Arvind Paranjape

Author of books on Investment

Think before you buy that piece of property...

Obsession with Real Estate Investing

“No asset class or investment has the birth right of a high return. An asset is only attractive if it’s priced right.”
― Howard Marks

Last week, Ketan, a non resident investor from Gulf country came to me to for advice on investing. As per my practice, before suggesting him anything I got information of his existing investment and objective for new investment.  When I prepared his investment kundali (pie chart), it showed that he was having 71% of his assets in real estate. (3 flats excluding the residential house).  

When he told me that he wanted to buy one more row house on a hill side, I was stunned. 
Next day another investor Chintan, walked in my office with his wife Nisha. Their objective was to invest 5 lac rupees but were not sure if they should buy a second house. They have 2 children and Nisha is house wife. My enquiries revealed that Chintan having just repaid their housing loan wanted to buy one more flat of Rs. 35 lac, as an investment.  I showed them their existing asset allocation.  FD 2 lac, Gold: .8 lac, and zero equity and some amount locked in few endowment insurance plans.  
Ketan and Chintan are just the few of a large number of investors who are just mad with the idea of investing in real estate. They have not looked at their asset allocation at all, which was skewed towards real estate. They are not aware that it is important to have asset allocation linked to the investor's financial goals and risk appetite.
They have not understood the relative strengths and weaknesses of all 4 asset classes; namely Fixed income(FD), Equity (shares of MF), Real Estate(house, shop, plot etc.) and Gold (physical or bonds). They need to learn that their Portfolio should be a balanced one. I drew their attention to the following important things. 
1.    You need to take utmost care  to ensure that title of the property, its location etc. are good and appreciation is possible. This means significant risk is there in real estate selection.
2.    It is not feasible to sell real estate in part. i.e. you cannot sell half of a plot or one room!
3.    You will have to pay long term capital gain tax on sale of the property or invest the gain in new house property to save the tax. Third option is to purchase bonds carrying 6% taxable bonds for 3 years.
4.    You can get regular income by renting the house or shop, but it is taxable and rate of return is lower compared to a deposit in a nationalised bank.  
5.     Majority of the investors believe that that property prices will always appreciate and that too by a proportion which will compensate the loss in rent.  But this belief is not true. E.g. In New Delhi region, property prices have declined by 20% in last 2 years!! Thus, real estate may not provide returns at all points in time and can go through periods of decline or long periods of stagnant prices (time correction) !! E.g.  Rate of appreciation as revealed by Magic bricks index since 2013 is just 2% per year.  
6.    Real estate markets are highly localized. This means appreciation depends mainly on a number of local factors like declaration of special zones, changes in development plans, layout changes, construction of ring roads or metro etc. 
7.    If the last few year returns are good then be more cautious, as the prices have tendency to move in cycles.
8.     If your friends are sharing with you stories of how they made windfall gains, be sceptical and recheck your calculations before proceeding. "It is in your interest that you are not lured by your friends' stories of lucrative gains on real estate. Think coolly before taking decision of buying that piece of property. Also have look at performance of equities. As an asset class equities can offer you better risk-reward ratio.!!" I said in conclusion.

(Reference: by Arun)

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