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Some New Old Lessons in Real Estate

Aug 2, 2016

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Yesterday (August 1, 2016), the Mumbai edition of The Times of India had a very interesting piece of news.

A bungalow on Nepean Sea Road (one of the poshest areas in South Mumbai), built in 1904, is on sale. The bungalow was last sold in 1917, for a little over Rs 1 lakh. In the recent past, similar properties in vicinity have been sold for Rs 400 crore, or so reports The Times of India.

Imagine, something bought for something as little as Rs 1 lakh being sold for Rs 400 crore. That is exactly what I was told by a friend who called me after he read the news. "See, this is why I keep saying property is the best form of investment. Nothing beats it," he said. "Such huge returns make real estate such a fantastic form of investment," he added for good measure.

I was groggy having just woken up, so just heard him out.

A little while later having read the news, I figured out that my friend had fallen for what I call the fallacy of absolute numbers in real estate.

The trouble is that whenever real estate is sold, we tend to look at absolute numbers. "You know, my grandfather bought this house a long time back for a few lakhs and now it's worth a few crores." That kind of stuff.

No one bothers to calculate the real rate of return. We just look at absolute numbers and conclude that real estate is a fantastic form of investment. But that is not the right way.

Let's look at the Nepean Sea Road bungalow with which I started this piece. It was a bought for around Rs 1 lakh and is now worth Rs 400 crore. The value has gone up by around 40,000 times in 99 years. Doesn't that sound fantastic? It surely does.

Nevertheless, what is the rate of return? The rate of return is 11.3 per cent per year. Over a period of 100 years, a return of 11.3 per cent per year, is very good. But a return of 11.3 per cent per year, sounds nowhere as sexy as the value of the bungalow going up by 40,000 times.

But they are one and the same thing. Further, in an Indian case, comparisons cannot be made, given that data for other forms of investment for such a long period of time, are simply not available.

Also, the question is would you buy real estate now, if it promises you a rate of return of 11.3 per cent per year, over a period of time? In most cases, the answer will definitely be no, given the hassles that come with owning real estate.

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Also, there are other mistakes that are made while evaluating real estate returns. Over a period of 100 years a lot of money would have gone into maintaining the house as well as paying those who maintain it. Further, property taxes would have been paid as well. Given that, such expenditure is regular in nature, nobody keeps a record of it, and hence, is not taken into account while calculating the rate of return on a property. This is a basic mistake that keeps getting made all the time.

Also, most people while selling property tend to deal in black and hence, they don't take into account the fact that a tax needs to be paid on a house being sold. Real estate returns are not tax-free though you can take inflation into account while determining the cost of purchase of a house.

Once we take these factors into account, the real rate of return on property can rarely be calculated and given this people tend to go with absolute numbers. And when we look at absolute numbers it is easy to come to the conclusion that property is the best form of investing.

In this particular case one needs to take into account the fact that the property is based on the Nepean Sea Road, one of the toniest neighbourhoods in Mumbai as well as India. Hence, there will be some premium for it.

Similar properties in not so tony neighbourhoods would not have given this kind of return.

In the India that we live in, there is a danger of the builder disappearing, and the home being built not being delivered. In that situation you will have to continue to pay the rent of the home that you are living in, along with the EMI on the home loan that you have taken in order to buy the house.

If you haven't taken on a home loan, then your savings are stuck in an asset that isn't giving you any return really.

More than the money, the stress that comes with an uncompleted home and the builder disappearing with the money, is extremely huge. I have seen a number of such examples among my friends and family, and believe me it's simply not worth the trouble. It's amazing to see so many builders get away after not delivering homes on time. There are those who disappear with the money as well. It's still more amazing to see people believing homes are the best investment.

Another factor that most people don't realise while buying property as an investment is that the timing the investment is very important. If you had bought property any time during the period 2002 and 2009, and sold it by now, you would have made good money. There is no doubt about it.

But if you had bought property post 2010 onwards, and if you take into account, the cost of maintenance (which needs to be paid every month in most building societies these days), property tax, EMI interest, or loss of interest on the amount invested in the property, etc., chances are your returns would be in single digit territory. In many cases, the returns will be flat. And if you start taking inflation into account, then the value of the home, would have actually gone down in real terms.

But the human brain is not used to dealing with so many factors at the same time. In the simplistic world of the human brain, investing in property continues to be a good form of investing and will continue to be so because it tends to look at absolute numbers and not the real returns.

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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11 Responses to "Some New Old Lessons in Real Estate"

Girish Sidana

Aug 22, 2016

So many responses in favour of real estate captures the Indian mindset perfectly. The most difficult thing in marketing is changing the consumer perception. Perceptions are made through generations and not so easy to change by few knowledge articles.

I would also like to comment on Niranjan's strong views. Since he is associated with this business, he just not wants to hear anything against it. There is a big difference between Real Estate and apartments being sold by builders. Apartments are a packaged products with practically no intrinsic value. It is like the difference between Gold and Jewelry.

