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Thursday, April 2, 2015

Real Estate investment: Facing the grim reality?

Last week I got an opportunity to moderate a BDB book club session in Pune. The event was on the book, Mad Money Journey. It is a financial thriller written by Mehrab Irani, GM - Tata Investments. The writer himself was present in the session and we had a wonderful audience asking questions.

It was amazing to know the financial awareness amongst the participants. The audience was having a healthy combination of common and smart investors; service & business class professionals, young and retired professionals alike. The questions were on all possible investment avenues available including mutual funds, bonds/debt, PPF, gold/silver, real estate, equity amongst others. However, I noticed one thing among all the participants. It was about the perception of high risk in equity investment while real estate considered as low risk and better investment avenue.

The perception of real estate investment is 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. Let me highlight some common points which are considered and some which are overlooked.

Understanding of common people about real estate investment:
1) Real estate prices never go south
2) Real estate provides good rental income
3) No one has ever made a loss in real estate investments
4) Home loan is an advantage due to tax saving on principal and interest paid. But if the home loan is at a floating rate and interest rate is going up, it certainly pinches.
5) Property prices go up because of the scarcity of land

What people do not consider/conveniently forget:
1) Real estate investment is not very liquid
2) One cant sell a part of the real estate investment. It has to be a complete entity.
3) Registration of property, maintenance, property tax and society charges are critical factors to decide the returns but are commonly overlooked
4) It requires a constant vigil especially if it is a piece of land, a bungalow.
5) Real estate prices have crashed in the past: most recent being 2008, earlier in 2000. 2008 was a V-shaped recovery but 2000 was a decline for a couple of years
6) Property prices also go up because of black money invested in the sector
7) The transparency in the sector is almost negligible and in many cases might is right.

The mobile industry where the pricing is now almost a paisa for a second has a regulator. But look at the amazing irony. The real estate sector where people put in their life time saving, running in few lacs to crores, does not have one. Why?

Real estate has given significant returns to the investors during the last 10years or so. The investment also gives an opportunity to earn rental income. This makes it attractive.

I would like to sight a simple example and I am sure the story would remain the same across India; villages and cities. A 1BHK flat (Bedroom, Hall, Kitchen) of 600Sqft in Pune was priced at Rs5,00,000 (Five Lakh) in 2003. I have chosen 2003 because after that the big rally in real estate started. If this 1BHK property was put on rent in 2003 then the yearly rental income was Rs40800 (monthly Rs3400). The rental yield (rental income divided by the price of the flat) was 8.16%. If we assume that the property maintenance, property tax and society charges around 3% then it was giving a net rental yield of 5.16%. This was excellent.

Now in 2015, the same flat is priced at Rs40,00,000 (Forty Lakh). The rental income is Rs96000 (monthly Rs8000). The rental yield is now 2.4%. If we keep the property maintenance, property tax and society charges at the same 3% rate then it is now giving a net negative rental yield of -0.6%.

The net rental yield is negative in this case, and I am sure in most of the property investments in India. Unless the rental income increases or the property prices go down the investment in this property would not make a sense.

Is there any trigger to believe that the rental income will go up? It could have gone up had there been a shortage of newly constructed home. The inventory of newly constructed homes which is normally 18-24 months has gone up to 36-48 months. This is not a very positive sign and may put pressure on property prices.

The prices of property in India are higher than the prices in many developed countries whereas the standard of living is far below. The counter-argument is the growth story of India vis--vis the growth in the developed countries. Was India rapidly growing during the last 5 years when the property market has gone up the roof? This invalidates the growth argument. We should look at the value derived and instead of falling prey to the growth argument.

The investment in property, or for that matter investment in any other avenues, is good as long as we are emotionally detached from it. We should apply rational thinking. However, during euphoric times (even post euphoria) most of the investors conveniently overlook the flip side. The euphoric movement may have ended in the property sector in India long ago.

These are my two pence worth. I look forward to receiving your feedback.

About the author: Niteen S Dharmawat is an MBA and cleared CFA Level 2, CFA Institute USA. He also conducts free investor education sessions, writes blogs. A firm believer in long-term financial planning, and a 20 years veteran of the stock market, he likes to study the economy and individual stocks. He also conducts free investor education sessions for common investors. Niteen blogs at http://dharmawat.blogspot.in/ and can be reached at niteen.dharmawat@gmail.com

Registration with SEBI as Research Analyst: The writer is not registered with SEBI under SEBI (Research Analysts) Regulations, 2014 as Research Analyst. As per the clarifications provided by SEBI: Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as a research analyst under RA Regulations. The article above is not with an intention of any research finding and recommendations. It is only with the intention to share the views with which the writer has taken a position.

Look forward to your comments 

Niteen S Dharmawat
Twitter: @niteen_india
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1 comment:

Ganesan said...

The prices of property in India are higher than the prices in many developed countries whereas the standard of living is far below.

this words are more remarkable one ... in many areas in chennai thereis no infra development like drianage, proper roads, but the prices are skyrocketting, people are madlybuying apartments , even they doesnot know the value of the single rupee..

really appreciating article, i am sharing to my friends