There is a worrisome trend today. The trend is to take loans to acquire
properties – not just their residential home, but investment in home &
land. The current thinking with people is that property is the only asset that
will give good returns and hence investors it. One may wonder - what is so
worrisome about this? The point is that
they are going in for multiple properties, in many cases liquidating most of what
they have and taking a loan for the rest.
What we need to understand is that, it is not just property loans alone
that people may have. Most people also have vehicle loans. Some have personal
loans, credit card EMIs, consumer durable loans etc. Property loans go on for long periods and
hence has to be properly thought through, before taking it up. Also, in case of
floating rate loans, the EMIs can go up.
So, we find many people with multiple loans – their overall loan
servicing burden goes as high as even
80% of their income, in some cases. When most of the income is going to service
the EMIs, even a small increase can be very difficult to service.
The second important point that we need to realize is that no asset class,
including properties will perform forever. There is a school of thought that
property prices can never come down. Some argue that even if it comes down, it
can come down by 20-30% and not like equity shares. It is true that property
prices may not come down by a huge percentage; but properties can remain
stagnant for long periods thereby depressing returns, like it happened between
1995-2003. So, there are up and down cycles in properties as much as there are
cycles in every other asset class. Gold is another favourite. About two years
back the gold fever was at it’s peak. Again, there are those who believe Gold
cannot come down at all. Gold has performed well in the past 10 years; but if
you look at the past 30 years, the annualized returns would be in high single
digits. That too is not due to gold
returns ; it is due to rupee depreciation!
The other aspect to consider is the return on investment in properties, in
the holding period. For land, there is no return. For residential properties, the gross returns as a percentage
of the property value would be 3-4%. For commercial properties it can be double
that. If one calculates the various outgoes like society charges, property
taxes, income tax on the rent received, brokerage etc., the net in hand would
only be between 50-60% of the rental income.
So, every year one is earning only about 2% on residential property and
may be twice that for commercial properties.
One is potentially losing 5-6% in terms of returns, every year. The capital returns on the property has to
make it up.
The other cost not factored are the registration, stamp duty, brokerage
& other incidentals, which adds to the cost, but does not reflect in the
value of property. Also, during the period when one is holding the property,
the property has to be maintained, which is over and above the costs discussed
earlier. At the time of liquidating the property, one also has to pay capital
gains tax. Else, one needs to invest in Capital gain bonds ( yielding 6%
taxable return ) or buy another residence to save tax!
However, most talk of creating an asset on borrowed capital and tax
savings. One is creating an asset using
borrowed capital but is also paying interest. Only for residential
property the interest rate is benign at about 10.5% and the real cost of
borrowing can be low, if it is a second home.
In case of commercial property, the cost of capital will be atleast 3%
more than the residential home rate.
The loans taken to create such assets are longterm loans which means the
loan taker is assuming significant risk. One is making a commitment for a long
period like 20 years to acquire a property, which itself is a huge risk. What
is working for property investors are not what they think. What works is 1) people
hold property for the longterm. They don’t look at the property prices every
second day 2) consistent investments into it for years.
But, this kind of commitment would have worked well for other asset
classes as well!
What people are afraid of is volatility. They do not realize that what
they should ultimately be concerned about is returns over their holding period.
Volatility is one of the accepted parameters of measuring risk. But given a
long time horizon, volatility is less and less significant. That is, risk goes
down as time increases, as one will be able to capture both up and down cycles
that way. It will be even better, if one is investing regularly over time, as
this will further ensure that the investor participates at all levels of the
markets. Long term investment horizon
reduces risk. This is an important fact to bear in mind while investing in
assets prone to volatility & cycles. Most investors dread volatility &
end up cashing in or out at the wrong time.
A portfolio is created to offer diversification, deliver returns after
taking into account risk, liquidity, maturity profile and other considerations. No asset class will perform at all times. Only
FDs or such fixed income products can always provide a stable & positive
return. But that return, especially
post-tax, will be miniscule.
A good asset
allocation should have equity, debt, property and other assets in the required
proportion, based on the investor’s needs. Moving from one to the other, just
because one asset is performing well, will skew the portfolio as well as create
liquidity issues, tenure mismatches, tax inefficiency & other problems. Also,
timing error will come in as we may not always be able to time correctly in
terms of moving back and forth. Also, there will be costs involved and there
could be other issues like liquidity, taxation, tenure etc.
In essence, it is better to stay true to the
desired asset allocation, save for any tactical calls of a minor nature.
Article by Suresh Sadagopan Published in Business Standard
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