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Niranjan

Aug 5, 2016

Firstly, I am a Real Estate Investor myself. This article is typical of the technique of choosing an asset class, deciding what one wants to do with it - promote it or pan it and finding hazaar points to prove what you have already decided the end result should be.

In the above example, it is obvious that the investment is spread out over 3 generations - so, practically, if say, I inherited a house worth 400 cr, does anyone think that I will be sitting down and saying - what a stupid person my grandfather was, he got only 11.3% return and he should have considered that there are so many builders who cheat their clients and yes, I may have to pay a lot for maintenance of this property, etc, etc.!!!

What Mr.Kaul is not talking about is what he thinks is a 'great' investment. Being sponsored by Equitymaster, I have a feeling that his 'ideal' investment would be equities - in fact, going through his archived articles, I didn't find any that show the negative side of stocks. But then he would be ignore things like front running, market manipulation, high speed trading, circular trading, rigging by 'market makers', etc, etc.

Mr.Kaul always makes it a point to inform his readers about the builders that have inordinately delayed or have run away with their investor's money. But being a so called 'economist', he doesn't serve up any statistics showing the ratio between total flats that were not delivered to the total flats that were delivered (even if it was a bit late). That would make for an eyeopener. In the 15 years or so that we have been investing in real estate, there has been no case of the builder not delivering. Of course there have been delays - sometimes it was because the builder was greedy and sometimes it was because the govt. changed rules halfway, but there was always a way to work through the problem and the delivery was done.


Every investment has its characteristics - there are positive and negative sides to every investment. A good 'advisor' highlights both sides of the coin and lets the investor take a call whether he is okay with the risks involved. I hope Mr.Kaul takes a more balanced approach in the future.

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arun Prabhu

Aug 3, 2016

Dear sir,
you have taken into account taxes and maintenance but not taken into account the 3 to 4 percent rental yield.

if you add 3 to 4 percent rental yeild to 11.3 percent it is about 15 percent over a period of 99 years

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Ramana

Aug 2, 2016

Hai Vivek,
I am a regular reader of You. I think the title is misleading realestate means buying a house I dont know? If i am wrong please mail me.
regards
Ramana

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Mohan

Aug 2, 2016

You have conveniently forgotten to add the additional yearly rental income at 4% , which would have increased the return to more than 15 % CAGR. As long as black money exists real estate especially land will be the asset which gives best return. Other assets such as gold, equity or debt cannot beat real estate. The Nifty is presently overvalued and still the Nifty returns are lesser than that of real estate.

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P V Samuel

Aug 2, 2016

Mr. Vivek,
You are thoroughly wrong on the assumptions and conclusion with reg. to the property. I know that every property does not appreciate like the Napean Sea property. But, it is one asset where you eat the cake and have it too. You stay all these years in such a tony place and yet reap the high return.
Alternatively, had it been let out, you get regular rental income from which you pay taxes, maintenance and still be left with good return, even after paying taxes which is applicable in many other cases like bank deposit, etc. Of course, I do not dispute the fact that real estate is not the only such valuable asset.
Well, I am a regular reader of your penetrating and though provoking analytical articles on economic issues. They are very good and I save them in a folder.
Pl. continue to engage your readers, as you do.
Regards

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Arun Sardessai

Aug 2, 2016

It appears that rental income has not been taken into account in this article. Also few people pay income tax on presumptive rental income in case of vacant properties which can play a major role in real return on property.

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mukul

Aug 2, 2016

I have read a few pieces from Vivek on the mirage that is real-estate returns. OK, no serious issue with his numbers - but he misses a very serious point about real-estate vis-a-vis other investment assets. And, this was pointed out by me earlier too, but as usual, he goes on and on with his assumptions and analyses without paying any attention to critical details.

OK, the issue is - all other assets just sit there - financial assets, stocks, bonds, even gold (to some extent unless it is in the form of jewellery) - without providing any intrinsic value to investor. But, in case of real estate, you live in a house, or you rent it out. Here, Vivek conveniently sums up all the expenses relating to owning of a house but does not care to consider the very tangible benefits (apart from appreciation) - that is you enjoy living in it, and if you don't yourself live in it, you can rent it out for some income. That does not enter into his calculations ever!

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srihari V

Aug 2, 2016

I totally agree with the comments made by Vivek. Real estate may not give the real return in money terms if you factor all other conditions like spending on maintenance, EMI etc., but the positive side of it is except govt., no body can steel the property, and also as it takes time to liquidate, people will think twice before distress sale of real estate. so it helps.
also, if the head of the family, a lone earner dies due to some unfortunate accident, a house property always saves the day for the rest of the family. it gives the foundation for their new journey

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Vipul Jasani

Aug 2, 2016

Hi Vivek,

as usual excellent article.

The real estate prices are also high because of

1. Black Money involved in Real estate transaction.
2. Income Tax benefits for investors.

If these 2 things are removed (Hypothetically, in real life I do not know when??)then real rate of return may turn negative while adjusting with inflation!!!

Thanks,
Vipul.

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