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 back..now 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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