Real Estate Investment: High Capital, Low Return



Mark Twine had once said, “buy land, they are not making it anymore”. Through his witty remark, Mr Twine conveyed one of the most important secrets of investment — scarcity accelerates demand. We have reached a point, at least in the urban regions, where we are facing a serious shortage of land for residential purpose. That is one of the reasons that our cities are expanding so rapidly. There are many people pouring into cities every day and there is less urban and residential infrastructure to accommodate them. This disparity in demand-supply has triggered the property rates to shoot upward in most of the big cities and the small towns have been quick to follow the suit.

As real estate sector is capable of such dramatic price movements, it has been a favourite investment avenue for ages. There is little doubt that investment in real estate if done at a fair valuation, can bring handsome returns. Having said that, if you are looking at real estate in 2018, then it will be advisable to check other investment options like equity and mutual fund which promise better returns by employing less capital.

Real Estate Investment Is Good Because:

Real Estate Is A Safe Investment - Real is a traditional investment class. It enjoys the tag of 'safe investment' like gold. While you are investing in gold, it is considered, that the value of gold will not fall beyond a point. This theory holds true in real estate, too. A look at the graph of real estate prices will show that it always trend upward. Of course, there are phases where the prices go through a certain consolidation, but slowly and steadily the prices of real estate always go higher.

Property Rent: Recurring Income - One of the greatest incentives of real estate investment is that when you buy a home or a shop you can let it on rent until the time the prices of the property reach the point where you want to sell it. The recurring income that you get as rent is like a dividend on your investment. You get the opportunity to invest this income in productive investment instruments like mutual fund through SIP. Moreover, when you let out a property on rent you also get a lump sum deposit amount (usually a rent of few months) from the tenant. As the deposit is refundable, you can invest it in stocks or fixed deposit and get additional income until the time you hold it.

Real Estate Investment Is Bad Investment Because:

Real Investment Is Highly Expensive — It goes without saying that to invest in real estate you need to have big money. Buying a shop or a house can cost approximately from Rs.8-10 lakh and the price tag can go up to any level as there is no upper cap. Furthermore, when you purchase a home in a developed neighbourhood, it will be expensive and will make the return on your investment low as the rates of that locality must have already reached the saturation point. Real estate is an expensive business unlike equity and mutual fund investment where you can start investing with as low as Rs.500. Even the old investment medium like gold is cheaper to invest in.

Real Estate Market Is Illiquid — The easy availability of buyers and sellers means liquidity of the market. The real estate market is known to be highly illiquid most of the time. This state is not because there is a lack of buying intent or ability or availability of funds but only because of the complicated nature of real estate trades.

Let me illustrate this point with an example. If you want to sell a house property you had bought as an investment, you will have to publish an ad in a newspaper on a real estate portal or you will have to hire a broker. Then interested parties come to see the property and take a long time to reply. Thereafter, there are numerous rounds of negotiations about rates. While this going on, there is always a possibility of a deal not working out at any stage. Similarly, the journey of buyers is equally tiresome. All this goes on to show that that the real estate market is highly illiquid.

Can Equity Outperform Real Estate?

Before comparing real estate with other investment instruments like equity and mutual fund, we have to understand whether returns on real estate can be any match to equity.

To illustrate this point there is a popular story of Rakesh Jhunjhunwala. It will correctly place the difference between equity and real estate.

Ace investor Rakesh Jhunjhunwala was considering the idea of buying a new home in 2005. He found a promising prospect in the posh suburb of Malabar Hill, Mumbai. The price of the home he had zeroed in on was Rs.27 Cr. To buy this home Jhunjhunwala sold some of his shares in Crisil.

Jhunjhunwala had been holding the shares of Crisil, a rating agency, for a long time. You may ask - so what's a big deal in that? He wanted to buy a home so sold his shares. The big deal happened a few years later. The stake that Jhunjhunwala sold in Crisil went on to become a multi bagger stock. The value of the stake he sold for Rs.27 Cr was approximately worth Rs.700 Cr in 2015.

In 2018, let's see where his real estate investment stands. Let's assume the property appreciated 200% (It's virtually impossible, though) which will make its value Rs.81 Cr. Still, against the blistering performance of Crisil, we can say that Jhunjhunwala lost around Rs.619 Cr. That's a big deal!

This story is a defining example of the power of equity.