Is real estate investment judicious?

Indians traditionally have had a high affinity for tangible assets and this shows in the way we accumulate gold and other precious metals or jewellery.

The indian ethos of having ‘Roti, Kapda and Makaan’ is fundamental to the way we people think of life, and this has resulted in a residential house to be considered almost mandatory from a security point of view.

While owning the first house has a sentimental value for most as much as a security, it is an investment in the future which is often a necessity. Plus it offers some lucrative tax benefits which can be availed by the owners.

But purely from a returns on investment perspective does additional real estate really make sense in your portfolio?

Broadly, the returns will be of 2 types-

The more significant ones which most investors look for is capital appreciation.

Rentals are the second important source of revenue here.

The investment in real estate could span across land, farms, residential house, apartment/villas, commercial property to name a few.

Real estate however has some peculiar characteristics making it an extremely difficult decision on choosing where to invest, some of which are-

1. Very area specific

Unlike other investments which have a uniform binding across the country, real estate prices are very skewed between different towns and often within pockets of the same town as well, thereby making it a very time consuming process to select the right place to invest in.

2. No clear pricing policy

It is almost impossible for an investor to know the actual worth of a property or project and at best it can be determined by using guidance values, enquiring in the market and through brokers, who often have a clash of financial interest with the clients. So judging whether you are over paying for a project or have entered at the right price will always be a nightmare.

3. Very low transparency

If it is a constructed property you are looking at, there is scope for a lot of ambiguity from the builders end. This includes the time to complete the project, the tranches of payment and the quality of the construction. Too often have we seen the residents of an apartment struggling with some of the facilities provided within few years of occupancy but with little legal remedy against the builder.

To add to it, we still hear of cases where part of the dealings are done off the books which adds to the opacity while also risking the wrath of the taxman.

4. Tedious paperwork

The paperwork involved in a real estate investment is significantly higher than any other medium, and has a lot of legality to be looked through and registrations to be done. Plus expenses on registration and taxes also are a significant outflow.

And we are not even getting into the nightmarish prospect of getting into a legal tangle over property which is not uncommon in India and can lead to massive financial and time losses in court proceedings and are a real hassle.

5. Extremely poor liquidity

Once an investment has been made in real estate and any liquidity requirement comes up, it has to be exited in full, and the market may not be ripe at all times to make a profitable exit. Any notional returns made in the property are also only on book till such a time that the entire project is sold off to realise the funds.

6. Cyclical business

It is the one investment which has made some people millionaires and billionaires in a very short span of time, however there is certainly a very high level of volatility. There have been periods spanning across years where real estate has also gone through a lean patch and where investors have not made any returns whatsoever, at times struggling to realize the principal amount as well. And in many cases real estate purchase is leveraged through loans which adds to the burden of repayment with no real returns.

7. Huge investment

It is basically a supply-demand factor and the price of real estate in the longer run has only one way to go - upwards.

This has however meant the average entry level investments in good real estate prospects has also been going up with time and it always means putting out a large sum of money towards this investment. It may affect the diversification of client’s by leaving less funds to be channeled into other sources.

8. Low rental ROI

In comparison with the investments being made, the rentals as a percentage are nominal. While commercial properties in growing towns can offer good rentals, but still as a return in investment it is normally seen in the range of 3-6% which normally doesn’t even beet inflation, so the real returns are only in capital appreciation unfortunately a lot of which customers don’t realise, because the idea of a property is to hold o to it and very few are able to trade regularly and make money out of it.

Don’t get me wrong, I’m certainly not against real estate and my family personally has also made money through investing in properties. However given its very distinct characteristics, I do feel an investor needs to give due consideration to all factors and avoid over investing in real estate, but rather diversify across various asset classes for a more well balanced portfolio.