry of Finance to provide a common platform to display details of mortgaged properties to be auctioned online by Banks, starting with Public Sector Banks. The link to this portal is https://ibapi.in/. It provides a list of the properties available in the auction under different categories. It also provides the property details from different cities.

Finally, the investment in property, or for that matter investment in any other avenues, is good if we are emotionally detached from it. We should apply rational thinking. Buying a property is an emotional decision for many. But it should be exercised with prudence.

However, during euphoric times (even post euphoria) most of the investors conveniently overlook the flip side.

These are my two pence worth. I hope this is helpful. As always, I look forward to your feedback.

Niteen S Dharmawat is one of the founders of Aurum Capital, a SEBI-registered Investment Adviser and Research Analyst company. This article does not constitute personal recommendations and advice. Niteen can be reached at his email id niteen.dharmawat@aurumcapital.in or Twitter handle @niteen_india

 

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First Published: 21 Apr 2022, 02:58 PM IST