How and why does a person buy an asset?

Well he sees the cost of the funds being laid out for the investing, considers the risk, then considers the cash INFLOW that is likely to come from the asset. If the NPV > 0, or in other words IRR is attractive enough, he buys the asset. Our class on investments said this is the HOW of investing.

The WHY of investing is of course, the same – to get cash flow/ appreciation much higher than the money laid out to get the asset.

Sadly this is NOT TRUE FOR MOST OF THE INVESTMENT MADE. And we have amazing rationalisations available for why this is not so.

So when a boy from a small town goes to Mumbai / Delhi for a job, his small town friends, and family are STUNNED at the CTC at which he has joined. He proudly tells his mother ‘I have a CTC of Rs. 9 Lakhs’. For most of the people this is far, far beyond comprehension. Even his parents who are working as a school teacher or a government clerk this figure is stunning. So they think he gets Rs. 9L / 12 = Rs. 75,000 per month.

So they start thinking that he has a huge surplus on a MONTHLY basis and start seeing what they can do. As they have no knowledge of ANY financial product, they turn to land. Do they know IRR? No.

However they ‘KNOW SURELY’ that land prices ONLY GO UP at a rate faster than INFLATION. Their basis for knowing this? You got to be joking. They know it, that is all.

So they go and see some land for Rs. 3 Lakhs (that is just 4 months salary is it not?). So the first investment is made – sometimes with a bank loan, most times by paying in installments. Hope fully that land will double in 10 years. That is fantastic..because the story is ‘I bought it long it has doubled’ Wow. IRR? 7% if it doubles in 10 years. It just might.

What about the Engineer who has got Rs. 10 lakhs from her dad’s Provident fund to buy a house in one of Mumbai’s extended suburbs? Well in 2007 she was looking around for a flat with a Rs. 10L down payment and a Rs. 25L Hdfc loan. Excellent, a small delay by the builder she got delivery in 2014 instead of 2012. Not too bad. Of course has been paying the EMI promptly. She said it is now DOUBLED. Her IRR is LESS THAN THE INTEREST COST THAT SHE PAID Hdfc.

But Subra Sir I am planning to give it ON RENT…She is looking for a tenant – expected rent Rs. 7k per month (quoted price). Assuming she gets a tenant for Rs. 6500 (society charges Rs. 2500 + Rs. 500 for renting it out) she will get NET rent of Rs. 3500*12 = Rs. 42,000 per annum. On the so called market price of Rs. 70,00,000 she is getting a partly 0.6% per annum.

Hey Subra you are playing with words. India is NOT A RENTAL YIELD market at all. It is an appreciation story. Sure.

If rents do not increase, but the price keeps increasing, in Economics that is called a BUBBLE. Think about it.

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  1. Shivam the English phrase is “I ran the thorn”…normally people say “the thorn pricked me”. One has to blame oneself for the thorn prick. OBVIOUSLY one did not see the thorn and hence the thorn pricked. OBVIOUSLY because there was a prick, IT MEANS there was a thorn which was NOT SEEN.

    I hope u get the drift.

  2. Subra Sir,

    I live in Thiruvanmiyur, Chennai.

    I have literally seen OMR, the IT corridor grew to the current state( I have played cricket in the waste lands of kanthanchavadi,perungudi and thorappakam ).I hear constantly people saying that how the locals have prospered. Also, hear the stories of peple who missed the bus.

    Even now, my relatives and friends are buying flats/plots around OMR, GST roads. Last month, one guy booked a flat @35 lakhs( 600 sq.ft, monthly rent around 7-10K per month) @sholinganallur. Another one bought 3-4 plots around chennai. He simply says that RE is the best and also does not know about other venues to invest.Last heard that he was planning to try his hand in currency trading, Lol…
    Whenever I say that you have to look at rental yields, they simply stare at me or ridicule me.

    For almost 20 years, nothing happened to chennai real estate market.Some price correction happened in 2007-08. May be I have to wait for another 10 or 20 years.

    God knows when things will crash ?
    May be it will not crash, giving only poor returns.

    PS: No flat/plot in chennai apart from the family-owned house.
    Sofar not succumbed to pressures from my wife and family to buy a plot in GST road.

  3. Hi,

    I think there is more to buying property than IRR. Some points i could think of:

    There is little risk of Value going to zero. (Unless its an upcoming building with un-reputed builder where there is potential of it never coming up )

    For people with minimum Financial Understanding it is an easier asset class to understand as there is a physical unit they can see.

    Practically in the long run, families expand .. from my limited experience i have seen that some how extra flats/lands get used pretty effectively.

    Also if there is a financial commitment towards any asset (property is just one of them) it forces one to save and reduce frivolous expenses.

    This is not to say its a superior asset class but that it is a serious asset class one should also work towards building

  4. Sir,

    I am observing this trend of diminishing rent yield in real estate since 2003-04. During that period, a 1 BHK in Pune costing about 6.5L used to get rent of 6000 p.m. (rent yield = 11%)
    Now that flat’s price is about 35L and rent about 9000 p.m. (rent yield = 3%).

    So, how much of yield can be considered healthy and how can we decide if the bubble is overdue (based on the rent yield)?

  5. I am not sure about flats, villas and agri land but let me tell you about residential land investment in Tier-1 city and small towns.

    In our family I was involved in 20 land transactions over a period of 10-15 years. The best case is 15X returns in 10 years and Worst case is 3X returns in 8 years.Should we not call these are multibagger investment?. None was sold in loss or had to hold up in want of buyers.

    There are somany great returns stories on property buying and selling as like equity investing. We always ignore or refuse to see the good side of our enemy.

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