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Stocks Can Crush Real Estate Over the Next 3-5 Years

Apr 21, 2016

In this issue:
» Private Banks far more prudent in lending than PSUs
» The business houses that have survived dramatic changes in economy
» And more....
0.00
Rahul Shah, Co-Head of Research

Water - or rather its shortage - is on Vivek Kaul's mind these days. And why not? We could certainly do with some water conservation. Especially when some regions are facing their worst draught in years. In fact, given that water is expected to be perennially in short supply, Vivek's efforts to educate readers are laudable.

But before he plunged into water, Vivek wrote a fantastic piece on the current state of India's real estate.

His argument was simple. Real estate prices have appreciated massively over the last few years, so it makes a lot of sense to exit and park the money in fixed deposits.

As you scroll down and read the comments that have poured in, it's clear not everyone agrees. The counterview is that real estate should still be held irrespective of the recent appreciation.

I think there are two different audiences here. Audience number one has been a beneficiary of the appreciation in real estate prices. Audience number two has been contemplating whether to buy real estate at current prices.

The guy mentioned in Vivek's article (a member of audience number one) has a valid reason to hold on to his real estate.

He has seen his property appreciate more than seven times over eleven years. Even if prices were stagnant or fell marginally over the next few years, the wealth he has earned would remain intact, and his eventual annualised returns would still be healthy.

This is similar to when we change our view on a stock from BUY to HOLD after it has appreciated a great deal. Under a HOLD view, the expected returns from the present levels are not great. But the stock has appreciated so much that the original buyers still end up with attractive returns on the stock from start to finish.

However, for investors who want to invest now - after the stock has changed from BUY to HOLD - the expected returns from the stock are not good enough to merit a BUY.

This is what audience number two should consider. When evaluating current property prices, this audience needs to look out the windshield rather than the rear view mirror. They need to focus on expected future returns, not what real estate has done in the past. The stronger the past returns, the greater the likelihood of below average future returns.

The flat Vivek mentions in his article went up seven times in eleven years. These returns are as strong as they come. If property prices were to go up at similar rates over the next, say, five years, they would be three times as expensive as they are now. Is this likely? We don't think so.

Builders are finding it difficult to sell property even at current prices. Appreciation in realty prices have come to a stop with prices stagnating over the last couple of years. Consequently, forget appreciation at double digit rates, a small fall from here looks a stronger possibility.

Throw equities into the mix and things get even more interesting. We think stocks are nowhere near as expensive as real estate. At current valuations, the Sensex stands at a trailing twelve month earnings of 19.6x, not far from its long-term average of 18x. At these levels, stocks have a realistic chance of going up 15% per annum over the next few years.

We recently made a claim that, if profit margins were to revert to the mean, a 70% point-to-point upside over the next two to three years would be a strong possibility.

The stage looks set for stocks to crush real estate over the medium to long term.

Even if you are in audience number one and have benefited from real estate appreciation over the last few years, it wouldn't be a bad idea to lighten up a bit on real estate and move into stocks.

We are no enemies of real estate. As an asset class, real estate has earned fabulous returns for investors in India. However, we seriously doubt it will be able to beat stocks over the next five years.

What do you think? Do you think stocks will comfortably beat real estate over the medium to long term period of say five years? Let us know your comments or share your views in the Equitymaster Club.

2.35 Chart of the day

You might have an inkling of how public sector banks have not been doing well in these sluggish economic times. But today's chart of the day shows that the problem is structural not cyclical, and a big one at that. For there is large difference in the proportion of public sector bank loans that have gone bad when compared to their private sector banks. And this difference has only widened in recent times.

The consistency and magnitude of the difference points to a big deficiency in the way public banks are judging the credit worthiness of their borrowers. This can be very dangerous on a systemic level. This is because banks operate on a very high amount of leverage. This leverage means that any deterioration in asset profile can a have an enormous effect on a bank's capital and solvency. And if weak lending is a problem affecting such a large portion of our banking system, it is indeed a cause for a lot of concern.

In a recent issue, we wrote to you about how the systemic risk of several Indian PSU banks wiping off billions of rupees of tax payer money is bigger than it is made out to be. The government squanders billions providing capital to these entities year after year. The RBI too will possibly do its bit and infuse liquidity again and again through various versions of QE Lite.

As a result, PSU banks will have very little incentive to put their house in order. Chasing Vijay Mallya can't be the solution. Banks need to be accountable to minority shareholders, depositors, and taxpayers for every additional rupee that they get from the RBI and government. Without that, the entire system is at peril.

