Ladder 7 Financial Advisories offers financial planning services to individuals to achieve their life goals.
A holistic plan is drawn up after understanding the income/ expense pattern, past investments, their specific situation, the time horizon, risk appetite etc. Tax, Estate, risk management issues are looked into and built into the plan. In short, this is a complete plan which is focused on achieving the clients’ goals in the best way possible.
16 January, 2017
Real Estate – The Real story
Picture Credit - www.Pixabay.com
Everyone likes property. It’s tangible; it’s easy to relate to & understand; we have been buying property since the simians evolved into humans – the early properties might have been caves and dugouts!
From times immemorial, properties have been one of the treasured assets. Wars were fought to acquire territory. The only other two things for which wars were fought were women & wealth!
Cut to the present, the war begins on servicing the EMI – for decades on end. Those who finish the loan fast display masochistic tendencies and take another loan!
The lure of property goes back to antiquity – but it’s tug is undiminished. In fact millions of people believe that property is the only one that can give great returns. We all hear about something bought in 1960 for Rs.40,000, now going for Rs.15 Crores… where everything is a profit, that looks stunning, eye-popping!
Fooled by absolute numbers - Rs.15 Crores is a fabulous amount of money. It has multiplied by 375 times! It almost looks like God has picked that one person for special, A Grade treatment.
But to get to that Rs.15 Crores, one should have held on to the property for 57 years –which may happen with property and not in many other assets. But even if this has happened, the compounded annual returns are just under 11%! Now, that does not look so appealing, does it? It no longer appears that God has showered his munificence singularly on that investor. Stock markets have offered a compounded 16%+ annual returns in the last 36 years.
We don’t count the costs… - There are so many costs in holding properties. The most important cost is the interest one would be paying. Suppose, one is buying a home today for Rs.1 Crore & one is paying Rs.25 Lakhs upfront & balance is taken as a loan for a 20 year period at 9% interest. the total repayment as EMI ( principal + interest ) would be Rs.1.62 Crores. The total cost of the home is hence Rs.1.87 Crores.
During the tenure, there are many other costs. Invariably there are repairs and improvement costs, which could run to tens of lakhs of Rupees, which we need to factor in. There are also society maintenance & property taxes, which we need to factor in as well. If all these costs are factored in, the returns may drop much lower, to single digits.
We don’t factor the efforts involved - There is not much bother in a financial asset – be it a FD, NCD, Bond, Mutual Fund or anything else. You just hold the asset & get regular returns, as per the asset type - which gets directly credited to the bank. In property, rents have to be collected, property maintained, society charges paid, interface with brokers, deal with tenants & in rare cases even be involved in litigation. Also, there are periods of vacancy that depress the returns, which needs to be factored in. Property atrophies if kept under lock & key, unlike financial assets. Hence, if property is acquired for investment purposes, one needs to consider all these as well.
Taxation on Sale - Properties when liquidated are subject to long-term capital gains tax ( after three years ). Hence, it is not that the entire proceeds are available. One needs to pay the tax and then take home the balance. In this Rs.15 Crore example, almost the entire amount will be long-term capital gain and will be taxed at 20% ( would come to Rs.3 Crores! ). To avoid this one can invest the entire Long-term capital gain amount ( which in this case is the full proceeds ) into another property. That beats the purpose of an investment in the first place, as if one has to reinvest, one cannot realize the cash value.
The albatross around the neck - Properties are high value transactions, which needs long-term servicing of loans. It is hence prudent to take loans to the extent that one can service comfortably. Many people take loans in a way that both husband & wife need to work necessarily, if they have to be able to service loans.
In such cases, it puts huge pressure & leaves no leeway for one person to drop out to raise a family or for health reasons. If there is a job loss, again there is a problem. Some have bought multiple properties & are servicing multiple loans, which builds a pressure cooker situation.
Under-construction property can pose huge problems for people. On one hand, they may be paying rent & they may also be servicing an EMI on the property they have booked, which makes it a double whammy. Now, if the property keeps getting delayed, they would simply be paying unnecessary extra interest, on their borrowed amount. If there are multiple properties, the problems compound manifold. Some properties are stuck in litigation and takes a long time to complete. Some are stuck in limbo forever and the money is as good as gone.
Property a bane for those on the move - Today, most upwardly mobile people would be willing to go where their career takes them. That means, they may be in Mumbai now, may move to Bangalore a couple of years down the line, or relocate to Delhi in future if their career parachutes them there. If they buy property in one city, there is a good chance that they may move to another city & stay on rent, while servicing loans of the property they have bought earlier. We have seen too many people like these. The best option for these people is to live on rent, which is available cheap in India ( read next point ).
Returns on investments – Property does not offer great returns – especially residential property – which may offer 2-3% gross returns on the current property value. After taking into account the property taxes, society charges, brokers fees, repairs, wealth tax etc., the returns are just 1-2%. Commercial properties may offer between 6-8% gross returns. But again, after accounting for all expenses, the returns may be more like 4-5%. The important error which people make is that they calculate returns on their cost & not on current price ( which is the opportunity cost ).
If you cannot sell a property, it is a FD yielding 2% returns
The menace of cash - Property transactions are prone to cash dealings. Many people who are salaried are forced to convert their tax paid money into cash for property transactions. Property is the biggest sink for black money & slush money.
While it is illegitimate & unethical to deal thus, there are more practical problems people would need to grapple with. When selling a property, there is invariably some cash which one gets. A normal person has no means to even know if the cash they get is in legitimate notes or spurious ones. If they are spurious & it is reported, a person can be arrested & questioned about the source. That will mean a lot of trouble.
Concentration Risk - Investing a couple of crores in a property is a huge concentration risk. If the area does not develop as envisaged, the property prices would not go up as anticipated. This would affect the entire investment. Had it been a financial asset, the investments can be distributed and hence one can attain diversification of the investments. If some components do not do well, it will not mar the returns from the entire portfolio.
Epilogue - Since 2011-12, the properties have not been doing well. They have been giving poor returns ( Bangalore ) in a lot of places and even negative returns in some cities ( Hyderabad ). In the past two years, property prices have come down almost across the board, all over the country. Most people who want to sell are not able to find buyers. Builders are offering various sops, which ineffect offers discounts from 5% to 20%. Apart from this, there have been actual drop in property values across properties in various locations throughout the country. Due to the base effect, property prices are expected to offer average returns ( single digits ) in the foreseeable future ( say a 10 year period ).
However, this is a great time for actual consumers who would like to buy property for self-consumption. There is a case of investing in property after investigating all aspects properly! Those wanting to invest in property should invest to diversify their wealth, not in quest of super normal returns, seeking their Eldorado!