Real returns on realty's really not much

Apr 29, 2015

- By Vivek Kaul

Vivek Kaul
Over the last weekend I got talking to an old friend. He had bought a one BHK flat that cost around Rs 28 lakh in the Western suburbs of Mumbai sometime in 2005. He was now looking to sell that flat and move on to something bigger.

The flat was now worth close Rs 1 crore and my friend was really happy with the decision he had made. I had tried to dissuade him from buying the flat in 2005. Those were the days when I did not like any kind of loan.

Given that he was living in the flat, it turned out to be an excellent decision because real estate prices rose in the years to come. Nevertheless, from the point of view of returns how well has my friend done?

Like most other people my friend looked at the absolute return. An investment of Rs 28 lakh was now worth Rs 1 crore, is the way he saw it. But things aren't as simple as that. An investment of Rs 28 lakh, amounting to Rs 1 crore over a period of ten years essentially amounts to a return of around 14% per year.

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Nevertheless, this calculation would be a very simplistic way of looking at the entire scenario. My friend had taken on a loan of Rs 20 lakh and invested Rs 8 lakh from his own savings. When he took the home loan in 2005, the rate of interest was at 7.25% and the loan was to be repaid over a period of 20 years.

His EMI worked out to Rs 15,808. Over the years, the interest rate kept shooting up. By mid 2012, the bank was charging a rate of interest of 14.25%. The EMI had shot up to Rs 22,183. Even that was not enough. The loan tenure had shot up to 405 months from the original 240 months or 20 years.

This was primarily because even at 14.25% only a limited amount of the EMI of around Rs 120 was going towards repayment of principal. Almost all of the EMI was going towards payment of interest on the home loan. A home loan amount of Rs 18.57 lakh was still to be paid. So, over a period of more than seven years only Rs 1.43 lakh of home loan had been repaid. The rest of the EMIs paid had gone towards payment of interest on the home loan.

This is when my friend decided to rebook the home loan by paying a one time fee to the bank. The bank added this fee to the home loan outstanding, and booked a new home loan of Rs 19.29 lakh. This home loan was to be repaid by mid 2025. The rate of interest to be charged on this loan was 10.75%. The EMI worked out to Rs 23,000 per month.

As of today, my friend still owes the bank around Rs 17.1 lakh. If he were to sell the house for Rs 1 crore, this outstanding home loan amount would have to be returned to the bank. This means that effectively my friend would get around Rs 83 lakh (Rs 1 crore minus Rs 17.1 lakh) on selling the house. Once this factor is taken into account, the rate of return falls to 11.4% per year. This is much better than the returns that bank fixed deposits pay. But its not very high by any stretch of imagination. An SIP on a good equity mutual fund over the same period of time would have given higher returns.

We are not done with this as yet. We also need to take into account the interest that my friend has paid on his home loan till date. From the financial year 2014-2015, interest paid on a home loan on a self occupied flat gets a tax deduction of Rs 2 lakh. Earlier the amount used to be Rs 1.5 lakh. Even after taking this deduction into account, there has been a considerable amount of interest outflow on the home loan over the past 10 years. Once this outflow is taken into account, the return that my friend will make on selling the house falls further.

A house also needs regular upkeep especially if you are living in it. This regular upkeep also costs money, which needs to be taken into account while calculating the returns on investing in real estate.

Also, long term capital gains on real estate are taxed at the rate of 20% with indexation, which allows you to take inflation into account. Of course, given this a lot of real estate transactions happen in black.

Long story short-once these factors are taken into account, the returns from owning real estate don't seem impressive enough in the long term. Given this, why are people so convinced about the investment potential of real estate?

There are multiple answers to this question. For most Indians (and even people living in other countries) a real estate transaction is typically the biggest money transaction they carry out in their lives. Hence, there is a tendency to look at absolute numbers. A Rs 28 lakh home now valued at Rs 1 crore, sounds fantastic. But this doesn't take the time value of money and other important factors into account.

Further, making these calculations is not easy. Most people I know do not know how to calculate compounded returns, even though this is something that is taught at the middle school level. Hence, there is a tendency to look at absolute returns and feel happy about the entire thing. Also, real estate is an excellent medium of hoarding black money. And people who have black money keep tom-tomming about the investment potential of real estate all the time.

To conclude, I have only discussed one example here and many other people may have different experiences. Nevertheless, once they start taking all the factors involved in calculating returns on real estate, their real returns will come down dramatically from what they thought they would be originally. If you do own real estate as an investment, try doing this exercise. The result might just surprise you.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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30 Responses to "Real returns on realty's really not much"


May 25, 2015

Its unpredictable when it comes to real estate field.
Best Homes for Sale in Logan Utah


Dilip Coulagi

May 14, 2015

Returns on real estate are somewhat uncertain, and depend on location, pricing, how pricing moves in that particular area, and so on. A flat bought about 5 years ago in JVPD in Mumbai (Juhu area) that cost under 5 crores is today worth some 13 crores. Another bought for under 4 cr is worth around 9 over the same time span. Obviously, this kind of growth would not be seen everywhere, but it is possible in some premium areas if you are as the right place at the right time. Same with commercial space, which would produce good rent and also growth, if bought at the right place at the right price!