Huge difference in lending prudence at public versus private banks


3.40

The only constant is change, they say. Perhaps there is a new constant: even faster change. Especially in the world of business.

Business daily MintI recently carried an interesting article about how the list of the top fifteen business groups in India has changed since the 1970s. Eight of these large business groups that were part of this list in 1970 made it through to the list in 1990. However from 1990 to now, only five groups have made it through. Looking the breath-taking pace at which things are now moving in the business world, this number may go down even further.

Nonetheless, some noteworthy names that have made it through the entire period from 1970 are the Tata group, Birla group, Mahindra & Mahindra and L&T.

4.15

Tomorrow is D-day, the 22 April 2016. By now you know that we will be celebrating our 20th anniversary. It is a time of ruminations and on this occasion we'd love to hear from you. In case you wish to share your experience with Equitymaster or read what some of our valued long time subscribers have to say about us, please do so here.

Here's what Ravi Bommakanti, Equitymaster Wealth Alliance Member and a subscriber since 2011, from Hyderabad had to say about his experience with Equitymaster:

  • Congratulations on completing 20 years. I admire and value your unbiased, objective, rational and long term approach to stocks based on solid fundamental analysis. I especially like your Warren Buffet type thinking and following his ideas.

    I am especially delighted that you have said NO to several IPOs that looked glamorous. Your rigorous analysis is the right approach and I hope you maintain the same approach. We would like to invest for the long term in solid, proven businesses with competitive advantage. We look to you for guidance in this.
4.45

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 122 points. Gains were largely seen in banking and energy stocks.

4.56 Investment mantra of the day

"With every new wave of optimism or pessimism, we are ready to abandon history and time-tested principles, but we cling tenaciously and unquestioningly to our prejudices." - Benjamin Graham

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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7 Responses to "Stocks Can Crush Real Estate Over the Next 3-5 Years"

SS

Apr 28, 2016

Real Estate prices have had a meteoric rise since 2006 with a major correction during the recession of 2008/09. The prices can be attributed to the fact that Residential or Housing has become like Gold. Housing is no more just a necessity but it has become an asset class which people want to hoard and then sell when the prices appreciate. Today only people with high salaries are able to buy, a clear sign of Crony Capitalism.

Builders like any other businessman are greedy and hence keep increasing the prices and then you always have gullible or even foolish buyers who get conned into buying at higher prices till it reaches a point when most of the people are not able to afford resulting in stagnation.

Its high time, the Govt. makes it a rule to restrict ownership of residential units only for self use and discourage speculation. If the Govt. wants Homes for all, people who have more than one house, need to pay be taxed heavily and should not be allowed any tax exemptions for home loan interest.

Like 

KD

Apr 25, 2016

I think, one should invest in the sector that is counter cyclical to real estate. Which sectors so you think is counter cyclical to real estate?

Like 

yogendra pal singh sirohi

Apr 23, 2016

Sir,
Black Money ,with in country and stashed abroad will play key role. Government has failed to control Black economy.Article has ignored the impact. Wait & watch.
y.p. singh

Like 

VINAY RANE

Apr 21, 2016

Sir,

I agree with you and it was my assumption also to my friends.
Nothing can go straight in one direction for a long time. There will be a curve at some time of the journey. I endorse your views.

Like 

Surendra G

Apr 21, 2016

Having a home is everyone's need and it keeps up the demand for real estate. As an investment it is not Rosy at the prevailing prices.

Like (1)

diwakar

Apr 21, 2016

Real estate prices are directly related to population growth and urbanisation. India has growing population and urbanisation is on rise. So demand for homes is bound to increase.

Like (2)

DWARAKANATH VALLAM

Apr 21, 2016

A very sensible prediction about the prospects of higher earnings from Real estate investment vs. equity investment. It is common knowledge that real estate prices have gone up due to people movementfrom their original location to a possibly more opportunity available location. once this becomes sizable then there will be spurt in demand for permanent settlement in new location which in turn pushes locals to sell and migrant people purchase.
Now with every town/state being given opportunity to develop and funds are being made available under strictly controlled plans with either centre or state, migration will significantly reduce and hence demand by 'other' people will reduce and hence real estate prices likely to stagnate or even go downwards ( due to lack of demand).Equity or stocks on the other hand will move upwards due to spread of demand across states and also increase in spending is possible due to improvement in disposable income. Here equity definitely scores over real estate.

Like (2)
  
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