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The UnReal State of India's Real Estate

Apr 11, 2016


Over the weekend a friend called and we talked about an interesting conversation he had with his landlord.

My friend's landlord is a successful corporate executive and doesn't live in the same city as my friend does. The landlord had bought the flat that my friend currently lives in, sometime in late 2004.

At that point of time he had paid around Rs 18 lakhs for it. This is what my friend could gather from the conversation with his landlord. The flat is currently worth close to Rs 1.3 crore.

In a period of close to 12 years, the market value of the flat has gone up more than seven times. And this is where things get interesting.

My friend currently pays a rent of around Rs 27,000 per month or Rs 3.24 lakh per year for this flat. The rental yield works out to around 2.5%. Rental yield is obtained by dividing the annual rent by the current market price of the flat.

The question is why would someone want to continue owning an asset which generates a return of 2.5% per year. The interest rate offered on money kept in savings bank account is at least 4%.

So the point is when you can earn a minimum 4% fixed return with none of the headaches that come with owning real estate, why would you choose to earn 2.5%? Also, the actual rental yield is lower than 2.5%, given that a certain amount of maintenance has to be paid to the building society every month.

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Then there is the cost of maintaining the flat. Further, property tax also needs to be paid every year. In this scenario it makes perfect sense to sell the flat and invest the money in bank fixed deposits, which currently pay around 7-8% per year.

I put this thought across to my friend and who in turn spoke to his landlord. And the answer he got was very interesting.

The landlord told my friend that his rental yield was 18%. It took me a while to understand how he came around to this number. He was calculating the rental yield on the original price that he had paid for the flat.

A rent of Rs 3.24 lakh on a purchase price of Rs 18 lakh works out to a yield of 18%. While, this is totally wrong, but this is the way my friend's landlord is currently thinking. He thinks he is earning 18% from his flat and won't sell.

But he can sell the flat, pay tax on the indexed capital gains and invest the remaining amount in a fixed deposit and earn much more than Rs 3.24 lakh he is currently earning. Over and above this, this investment comes with none of the headaches of owning real estate.

This is not exactly rocket science. It is simple mathematics. So what exactly is preventing my friend's landlord from selling out? One answer could be tax deduction on the interest payment of the home loan that he had taken in order to buy the house.

But given that the loan is in its twelfth year of repayment, the interest component will be quite small in comparison to the landlord's current income and really not worth the trouble.

So what gives? The landlord is totally anchored into the price appreciation that has happened till date. His investment has increased in value from Rs 18 lakh to Rs 1.3 crore in a period of over 11 years.

And this is something that is stuck in the landlord's mind. Before I go any further, it is important that I explain the term anchoring here. As Garly Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes and How to Correct Them: "Anchoring is really just a metaphoric term to explain the tendency we all have of latching on to an idea or fact and using it as a reference point for future decisions. Anchoring can be particularly powerful because you often have no idea that such a phenomenon is affecting you."

This applies in case of my friend's landlord. He has seen the price of the appreciate from Rs 18 lakh to Rs 1.3 crore and has a strong belief that the appreciation will continue. In the process he has held on to this flat. He is anchored into that belief.

Is a similar sort of increase possible? It would mean that the price of the flat would be more than Rs 9 crore (Rs 1.3 crore x seven times) eleven years from now. That is totally unbelievable.

Also, the real estate prices haven't gone anywhere over the last few years. Most people don't take that into account. The money illusion is at work. As Belsky and Gilovich write: "This involves a confusion between "nominal" changes in money and "real" changes that reflect inflation."

Real estate prices have remained flat across large parts of the country over the last few years. The average rate of inflation between 2012 and now has been around 7-8%. Once we factor this into account, the real estate prices have actually come down by a reasonable amount in real terms.

Again, this is something that my friend's landlord in particular and most other real estate owners in general don't seem to understand. It will take some time for these people to realise this. Plus, there is always the bit about owning something you can see and feel, which always works with owning real estate. This obviously does not apply to financial investments.

Further, with a huge amount of unsold inventory of real estate companies, as well as homes that have been built and bought as an investment, in the market, real estate is not going to match the returns that it gave between 2002 and 2012. Those days are long gone. Also, it has just become way too expensive.

Of course, people take years to come around to realising that they have been wrong for a long time. Mistakes are not easy to admit and this time will be no different. Until then, the stagnation in the real estate sector will continue.

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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28 Responses to "The UnReal State of India's Real Estate"


May 4, 2016

I don't agree to this article. I understand that the property price would not zoom to 9 crores in next 7 years, but in next 7 years there are high chances that it might reach 2 crores. On top of that this individual would have earned close to 35 lakhs in rental (provided rent is increased 10% every 2 years).