May 2, 2015

Dear Vivek,

Nice Column. However, I am wondering that whether you have safely ignored one glaring point. Though you have mentioned too much in detail about the big interest amount and most of the EMI going to interest payment only & the jibe about compound interest, did you really consider the point that he has only paid Rs. 8 Lakhs as his initial payment.

Just workout the real term of returns with the initial capital investment of Rs. 8 Lacs (after considering the compound interest on interest payments, tax rebates, maintenance cost of the house, tax on long term capital gains). The real term returns still works out to be phenomenal. This is in addition to almost guaranteed assurance of NIL loss, which a stock market cannot provide.



May 1, 2015

I am afraid that you have missed one important in real estate investment. What is the rent that has been saved by the investor all along? This must be substantial. Moreover share market investment is not predictable. Now the market is doing well due to Modi Factor. If the 'ache din' slogan sours due to some reason and foreign institutional investors start withdrawing their investments, the market will take a nose dive. Further not all shares are not doing well. For certain 'growers' there are lot of 'laggards'. When average yield is worked out, the situation is not that bright! Once petroleum price start raising and rupee starts depreciating, the FIIs will take to their heal quietly. Then we can see the real state of Indian Stock market. This is the best time to come out of the market. But how much percentage of the investors will be ready for that?



Apr 30, 2015

Hi Vivek

To start with, I am a regular reader and I mostly if not always read your article end to end. And so when I read this article, I thought you missed a few important points in your analysis.

Taking numbers from your article, investment amount was 8 lakhs(other amount was loan), and sale value would be 83 lakhs. Which is 10 times in 10 years. or 26.36% This is as good a return one can expect in any of the asset class.
Lets look at the other costs that you mention

1) Interest cost: A loan does come up with the interest but then one saves on the house rent, one needs to pay. A house that is worth 1 cr today, should command not less than INR 20k. lets not consider tax benefit one receives, as one also loses tax benefit by not renting a house.

2) Maintenance cost: This is a mandatory cost and one can not do without it even if living in a rented house. I have been living in a rented house and I have to spend on some or the other thing every other month.

3) Taxation on return: I have not done this myself, but as I understand this largely gets offset by the indexation as it moves along with the inflation rate or the interest rate one pays on home loan

But then all these are numbers, when one buys a house, more true for the first house, there is no price to the feeling when one lives in it. And that is the most important reason people want to buy a house, first house i.e. Of course, Second house onwards go with the calculations you and I went through.

There is another angle in buying house as investment which I have started to realize now is leasing it on rent. An example, my landlord bought this house in 10 lacs, but now earns 30k per month. This might be an extreme example, but the important point is that house rent, almost always moves with inflation and so is a good hedge against inflation.

Let me know if I missed any thing

Like (1)

Abhishek Chowdhury

Apr 30, 2015

The below analysis needs modification

"As of today, my friend still owes the bank around Rs 17.1 lakh. If he were to sell the house for Rs 1 crore, this outstanding home loan amount would have to be returned to the bank. This means that effectively my friend would get around Rs 83 lakh (Rs 1 crore minus Rs 17.1 lakh) on selling the house. Once this factor is taken into account, the rate of return falls to 11.4% per year. "

The "effective" money which your friend gets is 83 lakhs. The rate of return on the "effective" money which your friend gets should be calculated against "effective" money he put in which is the 8 lakhs downpayment. The effective rate of return comes to be 26%. Another way to look at it is before buying the house he had 8 lakhs in his savings account and now after selling it he will have 83 lakhs in his savings account. That I believe is a very good return ( a home loan is one of the safer way to use power of leverage).

Next, we do need to take into account the interest which your friend has paid till date, which will lower the return rate. But apart from the tax benefit, the interest outgo will also be nullified by the rent he saved. Average rent of a 1 BHK flat in Mumbai should be very close to the interest he paid of between 15-22K

In hindsight, if someone told me that in 2005 about this type of return, I would definitely invest my 8 lakhs on the house instead of a FD or even a NIFTY ETF.

Like (1)

Rajesh Gajabi

Apr 30, 2015

While working out the realization on the basis of loan taken, you have taken realized value as Rs. 83 lakh (after subtracting loan outstanding being repaid). That's fine. But then you should also consider investment as only Rs. 8 lakh (owner's equity) and not Rs. 28 lakh, and then calculate the returns on the same. Would appreciate your clarification. Thanks

Like (1)

Rajendra Khot

Apr 30, 2015

One thing not considered, is the rent income from flat. Considering 4% as standard rent, It works out to be Rs. 9000/- per month in 1998. Today rend would be Rs. 40,000/-. Considering simply it pay off the interest part of the Bank.
Then investment in the flat is just Rs. 8 lacs and return is Rs. 83 lacs. Then its whopping 10 times in 10 years absolute terms. CAGR returns it works out to be 26%. Then its worth investing in real estate

Like (1)

Amit Goyal

Apr 30, 2015

Dear sir,

Though I mostly agree with your argument, but...

In the scenario that you have built up his initial investment was Rs 8 Lakh and not Rs 28 Lakh. And the effect return needs to be calculated not from the purchase value of the flat but from the actual cash out flow which he has done since his date of purchase.

For a brief period of time, his return would have been equal to rate of interest. But mostly he was leveraging the banks money to get a higher return.

warm regards

Amit Goyal
Institute of Banking & Finance

Like (1)

Anadn K

Apr 30, 2015

Very good article Sir. I 100% agree with you.

Like (1)
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