Every few years, when the irrational exuberance around blindly investing in real estate dies down, people ask the question as to whether real estate is a worth while investment, is this the right time to buy etc. This issue, we examine the investment rationale for real estate as an asset class.
Real estate is an asset that every investor must have in their portfolio. However, there are certain aspects to keep in mind while doing this;
You should look at real estate as a long term investment. If you do, and look at historical rates, you will see that in the long term, rates have always moved up. Even if you look at rates of properties just prior to the downturn of 2008, by 2010, most markets had seen rates that had crossed the 2008 rates. This holds true for all previous cycles too. Fundamentally, this is due to a) with increasing urbanization, even localities that are considered outskirt locations today become main stream over time thereby raising the demand for these locations and b) due to inflation, replacement cost of the buildings goes up. Both these factors contribute to raising the long term values of real estate.
This rising tide effect eventually raises the prices of all properties- unlike investment in the stock market where many blue chips of yesteryears are today's laggards.
One of the other big benefits that real estate offers is the option to get a home loan to finance a large part of the house cost- this ability to invest in a high value asset by paying a small down payment (15% - 20%) is not offered by other asset classes. This effectively offers the opportunity to get sizeable returns - an investment of 15% down for a home that yields a price increase of 15% effectively leads to a return of 100% on your investment. The other benefit this offers is that you lock in the price of the flat today while making a part payment- compare this to putting an amount equivalent to your EMI aside every month into a mutual fund or gold - you pay the rate you pay on the date of purchase.
Residential properties yield 2%-3% of the capital values in terms of rental income. This helps to reduce the EMI burden once the property is leased out. The tenants also generally pay the society charges thereby reducing that holding cost as well.
The tax benefit of deducting the interest as well as the fact that you pay a lower income tax on rental income (as you are permitted to deduct 30% of the rental income from your rental income towards repairs) also act as sweeteners to investing in real estate.
Incase you are purchasing for self occupation (or as your first house), you must consider the fact that you are currently paying rent. The sooner you stop paying rent and convert that monthly payout to an EMI, you build your equity in your own home rather than spending the money on rent.
While investing in real estate is something that I believe to be a great long term decision, there are certain donts and notes of caution to keep in mind while considering a real estate investment-
Real estate as an asset is reasonably illiquid - meaning unlike gold or shares, selling real estate is a slow, time consuming process. Therefore, if you feel you may need access to the funds at short notice, do not put this into real estate. Put aside the amounts that you feel you can do without for a period of 6 months - the time it can take to sell a home. Else, you end up needing to sell at distress prices.
Many people have made money by investing the margin money in an under construction project while they did not have the balance funds and managed to sell the property for a profit- this requires both skill and constant market monitoring to time the market. Something that I do not recommend. Invest what you can afford to put aside- you have the benefit of getting a home loan- add this to your down payment and invest within your means.
Ask the developer the resale rules and transfer charges, understand the exit costs- can you get any benefit of the stamp duty paid etc.
Invest with a reputed developer- especially if the property is under construction.
All in all, real estate investment from the long term has historically proved to be profitable. There is no reason this should not continue for the future. In my opinion, the time to buy is the time when everyone at a party is not talking about investing in a property- when that happens, its time to watch out for a bubble. Fortunately, currently, I don't hear people talking about real estate investment at parties.
Managing Director - Gera Developments Pvt. Ltd.
As with other investments, real estate too carries a certain amount of risk. Readers are advised to undertake their own due diligence and take judgement calls based on their own research and not on the article.