Which means the total value of this property would be 2.35 crores which is a good enough return on 18 lakhs rupees in 14 years (peace of mind plus rental income secured). Economy never remains a same, whenever property is back in demand which it will be because of India's rising population and economy this location would fetch a huge premium. Instead of FD which would give a 7% return every year, and that too with TDS on the interest.



Apr 16, 2016

I agree with this article. Most people will not agree because a real crash like in America has not happened here. In the coming years a lot of factor will come into play. Main thing is affordability. The last boom in real estate came due to IT industry. At the current rates, for any new purchases, both the spouses need to work and one of them need to pay for the EMI. It is beyond reach for a lot of people even in IT now. We are looking at the saturation of salaries even in IT industry. Until the next boom happens which pushes the salaries to the next levels, price appreciation in real estate cannot keep up the pace year after year. After years of substantial gains, thinking that from now on, it will atleast keep up with the inflation rate is just that, wishful thinking. There needs to be a quick hard landing or at the very minimum a soft landing. This would mean the next 5-10 years would provide very less value for any new investments on real estate. If the black money curtailment happens sincerely then real estate will not hold water. But holding what you have might still make sense unless you have the financial acumen or wherewithal to redeploy your sale proceeds. New investments may not be a good idea compared to even term deposits for now.

Like (1)

Ullas Sharma

Apr 15, 2016

If people invest for real long term (say 20 - 30 years), then, apart from the yearly rental yield, you also get good capital appreciation. Hence, for long term, the arguments given in this article do not hold. The stagnant market for a few years would not matter in the long term. Also, the rents keep pace with the inflation so it can be a nice source of "pension" that adjusts with inflation while capital value also increases in the long term.

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Apr 13, 2016


Like (1)


Apr 12, 2016

Nice article. Many people foolishly believe that they can never go wrong with real estate. I booked a flat for around Rs 975 a sq foot in Pune in 2002. One and a half year before that prices were booming and my neighbors had booked a mirror copy of my flat for Rs 1500 a sq foot. My friends don't believe me when I tell them this story but it is true.

I had also warned a friend about gold when he was trying to enter in the bull market when gold as hitting record highs. His answer was, "Has gold ever gone down?" And pat a few years later gold is down around 30% from the highs.

People do not understand the simple concept that what goes up can come down. Real estate hasn't corrected in India for a while but that doesn't mean it can't happen. For those believing the wise guy must hold on to his Rs 1.3cr property in the hope that it goes to Rs 2cr and more, don't realize that it can easily come down to Rs 1cr and he can lose around 30% straight. :)

Like (1)

A C Dubey

Apr 12, 2016

Nice article "The UnReal State of India's Real Estate". We shall appreciate if you include a portion regarding cycles of boom and bust in property prices. Also the future direction and impact on real estate prices of declining interest rates and low levels of inflation. People generally hold on to real estate with an expectation based on past experiences that real estate prices will rise sharply during the next boom.

Like (1)

Rajesh Kusumwal

Apr 12, 2016

Some how, I feel siding with the landlord of your friend. Other things being equal, the value of the real estate should appreciate in line with the rate of inflation. Add to that 2.5% rent. So holding on to the flat is a good hedge against inflation.

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Apr 11, 2016

Very nice article. Explained in a simple way. Kudos to the author.

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Apr 11, 2016

The point that has been brought out is perfect. Sometimes attachment to sentiments anchors us around not realising the economic reality taking into account the opportunity loss. This is exactly the case with me too since I am not taking a decision despite the fact that a property bought for Rs.18 lakhs is now worth Rs.90.00 lakhs. Since the property is in a prestigious community. I am anchored. While my Tamilian Friend made good money. To get out one should shelve the sentiments. I am waiting for the day.

Like (2)

ameet parekh

Apr 11, 2016

dear vivek sir, making money and taking care of it are 2 different things.The landlord is right according to me.He made an investment at the right time-is holding it till date insuring that his 18 lac and the present market value of 1.3 cr are safe in his custody instead of putting it in indian banks which are bankrupt.Also he does not have the Income tax department sending him notices after he sells.The middle class always gets IT notice and the big business guys get away with anything without paying their debts.Multiplying money consistently is very difficult and who knows for a rainy day this property would bail him out.So many people make money but squander it away by investing in the next hot investing theme.The landlord knows he is lucky with this investment and rightly so does not to try anything "NEW"

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